Seagate Technology (Nasdaq: STX ) did indeed crush earnings targets this week. Analysts would have settled for adjusted earnings of $1.07 per share on sales around $3.14 billion, but the hard-drive maker came through with much-higher earnings on slightly stronger revenue. GAAP income landed at $1.28 per diluted share and the pro forma figure came in hot at $1.32.
A performance like that usually drives investors wild, but Seagate traded modestly down in early after-hours action. The company had primed the pump with a 29% gain in January, so that's hardly a catastrophe. But it's always a bit odd to see stocks barely budging on terrific earnings news. You can't even blame soft guidance, as the company didn't provide any in the press-release materials.
But that all changed when the analyst call started. Seagate opened about 16% higher thanks to the guidance provided there.
A bit of background
Let's back up a bit before digging into the market-moving guidance figures:
Archrival Western Digital (NYSE: WDC ) just reported a surprisingly fine quarter for itself, hurt by the Thailand floods inundating factories but helped by high market prices for hard drives. The floodwaters only washed out the supply side while customer demand remained constant, so the company was able to sell its limited supply at nearly 50% higher unit prices.
Seagate sells its products in the same markets, often to the same customers. The company had a choice: Go on a price-gouging rampage like Western Digital because the market conditions allowed it, or take a softer approach to win some friends.
Seagate took the somewhat higher road. Faced with $2.50 of additional costs per unit as the company's parts suppliers suffered in Thailand, Seagate jacked up average drive prices by $13 apiece, to $68. That's just a 24% boost.
"While market conditions would have clearly supported a higher price for our products across our portfolio, we balance this condition with the needs of our customers and suppliers, as well as our objective for more stability in our margins," explained CEO Steve Luczo.
In plain English, Seagate chose a smaller price increase in order to keep people happy up and down the food chain.
Prices will stay elevated in the next quarter while the supply chain mends itself. Seagate expects to ship at least 60 million units this quarter, leading to revenue of $4.3 billion or more. Working out that math, that's another 5% unit-price boost, to $71.
So that's the short-term impact of the disaster in Bangkok. But there are long-term effects as well, far beyond a simple supply-and-demand imbalance.
Luczo got downright philosophical when contemplating this sea change. "The question is: When does all this end? Which, of course, is the biggest question in life," he said. "And then what does it look like? That's the second-biggest question in life. And what I think the answer is: It doesn't end. This is a structural event that's happened, and the industry has changed."
Yes, it has. As a direct result of the floods, Seagate has changed its distribution model from a network of shipping hubs to direct factory shipments. So when Dell (Nasdaq: DELL ) or Hewlett Packard (NYSE: HPQ ) need a million drives for a new computer model, they'll be shipped directly from Seagate's factory to theirs cutting out a needless warehouse in the middle. Luczo expects this model to become industry-standard because his customers like it so much. Join the direct-ship party or get left behind.
Moreover, most of Seagate's large customers have signed binding long-term agreements, often for many years ahead. "LTAs of this nature are new to the disk drive industry and represent a structural change in the way we do business," Luczo said. Both the customer and the supplier improve their business forecasting with firm pricing and volume agreements in place, and these contracts will account for over half of Seagate's annual production going forward. Again, these are changes that HP and Dell will appreciate as well.
They say that what doesn't kill you makes you stronger. That's how Seagate comes out of the Thai situation – stronger, with a more-streamlined business model, strong end-market pricing, and long-term commitments from its major customers.
Moreover, the company just raised its dividend by 39% for a very healthy 4.3% yield. There's also a $1.9 billion share-buyback program in place, which is enough to retire nearly 20% of Seagate's shares at current prices. This is a shareholder-friendly business.
A bullish CAPScall on Seagate has served me very well so far, boosting my all-star CAPS score by more than 70 points. The company just proved that it can deliver when times are tough, and I like Seagate's position for the long term. That why I just re-upped my CAPS thumb for another couple of years. The next time this stock falls for no good reason, I might be tempted to buy a few shares. Add Seagate to your Watchlist if you want to be ready for that strategy.
If Seagate's dividend still isn't juicy enough, check out this free rundown of 11 top-notch payouts and the rock-solid businesses behind them.