Why This Hard-Drive Maker Could Head Even Higher

Shares of hard-drive maker Seagate Technology (Nasdaq: STX  ) hit a 52-week high on Wednesday. Let's take a look at how it got there and see if clear skies are still in the forecast.

How it got here
What we've got on our hands between Seagate is a fight between deep value investors and those who feel that earnings disappointments should be punished.

On the downside, Seagate recently preannounced that its earnings estimates wouldn't be up to par. Its officially reported $4.48 billion in revenue for the quarter was a clean $500 million below where the company had originally pegged its forecast as supply chain constraints and quality control issues still relating to the flooding in Thailand affected its results.

Despite its reduced forecast and results, Seagate still produced a 57% increase in revenue over the year-ago period and registered 42% global market share for hard drives shipped. Operating income more than quintupled as research and development costs shrank considerably.

The story behind Seagate and its rival Western Digital (NYSE: WDC  ) is really a story on the growth in cloud-computing. With the need for storage growing immensely on both PCs and for servers, Seagate can double-dip on the rapidly increasing demand from both ends. According to Cisco Systems (Nasdaq: CSCO  ) , it anticipates cloud-based workloads will rapidly increase from an estimate of 39% of average data center workload in 2012 to 57% in 2015. This is precisely why Intel (Nasdaq: INTC  ) is betting a fortune on the success of cloud-computing server chips and why Cisco redesigned many of its servers around Intel's new Xeon E5-2600 cloud-computing chip. Robust growth from Lenovo (OTC: LNVGY), which saw PC sales surge 35% last year, is another bullish factor for Seagate.

How it stacks up
Let's see how Seagate stacks up next to its sole publicly traded peer, Western Digital.

STX Chart

STX data by YCharts.

This round goes decisively to Western Digital, which has vastly outperformed Seagate over the trailing five-year period.

Company

Price/Book

Price/Cash Flow

Forward P/E

Dividend Yield

Seagate Technology 3.8 6.8 4.5 3.9%
Western Digital 1.5 4.2 5.3 0%

Source: Morningstar; Seagate's yield is projected.

Not to sound completely like a bird, but this highly commoditized sector is cheap, cheap, cheap! Although you probably won't go wrong with either company, they each offer distinct advantages.

Favoring Western Digital, it trades at a considerably lower price-to-book and cash flow ratio than Seagate. It also maintains a net cash position of $1 billion whereas Seagate has a net debt position in excess of $700 million.

For investors looking at Seagate, you'll be privy to a sizable dividend boost that now places its projected yield at a whopping 3.9%! In addition, Seagate's five-year projected earnings growth rate trounces Western Digital's by a count of 28% to 18%, according to Wall Street analysts.

Like I said, there's really no wrong answer here.

What's next
Now for the $64,000 question: What's next for Seagate? That question is going to depend on whether spending for the cloud remains robust, if it can control its debt and expense levels, and if it can quickly remedy its supply chain issues.

Our very own CAPS community gives the company a three-star rating (out of five), with 92.1% of members expecting it to outperform. Although I've yet to make a CAPScall on Seagate in either direction, I've decided it's time to enter a limit CAPScall of outperform on the stock at $28.

Seagate has had an impressive run since announcing an additional $1 billion in share buybacks on top of the $2 billion it authorized in 2010 and a 28% boost in its dividend. The company is doing what it can to return value to shareholders and it's being reflected in the company's share price. I feel investors are getting a great deal on Seagate at these levels, but even I understand that no company goes straight up. Seagate is vulnerable to macroeconomic weakness and input price fluctuations -- that's just part of its business. Taking the good with the bad, however, I feel you can't go wrong at less than five times forward earnings with a nearly 4% yield, especially if I get a retracement to $28.

Without question, Intel is poised to be a driving force in the hardware aspect of the cloud-computing revolution. But does that guarantee the company success? Find out in our latest premium research report on Intel that dissects the stock from every angle, discussing its various opportunities and pitfalls, and comes complete with a year's worth of updates. What's more, this premium report costs less than your cup of coffee will for a week. Get your copy by clicking here.

Craving more input on Seagate Technology? Start by adding it to your free and personalized watchlist. It's a free service from The Motley Fool to keep you up to date on the stocks you care about most!

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of Western Digital, Cisco Systems, and Intel. Motley Fool newsletter services have recommended buying shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On August 09, 2012, at 9:56 AM, EquityBull wrote:

    Seagate faces many headwinds. The biggest catalyst if you look at the news, timing, chart, etc was the floods. Nothing like a flood taking out all your competitors and leaving your production intact. However that gift from mother nature is coming to an end as capacity is restored in Western Digital factories.

    Once it does the vicious price wars will begin. Lower ASP's and margin cuts will be business as usual. Western Digital will try to gain share by slashing costs to make up for lost ground by the floods.

    Additionally a huge headwind in that SSD (Solid State Drives) are being used more in laptops (all mac laptops, ultrabooks), desktops and in the datacenters for performance.

    I think shareholders will have to time the exit or get out now. I'm seeing prices well under 20 in the next 12 months once all this comes to fruition.

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