Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low it's not even worth the paper your check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today, we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say that this stock doesn't share the same macro risks that other companies have, but it's a step above your common grade of dividend stock. Check out the previous selection.
This week, we'll turn our attention to storage solutions provider Seagate Technology (NASDAQ: STX ) and I'll show you how this tech giant on the precipice of a huge data revolution could pack quite the share price appreciation and dividend punch for your portfolio.
Solid results challenged in a flash
As we do with each company highlighted in this series, let's first take a gander at some of the challenges that Seagate could face in coming years. As much as we'd like to think that our investments or possible buys are perfect, every company has risks and it's important to understand what those might be.
For Seagate one of its biggest risks is long-term margin and pricing pressure for both hard-disk drives and solid-stage drives. As the production process for storage devices becomes more efficient, and operations continue to expand into overseas markets with competitive labor pricing, the overall cost of storage devices themselves is likely to fall. Seagate's sheer size could help balance out this pricing pressure, but without remaining innovative it could see its pricing power erode as time goes on.
Another primary concern is that Seagate isn't solely in the driver's seat when it comes to its growth potential. As the floods in Thailand proved three years ago, Seagate's suppliers matter just as much as its own production facilities. The downside of working in overseas markets where labor is cheaper is that the infrastructure behind its components suppliers can get disrupted somewhat easily. It's what you might call the risk Seagate takes to keep production costs in-line.
Finally, there are acquisition risks associated with incorporating new businesses into the fold. In December Seagate announced the purchase of Xyratex for $374 million, including debt, in order to get a hold of its hard-disk drive test equipment operations. Seagate views the acquisition as cost-effective since bigger drives in the multi-terabyte size can take a long time test. Xyratex's leading products should, therefore, help it scale its business. However, combining two businesses together isn't always as easy and one, two, three! With the acquisition not expected to provide an EPS boost until next year investors are left to wonder if there will be any delays in integrated Xyratex's operations or any future acquisitions.
The Seagate advantage
I don't think you can have a serious discussion about Seagate's long-term potential without first discussing what an important role big data centers will play in its growth. Big data centers are taking what had been static servers in a home or office and connecting them to the cloud where considerably more data can be stored and accessed from any form of mobile device in or outside the work place. The end result should be a more efficient workforce and lower long-term storage costs.
For Seagate this represents an enormous growth opportunity as businesses are expected to spend big money on their data center build out's. Research firm Gartner estimated last year that data center spending would reach $154 billion in 2014 , and I would project that this figure is on pace to top $225 billion annually by the end of the decade. IBM (NYSE: IBM ) , for instance, announced in January that it would be spending $1.2 billion on up to 15 big data centers in order to take advantage higher-growth emerging markets. IBM's hardware business has been lagging, so this beefed up spending represents its effort to catch up with its peers. There are plenty of deep-pocketed big tech companies expected to spend heavily just like IBM to build out their data centers, so Seagate looks perfectly positioned to take advantage of growing data storage needs.
Secondly, geographic diversity and Seagate's vertically integrated business should give the company an opportunity to outgrow its peers. In the company's third quarter, reported in late April, Seagate's results demonstrate that two-thirds of its revenue is still coming from original equipment manufacturer, or OEM, deals. OEM revenue is great for mass-produced tech companies because it implies steady cash flow and strong business-customer relationships.
In addition, the percentage of Seagate is attributing to the Asia Pacific region rose two percentage points to 54% from the sequential second-quarter. This is worth noting as the Asia Pacific region is the part of the world most likely to deliver decades of superior growth. In sum, Seagate is deriving the lion's share of its business from the fastest growing region of the world.
Also, solid-state drives represent an intriguing long-term opportunity for Seagate to further dominate the enterprise storage market. Solid-state drives offer a remarkably fast way for businesses to access data compared to standard hard-disk drives, but they also present sizable challenges to big business in that SSD's require a complete overhaul of a company's current infrastructure. While SSD's are extremely costly now, production efficiencies should lower costs over time and could allow these potentially high-margin storage devices to fuel Seagate's bottom line growth.
Finally, investors should keep in mind that intangibles matter. Given that Seagate is incorporated in Ireland it's exposed to some of the lowest corporate marginal tax rates in the world at 12.5%. By comparison, its peers are incorporated in the U.S. where marginal corporate tax rates top out at a whopping 40%. This tax gap allows Seagate to keep more of its earned money, which it can use to reinvest in its business or pass along to investors.
Show me the money!
The one final factor that allows Seagate to stand out, and the real reason we're taking a closer look at it today, is its impressive dividend.
As you might imagine, Seagate's business took quite a hit during the recession which forced it to suspend its dividend for more than two years. However, Seagate's payout has come back with a vengeance, as well as a hefty share repurchase program aimed at rewarding long-term investors.
As you can see above, with the exception of its two-year payout hiatus Seagate's dividend has grown with some regularity from just $0.03 per quarter in 2003 to $0.43 per quarter as of its May stipend. That's a 1,333% increase in just 11 years, or a 27.4% compounded annual increase even with two years of zero dividends paid! All told, Seagate is rewarding shareholders to the tune of a 3.1% yield which becomes even more impressive when you consider that shares are up 450% over the trailing five-year period.
But, as I mentioned above Seagate is also rewarding investors with a hefty $2.5 billion share buyback announced in 2012. Share repurchases help remove outstanding shares from EPS price calculations and can make a company appear cheaper. With a forward P/E of just 10 and data center growth just in its infancy I'd suggest that Seagate could provide income-seekers with decades of healthy dividends and share price appreciation potential.
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