The Storage Buy-In You've Been Waiting For

If you don't know any better, you might think that Xyratex (Nasdaq: XRTX  ) is a dying business today.

Shares of the British storage-systems builder are down more than 13% this morning, after the company coupled a positive earnings report with a seemingly pessimistic next-quarter forecast. Third-quarter sales increased 75% year over year to stop at $430 million, while non-GAAP earnings more than tripled to $1.20 per share. Both of these figures landed comfortably ahead of Street estimates.

However management said that about $70 million of these sales came from pulling forward what would normally be fourth-quarter orders. CEO Steve Barber seems to see this as a feature, not a bug, in fawning over his company's "excellent execution."

Xyratex's largest customer, NetApp (Nasdaq: NTAP  ) , appears to have slowed down its order volume somewhat, which signals that top-shelf systems integrators like IBM (NYSE: IBM  ) , Dell (Nasdaq: DELL  ) , and EMC (NYSE: EMC  ) all increased their relative share of Xyratex orders. This company builds hardware modules, which traditional systems storage vendors then combine with their own touches and special software sauce to create the products you see in the data center.

Recent buyout battles over storage specialists such as Data Domain and 3PAR have shown us how hot the storage sector is, and these trends have also pulled Xyratex's stock way up. Shares bought a year ago are worth 57% more today, even after that steep overnight fall. In the process, the former five-star CAPS stock has turned into a three-star nobody, seemingly on valuation issues.

That's kind of ridiculous for a stock that (including last quarter's profits) trades at less than 5 times trailing earnings. As hard drive builders Seagate Technology (NYSE: STX  ) and Western Digital (NYSE: WDC  ) have shown, while certain niches of the storage market are embroiled in heated buyout battles that push their valuation up to 10 times sales, it's nearly impossible for storage experts in other areas to get any respect in this market.

Whether the market eventually corrects this obvious imbalance between business strength and market cap, or one of the big boys decides to buy out this industrywide parts provider, loading up on Xyratex today seems nearly guaranteed to produce nice returns. I'm jumping over to Motley Fool CAPS to rate this stock "outperform" over the next two to four years. If you agree with the value picture I see, feel free to do the same.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. The Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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