Seagate Technology (NASDAQ:STX) stock is hopping.
This morning, shares of Seagate Technology leapt 20% in price in response to a whole raft of positive commentary out of Wall Street. According to the most recent count on TheFly.com, there have so far been at least three price target increases on Seagate (RBC Capital hiking to $27, Needham to $33, and Brean Capital pushing its target price all the way from $30 to $35), one reiteration of a buy rating (that being Needham), and a single actual upgrade (to equal weight, from Morgan Stanley), all accruing to Seagate stock.
But what does all this enthusiasm really add up to? Is Seagate stock a buy just because the analysts say so? Is it still a buy after so many investors have already rushed to take the analysts' advice, and bid up Seagate stock by 20%?
Here are three things you need to know.
1. Seagate sets the stage
It all started with a press release. Last night, Seagate issued an earnings preannouncement giving investors a glimpse at its Q4 and full-year fiscal 2016 earnings results for the year ended July 1, 2016.
In it, Seagate revealed that it expects to report earning gross margin of 25% (and a pro forma gross of 25.8%) on revenue of $2.65 billion for the fiscal quarter. Why this is exciting for investors is that previously, Seagate had promised only 23% pro forma margins on $2.3 billion in sales. Put together, that implies sales 15% higher than what investors were expecting to see, and profits (at least, gross profits) perhaps as much as 17% higher.
2. How'd that happen?
Seagate credits "better than expected demand for the Company's HDD product portfolio" for the unexpected surge in sales. And as for the profits, Seagate implies that with more volume going out the door, it's operating more efficiently and profitably, using more of its production capacity and leaving less capacity idle. Additionally, the company says it has succeeded with "cost containment" initiatives, keeping operating expenses at the $440 million level it previously promised to produce.
As part of this cost containment effort, by the way, Seagate noted that it has finalized its head count reduction target, and plans to lay off "approximately 6,500 employees " by the end of the current fiscal year 2017. That will cost Seagate about $164 million in pre-tax charges to earnings -- but cut its salaries and benefits expenses by perhaps 14% (the size of the payroll reduction) going forward, permitting the company to begin targeting a gross margin hike in the "range of 27-32%."
3. So how good is this news?
Pretty nice numbers, huh? And yet, not all analysts are convinced that it changes the story. At the same time as everyone else was singing Seagate's praises this morning, Swiss banker UBS put out a more somber note acknowledging the attractive numbers, but insisting the story has not changed.
As related on StreetInsider.com, while Seagate appears to have succeeded in getting customers to buy larger hard drives (HDDs) than expected, and is enjoying a boost in prices from the improved "product mix," as fiscal 2017 gets under way the company still faces the problem of "the price of HDD bits [continuing] to drop at about the same rate as before." Additionally, UBS is unconvinced that Seagate will succeed in selling more HDDs this year than last. Even if the HDDs Seagate sells have more memory, and cost more, UBS is holding its unit-sales estimate at 156 million units -- down 8% year over year.
And UBS still insists that Seagate is a sell -- targeting a price of $15 per share (albeit that's up $1 from before the preannouncement).
The most important thing: Valuation
Is that fair -- upping its target price along with everyone else, but still calling Seagate stock a sell? It sure sounds like UBS is hedging its bets here. And while I hate to go with the consensus on most things, I actually feel more aligned with what Seagate's cheerleaders are saying this morning, than with UBS' negative note.
Consider: Right now, with just $1.02 in trailing earnings, Seagate shares are selling for the seemingly high P/E ratio of 28.2. Analysts now expect earnings to rise sharply in Q4, however (UBS predicts earnings will be $0.49 better than it initially expected -- $0.62 per share), and then to surge as high as $2 a share or better in fiscal 2017.
If that's how things play out, it will drop Seagate stock's forward P/E ratio down into the 14-ish range -- about half what the stock currently appears to sell for. Additionally, data from S&P Global Market Intelligence show Seagate's free cash flow averaging $1 billion a year at last report. Thus, the stock sells for just 8.6 times free cash flow, while it's pegged for a 6% long-term profits growth rate, and pays a 10.5% dividend yield.
Combined, that's a 16.5% total return on an 8.6 times FCF stock -- which seems mighty cheap to me. At this valuation, I think the folks upgrading the shares, and marking up the price targets, have the better side of this argument -- and UBS is getting it all wrong.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 290 out of more than 75,000 rated members.
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