The data storage market is generally considered a slow-growth, heavily commoditized market. But as I mentioned in a recent article, there are still good growth plays in the space that crushed the S&P 500's return over the past 12 months. Today, I'll take a closer look at the best dividend plays within that industry -- Western Digital (WDC -0.34%), Seagate (STX), and NetApp (NTAP 0.44%).
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Western Digital
Western Digital, the biggest hard drive maker in the world, pays a forward dividend yield of 2.2%. Its earnings-based payout ratio is at a whopping 219%, but that figure was distorted by its $19 billion acquisition of SanDisk last year.
However, Western Digital spent just 24% of its free cash flow on dividends over the past 12 months, and SanDisk's assets are now boosting its cash flows -- which gives it plenty of room for future hikes. It's also raised its dividend annually for four straight years.
Source: YCharts
WD's purchases of flash storage makers like SanDisk helped it pivot away from the aging HDD (hard disk drive) market with smaller SSDs (solid-state drives) which load data faster, consume less power, and have no moving parts.
The SanDisk acquisition also helps WD benefit from growing demand for NAND flash memory -- which has caused prices to surge worldwide. Analysts expect WD's revenue and earnings to respectively rise 47% and 75% this year (due to the SanDisk purchase), followed by 6% sales growth and 34% earnings growth in 2018.
Seagate
Seagate, the second largest hard drive maker in the world, pays a much higher forward yield of 5.8%. It spent 77% of its earnings and 38% of its free cash flow on dividends over the past 12 months.
Those ratios look sustainable, but Seagate hasn't raised its dividend since 2015 due to cash flow concerns. However, Seagate's free cash flow has rebounded over the past year as data-heavy applications boosted demand for its enterprise storage products.
Source: YCharts
Seagate has a much smaller presence in the consumer SSD market than WD, but it still sells enterprise SSDs to big companies. It's partnered with memory chipmaker Micron (MU -2.06%) in these efforts, which partly offsets its lack of a dedicated flash memory division like Western Digital's SanDisk.
However, SanDisk lacks WD's growth momentum: its revenue is expected to dip 2% this year, but its earnings -- boosted by buybacks and better cost controls -- are expected to nearly double.
NetApp
NetApp is one of the biggest providers of data storage and management services in the world. It pays a forward dividend yield of 2%, and it spent 41% of its earnings and 26% of its free cash flow on those payments over the past 12 months.
NetApp started paying a dividend in 2013, and has hiked its dividend annually in every subsequent year. But unlike Western Digital and Seagate, NetApp's free cash flow has declined in recent years due to a series of acquisitions -- including its $870 million purchase of flash storage vendor Solidfire last year.
Source: YCharts
NetApp is a slow growth stock, and Wall Street expects just 2% sales growth this year. However, its earnings are expected to grow 11% this year as it cuts stock buybacks and taps the synergies of its acquired businesses. However, investors should note that rising NAND prices -- which act as a tailwind for Western Digital -- represents a headwind for NetApp, which purchases the chips for its flash-based devices and services.
The key takeaways
WD, Seagate, and NetApp are all decent income stocks, and they're not terribly expensive relative to the industry average P/E of 85 for data storage providers. WD has a negative trailing P/E, due to the SanDisk acquisition, but it trades at just 9 times forward earnings. Seagate and NetApp respectively trade at 18 and 37 times earnings.
Those ratios are surprisingly low, considering that WD and Seagate both nearly doubled over the past 12 months as NetApp rallied nearly 60%. But investors should also be aware that an economic slowdown could cause big orders of enterprise storage devices and services to abruptly stall out. Therefore, they should do their homework on these stocks before buying them as long-term income investments.
