Seagate Technology (NASDAQ:STX) might initially look appealing to income investors, since it trades at just nine times forward earnings and pays a forward yield of 5.5%. However, the hard drive maker's stock also tumbled nearly 20% over the past 12 months and canceled out its dividend gains. Let's see why Seagate slipped, and whether or not it's still a dependable dividend play.

Understanding Seagate's business

Seagate is the second largest maker of traditional platter-based HDDs (hard disk drives) in the world after Western Digital (NASDAQ:WDC). HDDs are widely used in PCs and data centers worldwide, but they're gradually being replaced by SSDs (solid state drives), which store data on flash memory (NAND) chips instead of platters.

A platter-based hard disk drive.

Image source: Getty Images.

SSDs are pricier than HDDs, but they're smaller, more power efficient, and less prone to damage. Seagate and Western Digital addressed the rise of SSDs very differently.

Western Digital acquired SanDisk to become one of the world's largest makers of NAND chips and SSDs in 2016. Seagate, on the other hand, didn't buy a major SSD maker, and focused on selling higher-capacity HDDs to enterprise customers instead, arguing that there would always be a market for cheap and plentiful storage solutions.

NAND prices peaked last year as smartphone shipments fell, Intel's (NASDAQ:INTC) chip shortage hit PC sales, and enterprise customers slashed their spending on big data center projects. The resulting oversupply crushed NAND sales at Western Digital, Micron, Samsung, and other chipmakers.

Seagate was insulated from some of that carnage, but it was also hit by several related headwinds. Soft demand from PC makers and enterprise customers throttled sales of its HDDs, while cheaper NAND chips reduced the price gap between SSDs and HDDs. As a result, Seagate's revenue growth stayed negative over the past three quarters as its gross margins fell year-over-year:

Period

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Q4 2019

YOY revenue growth

18%

14%

(7%)

(17%)

(16%)

Gross margin*

32%

31%

30%

27%

27%

YOY = Year-over-year. Source: Company quarterly reports. *Non-GAAP, rounded.

On the bright side, Seagate's declines are bottoming out. It expects its revenue to decline 15% annually at the midpoint (but rise 8% sequentially) during the first quarter, and for its non-GAAP gross margin to stay "relatively flat" sequentially.

Seagate expects its growth to stabilize as it launches higher-capacity HDDs, including its new 20 terabyte drives, throughout fiscal 2020. Other tailwinds include Intel's resolution of its chip shortage issues and a possible stabilization of the data center market.

Servers in a data center.

Image source: Getty Images.

But what about Seagate's dividend?

Seagate paid out $2.52 per share in dividends in fiscal 2019, which was easily covered by its adjusted EPS of $4.82. It spent $713 million on dividends throughout the year, which was a significant portion of its free cash flow (FCF) of $1.2 billion.

Those payout ratios indicate that Seagate can afford to raise its dividend, but it hasn't done so since 2015 -- which might disappoint dividend growth investors. That's likely because Seagate is also spending a large portion of its free cash flow on buybacks.

Seagate spent $963 million of its FCF on buybacks in 2019, which means that it spent roughly 145% of its FCF on dividends and buybacks. This indicates that the company wants to boost shareholder value, but there are three potential flaws with that strategy.

First, Seagate's FCF declined significantly over the past year, giving it less room for dividends and buybacks. That situation might improve as its declines bottom out, but the trade war, China's development of domestic memory chips, and other macro factors could cause its FCF growth to sputter out.

STX Free Cash Flow (TTM) data by YCharts

Second, Seagate's buybacks weren't well-timed, since the stock shed nearly a fifth of its value over the past 12 months. Lastly, the bears will argue that Seagate should spend more cash on forward-thinking investments (like SSDs) before memory prices rebound.

Keep your eyes on Seagate

Seagate's valuation and yield should limit its downside potential. However, it's more volatile than other dividend stocks with higher yields, so it's not the ideal play for queasy investors.

Seagate investors should also constantly check if HDD prices remain comfortably lower than SSD prices. If not, Seagate's business model could eventually crumble as forward-thinking players like Western Digital pick up the broken pieces. Therefore, Seagate remains a solid income play, but it's not a stock to simply buy and forget.