Seagate Technology (NASDAQ:STX) recently posted strong third-quarter numbers that surpassed Wall Street's expectations. The hard drive maker's revenue rose 18% annually to $2.72 billion, beating estimates by $80 million and breaking a five-quarter streak of declines. Its non-GAAP net income jumped 38% to $363 million, or $1.38 per share, which also beat estimates by seven cents.

For the fourth quarter, Seagate expects its revenue to rise 10% annually at the midpoint, and for its non-GAAP EPS to grow 35%. Both forecasts exceeded analysts' expectations, indicated it was weathering the COVID-19 headwinds, and suggested it could sustain its forward dividend yield of 5.4%.

However, Seagate's stock dipped after a few analysts trimmed their price targets, citing concerns about its ability to keep expanding its gross margins. Are those concerns valid, or did that noise merely make Seagate a more compelling buy for long-term investors?

Four open HDDs on top of other HDDs.

Image source: Getty Images.

Passing a cyclical trough

Seagate generated 93% of its revenue from traditional platter-based hard disk drives (HDDs) during the quarter. The remaining 7% came from flash-based solid-state drives (SSDs), enterprise data solutions, and other storage devices.

Seagate's strategy differs from that of its main rival Western Digital (NASDAQ:WDC), which diversified away from HDDs by acquiring SanDisk four years ago. Unlike WD, which pursued the higher-growth flash and SSD markets, Seagate focused on boosting the capacity of its cheaper HDDs for data center customers. Seagate's low-cost strategy shielded it from the declining flash memory prices that hurt WD over the past year, but that shift also reduced the price gap between pricier SSDs and cheaper HDDs.

Seagate pivoted away from the lower-capacity HDD market to avoid competing against SSDs, but sluggish demand for HDDs from data centers and PC manufacturers exacerbated its decline, resulting in five straight quarters of declining revenue. However, Seagate seemingly passed a cyclical trough in the second quarter, and its growth accelerated again in the third quarter:

Period

Q3 2019

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Revenue Growth (YOY)

(17%)

(16%)

(14%)

(1%)

18%

Gross margin*

26.8%

27.1%

26.7%

28.7%

28%

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

The bulls likely believe Seagate's growth will remain positive for the rest of the year as the COVID-19 crisis sparks stronger demand for HDDs in the PC and data center markets. PC manufacturers are struggling to produce enough devices to meet the needs of stay-at-home workers, and data center customers need to quickly upgrade their storage capacities to deal with the elevate usage of cloud-based apps, storage services, and streaming media.

However, the bears will note that Seagate's gross margin contracted sequentially despite expanding annually. During the conference call, CFO Gianluca Romano attributed the decline to "higher logistic, under-utilization and operational cost associated with COVID-19 disruption" as well as pandemic-related challenges for its non-HDD businesses. Those declines were partly offset by a higher contribution from its higher-margin mass capacity drives.

Is Seagate resistant to the pandemic?

The COVID-19 crisis is generating tailwinds for Seagate's core HDD business, but it's also disrupting its supply chains, logistics, and orders.

An open HDD.

Image source: Getty Images.

CEO Dave Mosley noted that the "full extent of the COVID-19 related impacts to the broader economy and associated impact to our market and business operations are yet unknown," and management has prevented the company from providing detailed guidance for the second half of the calendar year.

However, Mosley claims Seagate remains "on solid financial footing with a strong balance sheet, ample liquidity and exposure to secular growth trends that are tied to the world's insatiable demand for data and the need for mass capacity storage and data management solutions."

During the quarter, Seagate's cash position grew 16% annually to $1.6 billion, its debt declined 8% to $4.1 billion, and only $19 million of its debt matures in fiscal 2021. Its operating cash flow rose 1% to $1.33 billion, and it spent $795 million on buybacks and $505 million on dividends -- which indicates it's returning most of the excess cash from its lower-cost HDD business model to shareholders. Seagate notably raised its dividend for the first time in four years last year, and that streak could continue this year.

The bottom line

Seagate's gross margin might slip sequentially in the first quarter, but that pressure will likely ease as the COVID-19 crisis passes. For now, Seagate's strengths clearly outweigh its weaknesses, and its low forward P/E of 9 and its 5% yield should set a floor under the stock -- making it one of the safest tech stocks to buy in this turbulent market.