Not all tech stocks have had a stroll in the park in 2020. Take Seagate Technology (NASDAQ:STX), for instance. While pockets of the industry are experiencing unprecedented growth due to the pandemic, this company's legacy digital memory hardware is struggling to hang onto the positive traction it was building over the course of the last year. A dividend payout increase and new share repurchase authorization sweeten the deal for shareholders, but they should expect more turbulence ahead.
A busted ownership thesis?
I started eyeing Seagate early in 2019. A solid dividend payment still handily covered by long-term free cash flow (revenue less cash operating and capital expenses) generation caught my eye, and pessimism due to a cyclical downturn for semiconductor stocks made shares look too cheap to ignore.
While the thesis played out at first, 2020 hasn't been so kind. Seagate stock is down 19% on the year as of this writing as it struggles to rebound to pre-COVID-19 levels. The problem? Fiscal 2020 revenue (12 months ended July 3, 2020) managed to increase only 1% from the year prior, and free cash flow fell 3% to $1.13 billion -- good for a decent free cash flow profit margin of 10.8%.
However, the lackluster results didn't improve much during the first quarter of fiscal 2021 (three months ended Oct. 2, 2020). Revenue of $2.31 billion came in almost smack dab in the middle of management's guidance, and adjusted earnings per share of $0.93 was near the high end of the outlook, but both metrics represented a decline from a year ago by 10%. The second-quarter bar was also set lower than hoped. Expected revenue of $2.55 billion and adjusted earnings per share of $1.10 represent declines of nearly 6% and 19%, respectively.
To be fair, Seagate is getting some upward lift from cloud computing as some data center operators opt for the company's lower-cost hard disk drive wares for mass storage of information. But spending among its customers has been inconsistent. My thesis that lower-cost hardware would see a bump in demand during the recession isn't working out -- even with Seagate's outlook that the current period will mark the low point of pandemic disruption. Full fiscal-year 2021 revenue is expected to rebound, but still wind up flat compared to 2020.
Hold for the dividend or sell for the uncertainty?
The good news is that if it's income you're after, this remains a solid bet. Seagate just increased its quarterly dividend payment by 3% to $0.67 per share. As of this writing, it's good for an annual yield of 5.5%. Add to it the additional $3 billion in share repurchase authorization (which represents nearly 25% of the current market cap of $12.3 billion), and this is a pretty good investment income holding.
But things will need to change fast for me to feel really warm and fuzzy about this potential investment. Free cash flow can be highly variable from quarter to quarter, but the $186 million generated in Q1 is a precipitous fall from $309 million a year ago. $186 million also just barely covers the $167 million paid out via the dividend during the last period. If now truly is the bottom of the pandemic-fueled downturn, this metric should improve going forward, but it will be important to keep an eye on. $4.1 billion in debt and $1.7 billion in cash and equivalents at least prevent the situation from being an emergency.
At 12.5 times trailing 12-month free cash flow, Seagate looks neither too expensive nor overly cheap -- assuming no further deterioration to the fundamentals. The dividend and share repurchase are attractive, but I'm not purchasing any more for my portfolio at this time.