Seagate Technology (STX 0.17%) and Western Digital (WDC -0.16%) hold a near-duopoly in platter-based hard disk drives (HDDs). Seagate controlled 43% of the HDD market last year, according to Coughlin Associates, while WD ranked second with a 36% share. However, Seagate and WD operate very different business models.
Over the past several years, WD expanded its flash memory (NAND) business with big acquisitions and investments to address the disruptive rise of flash-based solid-state drives (SSDs), which are faster, smaller, more power-efficient, and less prone to damage than traditional HDDs. As a result, WD now generates more than half its revenue from flash-based products.
Seagate didn't chase WD into the volatile and capital-intensive NAND market. Instead, it doubled down on HDDs with cheaper and higher-capacity drives. It reduced its exposure to the consumer market, which was more prone to disruption by pricier SSDs, and focused on selling cheaper HDDs to cost-conscious enterprise and data center customers.
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Seagate's slow but steady approach has generated much bigger gains for investors than WD's aggressive response to SSDs. Over the past five years, Seagate's stock rallied nearly 80% as WD's stock was cut in half.
Will that trend continue for the foreseeable future, or will WD finally stabilize its business and impress investors again?
How fast is Seagate growing?
Seagate's revenue rose 1% in fiscal 2020, which ended in July of the calendar year, and grew 2% to $10.7 billion in fiscal 2021.
But in the first half of fiscal 2022, its revenue increased 26% year-over-year to $6.2 billion as brisk sales of its higher capacity HDDs to cloud and data center customers easily offset the slowing growth of the PC market. In addition, its smaller SSD business, which relies on outsourced NAND chips instead of first-party ones like WD's SSDs, also continued to grow.
During Seagate's latest conference call, CEO Dave Mosley said HDDs would remain a "critical enabling technology" for mass data management, and he didn't expect that to change "over the next decade or longer."
Seagate's gross margins have been squeezed by rising freight costs and a higher mix of lower-margin products over the past year, but its adjusted operating margins have remained broadly stable and near the top of its long-term target of 15%-20%. It also continued to boost its earnings per share (EPS) with consistent buybacks, which reduced its outstanding shares by 26% over the past five years.
Seagate's adjusted EPS dipped 4% in fiscal 2020, but rose 14% in fiscal 2021 and surged 115% in fiscal 2022. Analysts expect its revenue and adjusted EPS to grow 12% and 58%, respectively, for the whole year.
Seagate also pays a forward dividend yield of 3.3%, and it spent just 43% of its free cash flow (FCF) on those payments over the past 12 months.
How fast is Western Digital growing?
Western Digital's revenue rose 1% in fiscal 2020, which also ended in July of the calendar year, and grew 1% to $16.9 billion in fiscal 2021.
But in the first half of fiscal 2021, its revenue rose 26% year-over-year to $9.9 billion as the expansion of its cloud-oriented HDD and flash businesses offset the stagnant growth of its consumer-facing businesses.
During WD's latest conference call, CEO David Goeckeler said that in calendar 2021, the company had fulfilled its three main goals of delivering new SSD products, navigating the supply chain crisis, and improving its balance sheet.
WD's gross margins have been squeezed by the same supply chain headwinds as Seagate in the first half of the year, but its operating margins also remain stable and roughly comparable to Seagate's.
WD's adjusted EPS fell 37% in fiscal 2020, rose 50% in fiscal 2021, and more than tripled in the first half of fiscal 2022. Analysts expect its revenue and adjusted EPS to grow 19% and 89%, respectively, for the full year.
Those growth rates look slightly higher than Seagate's, but WD notably suspended its dividend in 2020 and hasn't repurchased any shares since the first quarter of 2019. It implemented those measures to reduce its debt, which had ballooned over the years as it acquired more companies to expand its NAND business. WD ended last quarter with $7.06 billion in long-term debt (versus $5.86 billion for Seagate), and it doesn't plan to reinstate its dividend or buybacks until it further reduces that leverage.
The valuations and verdict
Seagate and WD both look cheap relative to their growth. Seagate trades at just nine times forward earnings, while WD has an even lower forward price-to-earnings ratio of five. Both stocks are trading at such low multiples because investors are concerned about the ongoing supply chain challenges and a post-lockdown slowdown in PC sales.
Those concerns are valid, but both companies have withstood plenty of previous macroeconomic shocks and cyclical downturns. That said, I believe Seagate will continue to outperform WD for three simple reasons: Its growth is more stable, it isn't heavily exposed to volatile NAND prices, and it still returns most of its cash to investors through buybacks and dividends.
