Seagate Stock: Bear vs. Bull

Seagate Technology Holdings' (STX 0.67%) stock was nearly cut in half this year as investors fretted over slowing growth and declining margins. However, that sell-off also reduced the hard drive maker's forward price-to-earnings ratio to 11 while boosting its forward dividend yield to 4.5%.

That low valuation and high yield might attract some value-seeking investors in this ongoing bear market, but do the risks outweigh the potential rewards? Let's review the bear and bull cases to decide.

Image source: Getty Images.

What the bears will tell you about Seagate

The bears believe Seagate's dedication to traditional platter-based hard disk drives (HDDs) will be its ultimate downfall. Over the past decade, flash-based solid-state drives (SSDs) gradually replaced HDDs across many devices because they're smaller, faster, more energy efficient, and less prone to damage.

Seagate's main rival, Western Digital, aggressively expanded into the flash memory and SSD market to reduce its long-term dependence on HDDs. Meanwhile, Seagate continued to prioritize development of its higher-capacity HDDs, and only produced SSDs that were powered by third-party memory chips instead of its own first-party chips.

HDDs are still cheaper than SSDs, and Seagate believes that gap will keep aging HDDs relevant among larger cost-conscious customers. However, Wright's Law (the belief that fixed costs will decline by a constant percentage as more units are produced) suggests SSDs will achieve price parity with HDDs in the near future. When that happens, companies could retire their HDDs like tape drives and floppy disks. In addition to that long-term problem, Seagate faced a grueling near-term slowdown throughout fiscal 2022 as its gross and operating margins gradually declined.

Data source: Seagate. YOY = year over year.

In July, Seagate predicted its revenue would decline another 15% to 25% year over year in the first quarter of fiscal 2023. At the time, it blamed that slowdown on sluggish demand for consumer-facing PCs and external drives in a post-lockdown market, COVID-19-related disruptions in Asia, shortages of non-HDD components indirectly curbing its sales to certain markets, and intense inflationary headwinds.

But at the end of August, Seagate warned that its first-quarter revenue would likely drop 29% to 36% instead. It attributed that steeper decline to "weaker economic trends in certain Asian regions" along with "more cautious buying behavior" among large enterprise, original equipment manufacturer, and domestic cloud customers amid the "ongoing macroeconomic uncertainties." As a result, analysts now expect Seagate's revenue and earnings to decline 21% and 44%, respectively, for the full year.

What the bulls will tell you about Seagate

The bulls will acknowledge that Seagate faces some tough near-term challenges, but they'll also tell you the data storage market is cyclical. Seagate has weathered plenty of economic downturns since its initial public offering in 2002. But over the past two decades, its annual revenue still grew at a slow but steady compound annual growth rate (CAGR) of 3.3% while its earnings per share (EPS) increased at a CAGR of 16.3%.

Its profits continued to rise because it focused on producing cheaper HDDs instead of more capital-intensive flash memory chips and SSDs. As a result, it generated plenty of cash for big buybacks and dividends. Over the past decade, Seagate reduced its outstanding shares by 46%. It's also paid uninterrupted dividends for more than a decade, while Western Digital suspended dividends suspended for the past two years.

Over the past 12 months, Seagate spent less than half of its free cash flow (FCF) on its dividends. Its forward dividend rate of $2.80 per share also represents just 34% of its projected EPS of $8.18 this year. Those low payout ratios give Seagate plenty of room for future dividend hikes -- even if its near-term revenue and earnings growth stalls.

Analysts also don't expect Seagate's cyclical downturn to last that long. In fiscal 2024, they expect its revenue and earnings to grow 9% and 49%, respectively, as the macroeconomic headwinds wane.

SSDs still represent a long-term existential challenge for Seagate, but the company already pivoted away from lower-capacity HDDs for consumer devices -- which are more exposed to direct competition from SSDs -- and is focusing on selling much higher-capacity HDDs for cloud and data center customers. That strategy won't hold up forever, but it could buy it enough time to gradually develop more cost-efficient SSDs with its flash memory partner, Kioxia. 

Which argument makes more sense?

Seagate's stock will remain out of favor until the macro situation improves, but its high yield might limit its downside potential. However, it could take more than a year for those headwinds to dissipate -- and Seagate still needs to prove that its high-capacity HDDs can remain relevant against SSDs over the long term. 

Seagate isn't a bad value stock to own, but there are plenty of other high-yield tech stocks that are still on sale and face fewer cyclical challenges. Therefore, the bears could remain in control of Seagate's stock for the foreseeable future.