The semiconductor and hard-drive industry has been under fire lately, with PC demand continuing its downward spiral into obsolescence. Companies with heavy exposure to the PC business are scrambling to replace the dwindling revenue with fresh high-growth sources. For Seagate, this involves increasing attention to the cloud and solid-state drives. In the third quarter, the company was able to accomplish the rare feat of missing analyst expectations and not witnessing a damaging slide in stock price. Investors most likely understood going in that things weren't going to pretty given the PC climate and the company's prior warnings. Expectations aside, how is Seagate doing? Is it worth a buy at 4.5 times forward earnings?

Amid a dismal PC environment, Seagate Technology (Nasdaq: STX) brought in $3.73  billion in top-line revenue, missing analyst expectations of $3.8 billion. The miss was negligible enough not to upset investors, but the bottom line was a bit of a different story. In net income, the company brought in $594 million and $1.42 in earnings per share. Analysts were looking for an average of $1.70 for the quarter. The huge miss still didn't seem to upset the Street, and it's probably because the company was still able to post major gains over the last year's quarter. GAAP sales were up 33% to $2.81 billion compared with the year before, and earnings per share trumped last year's $0.32.

After the Thai floods last year, both Seagate and Western Digital (Nasdaq: WDC) enjoyed high margins because of supply shortages. Almost all products were sold at MSRP, with few discounts to be found. Analysts predicted that those margins would be briefly lived, and they did return to some level of normality in the following quarters. For the third quarter of this year, however, the company experienced substantial margin growth across the board:

  • Gross  margins were up 890 basis points to 28.4%.
  • Operating margins up 830 BPs to 16.7%.
  • Net margins sailed 1,060 BPs higher to 15.6%

So, overall the numbers look OK, despite coming in lower than expected. The stock bounced up a point or two during the week, which tells us investors feel the same way. With this business, though, past numbers aren't quite the main area of focus.

What lies ahead
As far as forward-looking numbers go, the company is expecting next quarter's revenue to be in the neighborhood of $3.5 billion, again below analyst expectations of $3.9 billion. Hard-drive demand is expected to continue its trend downward, which should be surprising to absolutely nobody.

The company took 17% of its outstanding shares off the market in the first nine months of the year, in an effort to return value to shareholders. This should have boosted per share revenue a bit more than we see here, but this at least demonstrates the company's effort to return value. To the company's credit, the stock is up nearly 90% over the last two years.

Seagate knows it needs to optimize the hard-drive business while simultaneously boosting its cloud exposure. This is perhaps best accomplished by a combination of focusing on inventory  management for hard disk drives and increasing its lineup of solid state drives -- something that has been widely acknowledged in management calls. In addition to the disk-drive business, the company recognizes its need to establish a presence in the cloud industry. For a few quarters now, Seagate management has referenced its intensive cloud buildout process as a major future growth driver.

One concern going forward for some investors and analysts is the dividend yield. With such a large number of shares taken off the table, some are concerned that the yield will inevitably lower. With no adjustment to the payout, this is probably the case. In the past, CEO Steve Luczo has acknowledged the point and alluded to board discussions about raising the dividend down the road. I expect to see this idea come to life in the next few quarters.

The biggest concerns going forward seem to be the softening demand in China, uncertainty in the U.S., and a quicker-than-expected slowdown of the company's enterprise business -- which was down 26% year over year this quarter.

The call
The company is trading around the midrange of its 52-week performance. At 4.5 times earnings going forward, it looks rather cheap, but keep in mind the strong headwinds. As many know, David Einhorn holds a large position in the company, and we have yet to see any sign that he'll sell His most recent purchase, reported in June, included shares priced between $22  and $32 per share.

Seagate looks, to me, to be in better condition than Western Digital given its acquisitions and inventory management efforts. Both companies, though, are difficult to forecast. Your attention may be better placed elsewhere in the bargain stock department.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.