At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.
But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.
When reasons and ratings reverse
On a generally "green" day for the Nasdaq, shareholders of Seagate
Why the sudden change of opinion? Aren't hard disks passe, made obsolete as Apple's ubiquitous iPad displaces the kings of PC, Hewlett-Packard
Perhaps they are, or will be eventually. But for the time being, so long as solid state memory costs umpteen times the price of old-tech hard disk drives, demand for HDD will persist. Indeed, as B of A explained in its dual-upgrade: "The reasons we downgraded both to Underperform in late-2009 have all reversed -- demand, pricing, margins, and capex trends." Furthermore, B of A predicts "meaningful share price outperformance over the next 12 months, on operating leverage and earnings revisions, aided by an aggressive share buyback program" at Seagate.
Is it right about that?
Where growth goes to die
I sure hope so. But if B of A is right about these two stocks getting ready to grow significantly, it just might be the only one to think that.
Both Western Digital and Seagate reported earnings last week, you see, giving Wall Street analysts (and us) super-fresh data upon which to work their growth projections. Result: Based on the most recent information, analysts expect to see just 4.5% annualized growth at Seagate over the next five years, and a mere 4% at Western Digital. That's slow enough growth to make even the rock bottom prices on these stocks (5.7 times earnings at Seagate; 7.3 times earnings at Western Digital) look expensive.
Curiously, though, it's this very pessimism about the stocks that intrigues Bank of America. According to the analyst, things have gotten so bad in the hard drive industry that "industry fundamentals are near cycle lows, with trough-like valuation." (In other words, they've got nowhere to go but up.)
Further bolstering the "trough" thesis, B of A notes that "unit shipments are now running below end market growth, which has typically been a signal of trough conditions and eventually reverses." And as any Econ 101 student can tell you, when demand is growing faster than supply, that almost certainly portends rising prices for the supplier. And that could bode ill for HP and Dell, among others.
Bank of America is a bottom-feeder
And that's the buy thesis this week, in a nutshell. Things have gotten so bad, and projections so pessimistic, that these stocks are bound to rebound in relatively short order. I don't know that I buy that argument entirely, but I do know that if I were interested in gambling on B of A being right about this, the stock I'd feel much more comfortable owning is Western Digital.
Why? Seagate may be the faster grower (by all of one half of one percent). It may also be cheaper than Western Digital on a pure P/E basis. But if you dig into the two firms' cash flow statements, what you'll find is that Western Digital is actually the hard drive maker with the firmer financials. Whereas free cash flow backed up barely 54% of Seagate's reported earnings last year, Western Digital's GAAP earnings and its actual free cash flow were almost identical.
Foolish final thought
Add in the fact that Western Digital boasts a balance sheet brimming with nearly $2.8 billion net cash, while Seagate is a net debtor (and fated to go even deeper into hock as it shells out for its share buyback), and the case in favor of Western Digital grows even stronger. By my calculations, the company's enterprise value is only 4.8 times its trailing free cash flow. Which at the risk of oversimplifying, means that even if Western Digital just staggers along at today's "trough" levels of business for the next five years, it would end up having more cash on its balance sheet than the entire company is currently "worth."
On the other hand, if Bank of America is right, and Western Digital sits on the cusp of a sharp rebound in profits and sales ... this stock really could roar.
Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 676 out of more than 170,000 members. The Motley Fool has a disclosure policy.
Apple is a Motley Fool Stock Advisor recommendation. The Fool has written puts on Apple. The Fool owns shares of Apple and Western Digital.
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