Fear begets fear. With Seagate (NASDAQ:STX) it is quite the same story when the whole community of investors panicked as SSDs started capturing market share. Although Seagate’s stock prices have almost doubled in 2012 YTD, we think it still has a lot of potential for upside with the lion’s market share in the HDD industry and on-going developments in cloud infrastructure. Hence we rate it as a buy.
A look at the SSD Monster: Is it really that big a threat?
1)A necessary trade-off between capacity and price: The Storage industry is very price sensitive as we have seen the price war in the past when Toshiba tried to ramp up its market share. NAND Flash is at a disadvantage in this price competitive industry as its pricing premium is about 14x higher than that of the rotational media. While the SSD costs have showed a decreasing trend for quite some time now, we believe that the inflection point is likely to come with Toshiba cutting its NAND production by 30% from July 24.
Although, we remain bullish about the long term adoption of SSD, we expect that it would only occur in areas where the utility of its strength trumps its higher cost. With the cloud infrastructure focussing mainly on capacity, we feel that it would be inefficient and cost accretive for them to shift to SSD’s anytime soon.
2)SSD- Work in Progress:
Seagate has been relatively slow to embrace the SSD trend compared to Toshiba and Western Digital (NASDAQ:WDC), but appears to have recently begun to step-up the efforts here. The company has shown some urgency in recent months as it took a stake in privately held Densbits for access to its controller technology, which will be required to address flash longevity issues for Seagate’s hybrid drive business. We believe that acquisition is the way to go for the company to succeed in the SSD market and hope to see many more before the year’s end. Furthermore, Seagate’s partnership with Samsung on enterprise SSD (as a result of the Seagate’s purchase of Samsung’s HDD business) gives Seagate access to controllers and flash chips. We believe that Seagate is in the process of formulating a more defined long-term strategy to compete with big players like Sandisk (NASDAQ:SNDK) and Micron (NASDAQ:MU) and expect to hear more about it in the September analyst meeting.
3)Hybrids anyone:
Hybrids combine the capacity benefits of HDDs while offering the performance benefits of an SSD by having some NAND flash capacity integrated into the drive. Seagate has been the most active proponent of hybrids and if they gain traction, it could limit the appeal of SSDs in notebooks with their low pricing and similar performance to SSDs.
In a Tussle for margins rather than share:
Despite on-going demand weakness and the receding peak margins in the adverse macro environment, we believe that the aftermath of the floods in Thailand have changed the pricing dynamics of the industry. The removal of the smaller HDD companies is clearly a positive development for the industry on a whole as HDD market share is now distributed among just three players- Seagate, Western digital and Toshiba coming in at a distant third. We believe that we would see an increasing shift in focus from gaining share to growing profits in the coming time. We expect that the improving pricing dynamics will yield higher and more consistent levels of profitability for Seagate compared to previous cycles.
Catalysts in Place with share buyback and Windows 8 Launch:
Despite the June quarter top-line miss, Seagate plans to return value to shareholders by increasing its quarterly dividend by ~30% to $0.32 a share and intends to reduce its share count by 40% over the next ten quarters. We believe this emphasises management’s confidence in the company’s ability to generate incremental FCF and we see buybacks as a catalyst for the stock moving forward.
Furthermore, Seagate is one of the many companies which will be benefitted by the launch of Microsoft’s (NASDAQ:MSFT) Windows 8 and we believe that windows 8 traction could act as a potential catalyst going forward.
The bottom Line:
Seagate is at the low end of their historical valuation range as it trades at a dismal forward PE of 4.68 consensus estimates. While macro headwinds and “SSDs” pose concerns, we believe both are largely reflected in the numbers and find current valuations attractive. We believe that the current industry dynamics provide a window of opportunity for long term investors and rate Seagate as buy.
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