Sunday, April 22, 2012

Material share buybacks, pricing power due to industry consolidation and strong fundamental provide substantial upside to Seagate (STX) shareholders

This article is a summary of what I read online on Barron's and my own research. I thought this was interesting to point to readers looking at firms with material buybacks and fundamental trades. The valuation, like those published exclusive on seeking Alpha, is not mine.
  • Seagate Technology PLC (STX) - Currently trades at $29.00
  • Potential Upside by Industry Estimates: Approx. $10-$15 per share
  • Market Capitalization: $13.11B
  • Cash: $2.05M; Total debt: $2.86M
  • Shares Outstanding: Approximately 448M
  • Dividend Yield: 3.5%; Operating Margins: 16.89%
  • Sector: Technology; Industry: Data Storage Space
  • Main Catalyst:  Pricing power, share buybacks, Upside from industry consolidation, long term contracts, strong fundamentals

What does STX do?
     Seagate Technology plc (Seagate) designs, manufactures, markets and sells hard disk drives. Seagate produces a range of disk drive products addressing enterprise applications, where its products are designed for enterprise servers, mainframes and workstations; client compute applications, where its products are designed for desktop and notebook computers, and client non-compute applications, where its products are designed for a range of end user devices, such as digital video recorders (DVRs), personal data backup systems, portable external storage systems and digital media systems. In addition to manufacturing and selling disk drives, the Company provides data storage services for small- to medium-sized businesses, including online backup, data protection and recovery solutions. The Company sells its disk drives primarily to major original equipment manufacturers (OEMs), distributors and retailers. (Source: Google Finance)

Disk drives are data-storage devices widely used in desktop computers, notebooks and servers. While annual industry unit sales top 600M, generating over $30B, STX a rare find in an improving industry trades for just three times earnings. Seagate dominates the disk-drive industry, along with Western Digital (WDC). Sales of Seagate disk drives are benefiting from tightness in the market after extensive flooding in Thailand last year hurt competitor Western Digital. Seagate shares, at $29, trade for approx. four times a projected profit of $6.28 a share in its current fiscal year, which ends in June, and three times the $8.52 expected in fiscal 2013.Seagate looks appealing because of its super-low valuation, strong market position, and shareholder-friendly management, led by CEO Steve Luczo.

Potential Catalysts:

Share buybacks and strong dividend yield:
The company has a 3.8% dividend yield, having boosted its payout 39% in January. Another dividend boost could come in the next year. Seagate also is aggressively repurchasing stock. The CEO has said the company aims to cut its share count by about 25% in the current calendar year to 350 million shares. Investors can follow Seagate's buyback progress in almost real time on its Website because the company, which is domiciled in Ireland (although run out of Cupertino, Calif.), complies with Irish rules that require prompt repurchase disclosure. Seagate has stepped up its buyback lately, repurchasing 3.85 million shares in the first three days of last week.

Market Demand and Industry consolidation creating pricing power: Seagate is benefiting from tightness in the disk-drive market, caused by the massive flooding in Thailand last summer, which caused an estimated $45 billion in damage and knocked out a big part of Western Digital's production. Seagate's factories were unscathed, although it was affected by component disruptions from suppliers. Why does Seagate trade so cheaply? Wall Street is skeptical that the good times will last beyond this year and believes that the disk-drive industry, which has a history of low margins and fierce price competition, will return to its bad old ways. However, one key positive that they ignore is the industry consolidation. A decade ago, there were eight major manufacturers. Now there are three, down from five last year. In December, Seagate paid $1.4 billion in stock and cash for the disk-drive operations of the No. 5 player, Samsung (005930.Korea). And this year, Western Digital bought the business of the No. 3 maker, Hitachi (6501.Japan). The only other independent producer is Toshiba (6502.Japan). Seagate and Western Digital both have a roughly 43% market share, which bodes well for firm pricing. In addition, the Thai floods created a temporary shortage of disk drives that may persist until the end of this year.

Benefits from long term supply contracts and incremental demand for storage: Rather than push up tabs quickly, Seagate has opted to ink long-term supply agreements with key customers like Dell which means better prices for a longer period. Some investors worry about the increasing competition that disk drives face from solid-state memory, like that used in Apple's iPad and other devices, including ultrabooks. Add to that doubts about the future of personal computers. But industry analysts argue that storage demand is growing sharply, thanks to an explosion in mobile and PC-generated content, and that disk drives will supply part of that need. The CEO has even talked about a scarcity of storage capacity. This could support double-digit annual growth in production. PC disk drives, which cost under $100, are a cheap source of data storage, costing a fraction as much as solid-state memory.

Strong Fundamentals:
Some industry analysts see plenty of upside in Seagate, with some carrying a $40-$45 price target and a Strong Buy rating. They say that the STX valuation is "absurd" and that the disk-drive stocks represent one of the "best plays" in technology outside of Apple (AAPL). There is also a belief that firm will generate strong cash flows in the next quarters, with few tech companies returning so much cash to shareholders in the coming year, relative to their market value. Seagate sees $20B of revenue this calendar year, up from $11.5 billion in 2011. CEO's bullish guidance for the March and June quarters bolstered the stock at the time of his February conference call. While he didn't provide earnings projections, his guidance on revenue and margins enabled analysts to come up with profit estimates. The Street sees $2.09 a share for the March quarter and $2.58 for the June quarter. Investors are eagerly awaiting third-quarter results, to see if Seagate is delivering. Industry estimates that Seagate trades for just 2.4 times forward EBITDA, which is one of the lowest valuations among major tech outfits. It should also be noted that Industries in transition can be profitable because the markets value them very cheaply. Seagate shares seem to be reflecting fear of a profit collapse; that seems too dire a scenario, given the disk-drive business's consolidation, which should lead to better long-term pricing and margins. Even if Seagate's annualized profits drop to $5 to $7 a share, the stock looks inexpensive.And with no need for acquisitions, given its dominant position, Seagate is apt to continue repurchasing stock and may further boost its dividend—a great combination for investors.

The disk-drive industry's two giants trade at tiny multiples of their expected earnings.

Mkt Val (bil)
Seagate Tech/ STX
Western Digital /WDC