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What do folks think about Seagate (STX)? It’s trading at a PE of 5.3 with yield of 4% per Yahoo’s numbers. That looks pretty good from my vantage point. Is it a Cigar Butt or a real opportunity? With the expansion of the internet and cloud computing, even laptop computers are looking more and more like yesterday’s technology. Cloud computing, netbooks, tablets and other mobile devices look like the winners. Some are predicting that the hard disk drive (HDD) is destined to the same fate as the floppy drive. Techs like disk drive makers look like dinosaurs, with Solid State Drives (SDSs) getting more affordable and benefitting from greater speed. The list of defunct hard drive makers is startling. A Wiki page lists 88 defunct manufacturers. That same page says an estimated 200 companies filled the space at its height. They now list four: Seagate, Western Digital, Toshiba and Simmtronics. From two hundred to four. Is the whole industry a fly looking for a windshield?

A look at the financials of some of these companies tells a really different story though. There’s a compelling argument for value in these stocks. The three largest makers (Seagate, Western Digital and Toshiba) have consolidated much of the competition and the profitability of the remaining firms is actually rather impressive, once you get past the Buggy Whip bias. Seagate and Western Digital own the Lion’s share of the space, having just acquired Samsung’s HDD business and Hitachi’s HDD businesses, respectively. Seagate’s operations were less impacted than Western Digital’s giving them a competitive edge for FY 2012. There was a HDD shortage that helped pricing with Western Digital on the sidelines. Seagate posted net income of $2.86B in 2012 on $14.9B of revenue

I think it’s important to consider that the FY was helped along by Western Dig’s plight, but the numbers don’t look much like a Cigar Butt Consolidation may have helped this industry:

Year Revenue Net Income
2012 $14,939.00 $2,862.00
2011 $10,971.00 $511.00
2010 $11,395.00 $1,609.00
2009 $9,805.00 ($3,125.00)
2008 $12,708.00 $1,262.00
2007 $11,360.00 $913.00
2006 $9,206.00 $840.00
2005 $7,553.00 $707.00
2004 $6,224.00 $529.00
2003 $6,486.00 $641.00
2002 $6,087.00 $153.00
2001 $3,656.00 ($101.00)

All numbers in millions of $USD. That negative number in 2009 sticks out. Much, but not all of it was attributable to a non-cash charge off of goodwill. Excluding the impairment, Seagate lost $835M in 2009. It’s also significant that their fiscal year ends in June, so FY 2009 is July 2008 to June 2009. That wasn’t a fine vintage for anyone.

Margins tell a similar story of short term momentum. Seagate’s Gross margin was 31%, up from 20% in 2011. Profit margins jumped from 5% to 19%. At first glance, this can easily be attributed to the Thai floods having a lesser impact on Seagate’s production capacity. But, 2010 was also a good year, with 28% Gross margins and 14% Profit margins, and Gross margins sit around 20% for the prior decade with Profit margins in the 8-9% range:

Year Gr. Margin Profit margin
2012 31.4% 19.2%
2011 19.6% 4.7%
2010 28.1% 14.1%
2009 14.4% -31.9%
2008 25.2% 9.9%
2007 19.2% 8.0%
2006 23.2% 9.1%
2005 22.2% 9.4%
2004 23.4% 8.5%
2003 26.6% 9.9%
2002 26.2% 2.5%
2001 20.0% -2.8%

The terrible Profit margin for 2009 is the result of the impairment. The company IPO’d in 2002, so those early numbers are questionable for comps. Overall, it looks like the modest results of 2011 are the outlier, not the improved numbers of 2012.

There’s another factor driving the improvement, and that’s the acquisition of Samsung’s HDD business. Volumes were obviously up in 2012, but that boost was also geographically skewed. Sales in Asia improved dramatically. Samsung had made good inroads into China, so Seagate’s revenue mix has shifted toward Asia with the acquisition of Samsung’s HDD business:

Year Units Americas EMEA AsiaPac
2012 224 26% 19% 55%
2011 199 29% 20% 51%
2010 193 26% 22% 52%
2009 163.8 28% 27% 45%
2008 182.6 30% 27% 43%
2007 159.2 30% 27% 43%

Units are in millions and percentages are a percentage of total revenue. The move towards China and greater growth opportunities is interesting, providing some opportunity for growth.

Seagate also pays a healthy dividend, which should help stimulate interest in the shares. Dividends in 2012 were $372M, a 13% payout ratio. There’s clearly room for increases here. Seagate is also actively buying back shares, retiring $2.4B worth of shares in 2012. And that’s not just offsetting options dilution. Share count has been on a downtrend since 2006, with only 2009 disrupting the trend:

Year Share No.
2012 396
2011 425
2010 470
2009 493
2008 485
2007 535
2006 576
2005 477
2004 460
2003 439

Counts are in millions of shares. As for the effectiveness of repurchases versus dividends, shares are definitely cheap. Plus, the dividend yield is far from stingy at 4%. They seem to be treating shareholders well in this regard.

Cash levels are more than comfortable with $2.1B in cash and short term investments. They do have significant debt, with $2.86B in long term debt used to finance acquisitions. Service cost is minimal with respect to cash flow though, and this is a high cash flow business. With $241M of interest expense, EBITDA coverage is 16 times 2012’s numbers and 11 times their 3 year average EBITDA. Debt is not a worry.

It seems like the market is very down on Seagate. Is this a Cigar Butt, a Value Trap or a legit opportunity? At a PE of 5.3 it’s cheap by any standards. With a 4% current yield and financials that seem in line with continued dividend and/or repurchase hikes it seems very cheap. Any opinions from the Hounds?

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If you haven't seen this thread you should:

Precis: Yes, SSDs (solid state drives) are cool, but the cloud is using spinning disks and will continue for many years. Price/bit for disks is significantly lower than for SSDs, so if portability isn't an issue disks are the way to go. Data storage in the cloud is expanding dramatically, so need for boring spinning disks will continue to increase. STX and WDC are a duopoly. Both likely to make money.


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I read somewhere within the last ten days that server farms will be replacing some RAM with flash memory to cut power consumption because the price of flash memory is dropping fast.

It's not a straight swap. The article talked about three different kinds of memory: RAM, flash memory and spinning disks (plus fast cache, etc.) and software that would help the server decide where to put what. Sorry, too technical for me to explain. The upshot is that the equipment in server farms could change a lot in the near future.

It makes sense than an industry as mature as disk drive should have consolidated into three or four manufacturers. The first disk drive was built over 50 years ago:

RAMAC 305, 1956

Those that remain are likely value plays, at least for a few more years.

Denny Schlesinger
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I work as a system admin at a hospital an our growth rate for storage is ~ 40%. Most of these are 2 TB SATA disk drives for storage of medical images. Access to all of this data is mostly sequential read/write. We even still use tape for older images. Flash memory is used for fast random access. Typically when I used to spec out storage for an application that was I/O intensive many disk drives were required to handle the I/O load. A fiberchannel 15K RPM drive can handle ~ 150 I/O /sec. A SSD can handle 10K - 20K I/O/sec on a single drive.
The drawback is that t5hey are still fairly expensive. Anyway I predict high growth in both SSD and conventional disk drives.
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Peter, the thread HH/Sean cited was what initially got me interested, so I'd say it pretty much was my investment thesis. The Mar13 $28 calls I got at the end of July won't be the last..... too bad there aren't longer expiries since the overall results I'm looking for should take a lot longer to come to pass.

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That was a good thread. The piece that I'm missing is the tech aspect. I don't have a background with computers beyond their use. It's hard to assess the chance that HDDs will go the way of the floppy without being in the IT field. There are a number of folks with that knowledge here, so I posted. Seagate could certainly move toward the SSD market longer term as well, mitigating that risk to some extent.

I can buy the argument that HDD obsolesence won't come soon and that cloud computing will boost storage needs, not reduce them. Data still needs to be stored, and cheaper solutions will always have a place. Even if HDDs are phased out longer term and/or margins compact, the fundamentals still seem to justify higher valuations. The numbers are compelling.

Buybacks alone will probably propel the shares and there's certainly potential for a dividend increase with such a low payout ratio. Have to watch out for a supply correction or price wars though, now that Western Dig is back to the party. I read one article talking about a bang-up Q4 for them (curiously they're on a June FY end as well). They have the Hitachi ops phasing in on their end. They're cheap in their own right. They also hold more cash and have less debt, but pay no divi as a downside. That divi is the friend of shareholders in out of favor stocks. Yield hunger helps hold them up. I think I like STX better, but haven't taken as close a look at WDC as I should yet.

STX seems like a pretty conservative pick at these levels with a lot of potential upside. Thanks for mentioning it to me. I was surprised at how cheap it was, especially after I read through the 10K.

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Yeah. I hope that most people ignore it until I'm fully loaded with it. :)

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Just to add my own two cents, based on casually following the retail market for some years.

Historically the price for the most popular drives had been pretty stable until the Thai floods. While the price per GB dropped, the GB per drive rose, so the sweet spot in terms of capacity for your dollars held around the same price range as capacity of the drives increased. In 2007 I was paying $53 for 160GB drives. In July 2011 I paid $60 for a 1TB drive.

The floods raised prices, and they have not returned to their old levels. The same hard drive I bought a year ago for $60 is now $100. This means that margins have improved considerably. With only three remaining manufacturers it is worth considering whether any of them is likely to reduce those margins to increase market share. If none are ready to cut prices, and ongoing high demand for disk capacity gives them little incentive to do so, those improved margins will be around for a while.

RH in CT
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What do folks think about Seagate (STX)? It’s trading at a PE of 5.3 with yield of 4% per Yahoo’s numbers. That looks pretty good from my vantage point. Is it a Cigar Butt or a real opportunity?

5 times earnings look great, and I think this is a good investment, but the problem I see is that those $2.8 billion in earnings last year were by far their highest ever earnings, in a year when their major competition was hurting because of Thai flooding. Yes, STX was hurt too, but not as badly. $500 million is their average earnings level in the last 5 years, so that would put them at more like 30x earnings.

Now the business has improved, with consolidation, and we may not get another financial meltdown in the next few years. Plus, the trends are in favour of sustained high demand for storage, and most of that will be traditional storage that STX makes. So I think this is a growth investment, maybe 10x sustainable earnings, and those earnings should grow quickly, but as an investment, it masquerades as a deep value investment of a technology that is going out of business at 5x earnings. If you believe the growth hypothesis (as I do), then it is a great deal. If you think the technology is on its way out, then as a cigar butt it is not a good deal at all, since last year's earnings were an anomaly that will not happen again.

Regards, DTM
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Flash memory disk drive post at NPI:

Something that turns flash memory into the cost effectiveness of hard drives!

Denny Schlesinger
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