Seagate’s Revenue Declines But Improving Outlook Lifts Shares

Seagate Technology (NASDAQ:STX) announced its Q3 FY 2013 earnings on May 1, where it reported total revenues of $3.5 billion, a 21% year-over-year (y-o-y) decline. ^[1] Revenues declined mainly due to lower shipments and average selling prices (ASPs). The storage company shipped a total of over 55 million units during the quarter down from nearly 60 millions it shipped in the same period a year ago. ^[2] While the company experienced significant weakness in the PC and notebook market in Q3, all other divisions showed yearly growth driven by storage demand from cloud computing and growth in digital content.

However, what came to rescue for the storage company was a better product mix and improvements in high-end enterprise and consumer storage devices. This resulted in better pricing than many had feared, helping the storage company in beating market expectations. Average selling price (ASP) per hard drive was over $63 in the quarter, down from $73 a year ago, but in line with Q2’s ASP. ^[2] Gross margin declined to below 27% from around 37% a year ago but was better than expected due to a better mix of products and cost improvements. ^[1]

Seagate generated over $450 million in free cash flow even as it spent nearly $300 million and $220 million towards products development and capital expenditures, respectively. Overall cash and cash equivalents increased to $1.4 billion despite the fact that company returned 75% of its operating cash flow to shareholders and retired part of its debt early. The storage company expects Q4 FY 2013 revenues in the range of $3.3 billion to $3.45 billion due to a flat-to-slightly down total available market, coupled with a seasonal change in the business mix. ^[3]

We are updating our price estimate of Seagate, to reflect earnings and recent trends. Below we take a look at major growth drivers for the company.

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PC Sales To Pick Up, Seagate Readying Itself To Tap The Growing SSD Demand

While PC sales have been declining due to consumer softness in the mature markets, slowing demand from emerging markets and IT spending cuts amid a weak macroeconomic environment, the trend is expected to improve in the second half of 2013 as enterprises and retail users upgrade computers as spending recovers. ^[4] Further, users who have been delaying purchases due to weak consumer sentiment and the economic uncertainty could start spending more as the economy recovers.

However, this spending could come with a higher adoption of solid state drives (SSD). Currently, SSDs are at least twice as expensive as regular HDDs and this cost differential is still causing price-conscious customers and enterprises to prefer HDDs. However, going forward SSD production costs are likely to drop significantly due to an improvement in technology. This should boost demand of SSDs as the cost advantage of HDDs diminishes.

The other major reason for decline in PC sales was the cannibalization from tablets. We estimate that tablet sales will outstrip notebook and netbook sales by the end of our forecast period. All tablet computers use solid state (SSD) memory chips as their primary storage memory since HDD memory generally is comparatively unresponsive and bulky.

While Seagate was a little slow to adapt to changing trend in favor to the SSD space, it has been increasing its focus on SSD business to tap the growing demand. Last year, Seagate made investments in companies such as LaCie and DensBits to acquire expertise in the SSD and USB flash storage market. Seagate and DensBits are working on building “low-cost, high-performance” consumer SSDs. ^[5]

Further, LaCie has given Seagate access to an established consumer brand known for innovative designs. ^[6] According to recent earnings, approximately 4% of Seagate’s revenue is being spent towards maintenance of existing operations to support a broader product portfolio mainly hybrid and solid-state drives. Around 2% of revenue is going towards improving global R&D.

With the aforementioned acquisitions, its relationships with industry-leading original equipment manufacturers (OEMs), sales clout, and production facilities should help, Seagate could outpace the overall SSD market growth and see its SSD market share increase going forward.

Soaring Storage Requirement Presents Opportunities

Storage requirements are rising as evidenced by the fact that Seagate shipped over 47 exabytes of storage in Q3 with each disk averaging approximately 842 gigabytes. This is a 15% and 25% y-o-y growth in exabyte and average capacity per drive, respectively. This growth is being driven by the increasing use of high definition (HD) content for media consumption and rich formats such as HD DVD and Blu-Ray.

Further, the high growth rate of digital content is driving the need for high capacity storage to aggregate, host, distribute, manage, back up and use digital content. Tablet and smartphone users also consume more digital content like online video streaming, email and music. While many of these mobile devices are increasingly becoming dependent on network attached storage, tablets with USB ports are also looking at external drives for additional storage capacity. Seagate, being one of the market leaders in hard disk drive (HDD) market, will continue to benefit from this surge in storage demand.

In addition, remote storage is becoming a standard for most enterprises and has even gained traction with retail customers for services like iCloud, Dropbox, Skydrive and Google Drive. An increasing number of businesses are deploying cloud computing environments in an effort to pool resources and cut costs. The traditional enterprise and client compute markets will continue to demand high capacity storage solutions.

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1. 10-Q, SEC Edgar, May 02 2013 [↩] [↩]
2. Fiscal Q3 2013 Supplemental Financial Information, Seagate, May 01 2013 [↩] [↩]
3. Seagate Technology Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, May 01 2013 [↩]
4. Fitch Lifts Seagate’s Ratings into Investment-Grade Territory, WSJ, May 01 2013 [↩]
5. Seagate And DensBits Announce Strategic Agreement For Development Of Solid State Drives For Consumer And Enterprise Markets, Seagate, May 25 2012 [↩]
6. Seagate And LaCie Announce Exclusive Agreement With Intent For Seagate To Acquire Controlling Interest In LaCie, Seagate, May 23 2012 [↩]