Seagate: Weak Storage Demand To Continue Through First Half Of 2016

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Seagate Technology (NASDAQ:STX) announced its Q2 FY 2016 earnings late last week, reporting a 19% year-on-year decline in net shipments to 45.9 million units. Correspondingly, the company reported a 19% annual decline in revenues to just under $3 billion. [1] The decline was largely driven by sustained weakness in the PC market, which led to low product shipments – a trend which consistent over the last few quarters. Moreover, the enterprise storage segment also observed low product sales after witnessing solid growth through fiscal 2015. Seagate’s consumer electronics and branded product sales (mostly sold via the retail channel) faced relatively moderate year-over-year declines through the year. [2]

After a sustained period of weakness in the storage industry coupled with surprisingly low enterprise unit shipments by Seagate in the second half of the year, Seagate’s stock price fell by over 50% through 2015. We are in the process of revising our price estimate for Seagate.

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See Our Full Analysis For Seagate’s stock

Enterprise HDD Shipments Stay Low In Fiscal 2016

Seagate’s enterprise storage unit shipments were particularly high through fiscal 2015, with unit shipments rising by almost 14% y-o-y to 35.2 million units. However, unit shipments fell by over 11% y-o-y to 7.8 million units sold through the Q1 FY’16 ended September. The trend continued through the December quarter, with unit shipments falling by 10% y-o-y to 8.1 million units. Demand for enterprise storage was low through the quarter owing to a relatively compact and concentrated OEM customer base, leading to higher susceptibility to variable demand. The resulting volatile demand led to lower shipments and higher inventory levels. Despite low shipments, the company reported a 6% gain in the total capacity shipped in the enterprise segment to 17.7 exabytes (1 terabyte = 1 billion gigabytes). [3]

Seagate successfully launched the the 10TB 3.5″ form-factor enterprise capacity HDD and the 8TB network-attached storage hard disk drives in the December quarter. The company expects the demand for high-capacity enterprise storage units to pick up in the coming quarters. Growth is likely to come from hyperscale deployments for data science applications and machine-to-machine data creation in addition to unstructured data in the form of high-definition video and other content created globally. As a result, the company expects a 35% annual growth in data storage capacity or “exabyte growth” for enterprise storage. [4]

PC & Laptop Shipments Plummet In 2015

The PC market has been exceptionally weak over the last few quarters, owing to the anticipated mid-year release of Windows 10. According to IDC, PC shipments fell by almost 11% y-o-y to 276 million units through 2015. [5] This was the first time since 2008 that shipments fell below 300 million units. This translated to low PC and notebook hard drive sales for hard drive makers through the year. Seagate’s PC and notebook HDD shipments combined fell by over 23% on an annual basis to 111.7 million units for the full year. Seagate witnessed a nearly 30% decline in desktop and notebook HDD shipments to 25.3 million units in the December quarter. Similarly, rival hard drive maker Western Digital (NASDAQ:WDC) observed a 24% and 21% year-over-year decline in PC shipments to 27.8 million and 114.7 million hard drives for the quarter and the full year, respectively. Going forward, it is likely that PC shipments don’t pick up immediately and begin to stabilize from 2016 onwards. [6]

Margins Take A Hit

Seagate’s consolidated gross margin (GAAP) in the December quarter stood at 24.8%, which was about 3 percentage points lower than the prior year period. Similarly, the gross margin for the full year was about 2 percentage points lower than the previous year at just under 26%. On a non-GAAP basis, Seagate’s gross margin for the quarter was around 25.6%, which was lower than the long-term targeted margin range of 27-32%. Low demand for PC storage coupled with weakness in the enterprise storage sales through the quarter led to pricing pressure and margins to decline.

Going forward, management expects revenues to be around $2.7 billion for the March quarter, which translates to a 19-20% year-over-year decline. On the other hand, a rise in prices across certain markets and supply chain optimization (such as reducing manufacturing capacity) could help drive margins in the coming quarters. Gross margins are expected to be flat sequentially in the March quarter and subsequently improve by Q4 FY’16. Seagate intends to bring back its non-GAAP gross margin within the 27-32% range by the June quarter. [3]

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Notes:
  1. Seagate Technology Reports Fiscal Second Quarter 2016 Financial Results, Seagate Press Release, January 29 []
  2. Seagate Fiscal Q2 2016 Supplemental Information, Seagate Press Release, January 2016 []
  3. Seagate Q2 FY 2016 Earnings Call Transcript, Seeking Alpha, January 2016 [] []
  4. Seagate Q1 FY 2016 Earnings Call Transcript, Seeking Alpha, October 2015 []
  5. PC Market Finishes 2015 As Expected, Hopefully Setting the Stage for a More Stable Future, According to IDC, IDC Press Release, January 2016 []
  6. PC Sales Are Imploding, Business Insider, July 2015 []