Board: Value Hounds
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 benefiting 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:
[See Post for Tables]
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.
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.
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.
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?