This Just In: Upgrades and Downgrades
At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
And speaking of the best ...
The fallout from Dell's (NAS: DELL) disastrous fiscal first quarter continues. (And while Mr. Market treated Hewlett-Packard (NYS: HPQ) more kindly, the truth is that HP really didn't do much better.) As with many things radioactive, it's best not to get too close to the glowing stuff.
In illustration of which, yesterday, ace Brit mega-banker Barclays announced it's pulling its buy ratings on two companies that have hitched their fortunes to the PC industry: hard-disk-drive makers Western Digital (NYS: WDC) and Seagate (NYS: STX) . According to Barclays, Dell's and HP's (and others') reports imply "tepid" demand for PCs. The banker believes this will prompt production cutbacks in personal-computer manufacturing -- and, consequently, weaker demand for the hard disk drives that go into these never-to-be-built PCs.
Who's to blame?
By now it should be obvious: The primary culprit for this development is a certain company whose name rhymes with "Snapple," whose popular tablet computers are sapping demand for traditional laptop and desktop PCs. However, this isn't a story about "Snapple," but rather the companies losing sales to it.
So long as tablets continue rising in popularity, Barclays fears Western Digital and Seagate shares will remain "range-bound" as investors wait to hear whether the situation might improve in September through December. The best Barclays can say about the hard-drive makers, therefore, is that they're worthy of an "equal weight" (i.e., "hold") rating.
Bad news for Seagate and Western D. Worse news for...whom?
And don't expect the damage to end there. If Barclays is down on Western Digital and Seagate, chances are it's going to start having second thoughts about companies further up the supply chain as well. Indeed, just yesterday, we saw rumblings of Barclays' disquiet in its decision to cut its target price on LSI Corporation. LSI, as you probably know, makes semiconductors used to control the hard disk drives that Western Digital and Seagate build.
It seems logical that similar reservations might soon surface with regard to rival HDD-related chipmakers such as STMicroelectronics or Marvell Technology (NAS: MRVL) -- a stock that I've lately become less enthusiastic about myself. What's more, these latter downgrades, if they come, would have more merit to them than the ones Barclays has already issued.
Why do I say this? Simply put, because Barclays is far too pessimistic about the prospects for Western Digital and Seagate (and perhaps not pessimistic enough about STMicro, Marvell, and LSI).
Consider: Barclays' skepticism notwithstanding, most Wall Street analysts agree that Western Digital is likely to grow earnings north of 20% per year for the next five years, while Seagate could grow even faster. Yet at P/E ratios of just 7.7 and 5.7 times earnings, respectively, Western D and Seagate are both priced for long-term growth in the mere single digits.
Now, the analysts could be wrong about that. Barclays could be right that growth will slow. But the discrepancy here is so huge that the other analysts would have to be very wrong about the companies' prospects -- and Barclays even more right than in its worst nightmares -- for Western Digital and Seagate to be anything but screaming "buys" at today's prices.
Valuation still matters
In contrast, there's less room for error with the HDD companies' semiconductor suppliers. Sure, on the surface the stocks don't look expensive. LSI costs only 10 times earnings, while Marvell's a bit pricier at 14 times, and STMicro at 15 times. But here the case is less clear-cut.
Behind LSI's strong GAAP earnings lie weak free cash flows, while STMicro is actually burning cash. And Marvell, although a strong cash-producer, boasts one of the slower growth rates of the group -- just 14%. That's a fair price to pay if growth goes as planned. But if Barclays is right and a slowdown in PC manufacturing foreshadows weaker results in HDD manufacture -- and on up the supply chain to the semiconductor makers -- Marvell, too, might turn out to be overpriced.
The numbers here have me re-evaluating my previous opinions of the PC industry suppliers. Based on where things stand today, I'm pulling my CAPS endorsement of Marvell -- but I'm doubling down on Seagate and Western Digital. Unlike Barclays, I think both of these companies are long-term winners. Other Fools think there are better options in the semiconductor industry, such as the stock featured in our recent report on "The Next Trillion Dollar Revolution." As for me, though, I see better bargains in Western Digital and Seagate. That's my opinion, and I'm sticking to it.
Will these calls pan out? Follow along and find out.
At the time this article was published Fool contributorRich Smithdoes not own shares of, or short, any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 345 out of more than 180,000 members. The Motley Fool owns shares of Apple.Motley Fool newsletter serviceshave recommended buying shares of Apple.Motley Fool newsletter serviceshave recommended creating a bull call spread position in Apple. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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