Bad News and Good News for Seagate


Hard drive manufacturer Seagate Technologies (NYS: STX) recently announced some bad news. Revenue and gross margin missed projections for the quarter ending in June. I think this is just one of several examples, though, where bad news contains good news for the company. Let's take a look.

Missing the target

Missing revenue and gross margin estimates is certainly bad news. But why were these numbers missed?

Steve Luczo, Seagate's chairman and CEO, provided two reasons. First, he said that the company "reduced shipments in response to the industry's faster-than-expected recovery from their supply chain disruption." Translation: Seagate overestimated its selling advantage after last year's flooding in Thailand.

Seagate wasn't as badly impacted as chief rival Western Digital (NYS: WDC) during the 2011 floods in Thailand. As a result, the company was able to sell more of its products for a while. That window of opportunity looks to be closed now. This seems to be the ending of unexpected good news for Seagate rather than overtly bad news.

The second reason given by Luczo for the missed numbers was that Seagate "experienced an isolated supplier quality issue" that impacted enterprise product shipments by around 1.5 million units. According to Luczo, the issue has been resolved. In this case, Seagate had temporary bad news that doesn't appear to have long-term implications.

My opinion is that we can miss the target ourselves by reading too much into Seagate's overestimated numbers.

Dinosaur technology

Another piece of bad news for Seagate is that it is primarily a hard disk drive (HDD) manufacturer at a time when many are enthralled with the rise of solid state drives (SSD). SSD technology offers several advantages over HDD, including energy efficiency and speed. The popularity of hand-held devices, like smartphones, has driven much of the growth for SSD technology.

Is Seagate a purveyor of dinosaur products destined for extinction? I don't think so. For one thing, the rapidly increasing need for data storage should continue to be a catalyst for HDD sales. The economics favor HDD for the next few years, at least.

Also, Seagate isn't allowing the changing world to pass it by. The company developed a hybrid solid state drive that provides near-SSD speeds at a significantly lower cost. It also acquired the HDD business unit from Samsung, which Seagate believes will allow it to better compete in the mobile, cloud, and SSD markets.

To call Seagate a dinosaur technology vendor seems off-base. But, then again, plenty of money is made off dinosaur technology. Just ask the oil companies.

Cheap for a reason

Some investors look at Seagate's numbers and think that a stock this cheap must be a value trap -- cheap for a bad reason. Seagate is definitely cheap. Its forward P/E is barely over three, and its price-to-sales ratio is 0.81. Is there a negative reason that Seagate is this inexpensive?

I suspect that the primary reason is the dinosaur technology fears mentioned above. Primary HDD competitor Western Digital also looks inexpensive, with a forward P/E of less than four.

SSD manufacturers aren't as cheap. Fusion-IO (NYS: FIO) trades at a forward P/E multiple of 63. Fusion-IO became the first company to achieve one billion input and output operations per second earlier this year. That's a significant accomplishment.

Sandisk (NAS: SNDK) has a less stratospheric forward P/E of 10. LSI (NYS: LSI) trades at a forward P/E multiple of seven. Neither of these companies garners the buzz of Fusion-IO, but they both are still more highly valued than Seagate and Western Digital.

Whether Seagate is a value trap or not depends whether you think there's a future for HDD, and if you think Seagate can adapt to changing technologies. To me, the answers are in Seagate's favor. I see value rather than value trap.

Driving solid

Even with bad news about missed estimates this quarter, Seagate expects to report record revenue and unit shipments. That's good news -- and there's more. Seagate is still sitting on $2 billion of cash and short-term investments after buying back around $1.2 billion in shares. The company pays a dividend with a 3.9% yield.

The best investing bargains are found in stocks that are cheap, yet still have great potential. Seagate belongs in this club, in my view. This is one inexpensive stock that I think will drive solid profits for investors over the long run.

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Fool contributorKeith Speightshas no positions in the stocks mentioned above.The Motley Fool owns shares of Western Digital and Fusion-io. 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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