Seagate Technology Plc (STX) is scheduled to announce its fourth quarter 2011 results on July 20, 2011 and the modest revision in estimates reflects some key changes in the company’s future business prospects.
Third Quarter Overview
The company reported dismal third quarter 2011 results. Earnings per share (EPS) of 25 cents missed the Zacks Consensus Estimate of 27 cents. The third quarter earnings were also below the year-ago quarter level.
Seagate reported revenue of $2.70 billion in the third quarter, down 11.6% from $3.05 billion in the year-ago period. The quarter’s revenue was in line with the higher end of the company’s guided range. The company shipped 49.0 million disk drive units in the third quarter, compared with 50.3 million units in the year-ago quarter. The decline in shipments was due to preferential shift toward flash drives from traditional hard drives.
Operating income on a GAAP basis was $179.0 million, down 68.0% from $560.0 million reported in the year-ago quarter. The GAAP operating margin was 6.6% compared with 18.4% in the year-ago quarter. Excluding restructuring charges and amortization of purchased intangible assets, non-GAAP operating income was $182.0 million, down 68.2% year over year. Non-GAAP operating margin was 6.8% versus 18.8% in the year-earlier quarter.
Cash, cash equivalents, restricted cash and short-term investments totaled approximately $2.58 billion at the end of the March quarter, down from $2.91 billion in the previous quarter. Accounts receivables remained flat sequentially at $1.39 billion and inventories increased $26.0 million from the previous quarter to $834.0 million.
Agreement of Analysts
Out of the 29 analysts providing estimates for the third quarter, five analysts revised their estimates upward over the last thirty days. Out of the eighteen analysts providing estimates for next quarter, five analysts increased their estimates in the last thirty days while none moved in the opposite direction. For fiscal 2011, four analysts made upward revisions while for fiscal year 2012, 2 analysts made upward revisions, with two others moving in the opposite direction over the last thirty days.
Some analysts believe that pricing is a real positive factor, with stability in the channel perhaps spilling over into OEM negotiations for the next quarter. Pricing has been firm in the channel throughout the quarter, while price increases have been staggering over the last several weeks, resulting in flat to slightly up channel pricing on an absolute basis versus expectation of normal sequential declines. In addition, it appears that HDD vendors will attempt to stabilize pricing with OEM customers for the upcoming September quarter. This will likely ensure that demand forecasts remain in line with expectations.
Some analysts believe that by the end of September, TAM is expected to be roughly 165M with upside possible to 170M if components are available. Pricing will likely rise for OEMs once again due to constraints, partly mitigated by stable conditions in the channel. Moreover, the analysts also expect GM to rise sequentially for STX and WDC.
Some analysts also expect the full year HDD between 3-5% compared with the earlier projection of 7%. Moreover, the Seagateestimates are also revised for an assumed slower buyback level until the Samsung (N/R) acquisition is completed.
Both Seagate and WD announced this week that EU intends to conduct more in-depth review of their proposed acquisitions of Samsung and HGST. We note that this was fully expected, and that even with the additional reviews, the deals remain on track to close by the end of this year.
Moreover, the analysts also believe that Seagate’s June quarter will be strong, with solid upside potential unless any major issues arise in June . It is expected that Seagate will capitalize on the ongoing industry consolidation, although there is some fear that Seagate’s free cash flow potential may be affected post-merger. Some are of the opinion that Seagate should be able to expand margins and deliver very attractive ROIC.
Magnitude of Estimate Revisions
Since the third quarter earnings release, the magnitude of revisions has been modest. Overall, estimates for the upcoming quarter inched up to 24 cents from 23 cents in the last 30 days while the Zacks Consensus Estimate reduced by 4 cents over the past 90 days.
For fiscal 2011, estimates have increased from $1.18 to $1.19 over the last 30 days.However, estimates have dipped by 6 cents in the last 90 days. For 2012, estimates have gone down from $2.00 to $1.93 over the last 90 days, while it reduced by 2 cents over the last 30 days.
Recommendation
We believe that Seagate’s strong foothold in the Enterprise SSD market will enable it to generate solid revenue growth in fiscal 2011 and beyond, which in turn will drive margins. Improving supply-demand balance in the HDD industry will also act as a catalyst.
We also believe that the company’s decision to buyback shares and pay out dividend will be welcomed by income-seeking investors. But weakness in the consumer segment, price erosion, rising demand for flash drives and competitive pressures from Western Digital Corporation (WDC) keep us on the sidelines.
Currently, Seagate has a Zacks #3 Rank, implying a short-term Hold rating.
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