Western Digital vs. Seagate Technology: Which Is Better?

by Will Ashworth | July 1, 2013 11:04 am

Hard-disk drive manufacturers got a helping hand from analyst upgrades[1] last Thursday, and as a result, Western Digital (WDC[2]) and Seagate Technology (STX[3]) saw their shares get a respectable boost on the day.

With the PC market in the dumpster, it’s hard to comprehend how a couple of old-school tech companies are doing so well. But given the upgrades and stock performance, investors have to be wondering which stock is the better buy.

While the details of the technology are an important piece of the puzzle in their own right, today I want to focus on financials, stock performance and the outlook for the next 12 to 24 months. Being a relative outsider, I’m not likely to favor one or the other by analyzing the facts, not out of some emotional attachment.

Western Digital 

Of immediate interest is Western Digital’s June 24 announcement that it was acquiring sTec (STEC[4]) for $340 million in cash. I might be a technology neophyte when it comes to data storage, but everything I’ve read indicates that the future is in solid-state drives. Right now, cost considerations continue to make HDD products a bigger revenue generator, but that’s obviously going to change in the coming years.

When WDC acquired Hitachi Global Storage Technologies in March of last year for $3.7 billion in cash and $877 million in stock, it gained a strong platform into the enterprise SSD business; the sTec acquisition accelerates that growth.

The company had some good points and bad points in its fiscal third-quarter report. The top line was very positive in Q3, with revenue growing 24% to $3.8 billion thanks to a 36% increase in the number of units shipped — most of which came from a full quarter with HGST in the fold. Unfortunately, while Western Digital’s gross profit increased by 9%, its margin declined by 400 basis points year-over-year, providing very little additional gross profit despite the acquisition.

Further down the income statement, WDC showed an 11% decline in operating profit (excluding $63 million in employee termination benefits), due primarily to higher R&D and SG&A expenses incurred with the addition of Hitachi Global Storage.

On a positive note, WDC added $727 million in cash in the quarter ending March, bringing net cash to $2.1 billion. Assuming that the company will find ways to move the bottom line in future quarters, its rating likely will rise in subsequent quarters.

Right now, the stock is sitting less than 5% from its five-year high of $65.26 and is up nearly 50% year-to-date. With the exception of 2008, when its total return declined by 62%, it has had a very good run the past decade. Even with the Q3 decline in earnings per share, it looks as though WDC will earn well more than $8 per share for fiscal 2013 and right around the $8 mark in 2014.

As Joseph Wittine of Longbow Research suggested in his upgrade, WDC is trading considerably below its historical forward price-to-earnings ratio of 10. I have to think any downside at this point is relatively insignificant.

Seagate Technology

STX hit an all-time high of $45.50 last Friday and is up 48% year-to-date. In recent years, Seagate’s stock has performed better than WDC; however, if you look at the longer-term — say the last decade — WDC is the stronger of the two.

Of course, both are on fire now, and I doubt the momentum’s going to end anytime soon.

Seagate’s third quarter turned out better than analysts expected. The company shipped 5 million fewer units at an average selling price $10 lower than last year’s Q3, dropping revenues by 21%. (The revenue drop was anticipated, given the surge in prices in 2012.) Even though Seagate’s gross margin of 27% was 120 basis points lower than WDC, it managed to generate an operating margin of 13% — 190 basis points higher. The same holds true for the first nine months of the year.

When Seagate announced its Q3 earnings, CEO Steve Luczo mentioned that the cloud continues to play a big part in its business — 20% of the company’s revenues came from drives shipped to cloud customers. Based on this business, Luczo was enthusiastic about the fourth quarter and everything through 2014.

Regardless of what happens with SSD, HDD will continue to carry the lion’s share of the work load when it comes to data storage. In this respect, both companies will continue to do very well considering they control about 88% of the HDD market.

Verdict

In terms of valuation, there’s almost no difference between the two companies. Both are trading around eight times their forward P/Es and are undervalued when compared to the market as a whole. However, Western Digital has $2 billion in net cash compared to Seagate’s $569 million in net debt. When push comes to shove, I always go with the more conservative balance sheet.

For that reason, I believe Western Digital is the better buy.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

Endnotes:
  1. analyst upgrades: http://blogs.barrons.com/techtraderdaily/2013/06/27/wdc-stx-rising-longbow-ups-to-buy-hard-drives-grow-beyond-pc-market/
  2. WDC: http://studio-5.financialcontent.com/investplace/quote?Symbol=WDC
  3. STX: http://studio-5.financialcontent.com/investplace/quote?Symbol=STX
  4. STEC: http://studio-5.financialcontent.com/investplace/quote?Symbol=STEC

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