Gateway to the Digital Age

02/09/2010 12:00 pm EST

Focus: STOCKS

Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says data storage has become more critical as consumers use more technology, and he likes one leading device maker.

Seagate Technology (NYSE: STX) supplies hard disk drives (HDDs) for the enterprise storage, personal computer, and consumer electronics markets. STX generates half of its sales in the Asia Pacific region, 26% in North America, and 24% in Europe.

Demand for data storage hardware has been robust as more consumers create, share, and store increasingly rich digital content such as digital photographs, music, videos, and other multimedia files.

The expanding availability of broadband Internet and increased emphasis on backing up data are also fueling demand. HDD volumes were historically tied to personal computer sales. More recently, demand is being driven by consumer electronic devices.

Desktop storage drives accounted for half of fiscal second-quarter unit volume. They include the Barracuda and DiamondMax product families of 3.5-inch drives with up to 2.0 terabytes (TB) of capacity delivered at up to 7,200 RPM.

Mobile computing drives, sold under the Momentus brand name, accounted for 30% of unit volume. They are designed for notebook computers, tablet computers, and digital audio devices. They have up to 640 gigabytes (GB) of memory capacity and speeds of up to 7,200 RPM. Enterprise storage products were responsible for 9% of unit volume.

Finally, drives for consumer electronics produced 11% of unit volume. These drives are installed in digital video recorders, video game consoles, home electronic entertainment devices, and other consumer products.

STX also sells branded external backup storage devices. Original equipment manufacturers generated 64% of net sales [in the fiscal year ended June 2009]. Distributors and retailers accounted for 27% and 9% [of sales].

[Recent] price increases, along with cost cuts and a rebound in demand, produced stellar profits. Fiscal second-quarter net sales jumped 33.3% year over year to $3.03 billion. STX shipped 49.9 million units, up 35.8%. The gross profit margin surged to 30.49% from just 13.92% a year earlier. Pro forma net income was $543 million, or $1.05 per share, easily beating the consensus estimate.

Investment risks include the weak economic climate and further deterioration in consumer and business spending trends, an oversupply of product due to improper demand forecasts, and the increasing popularity of solid state drives (SSDs). However, because SSDs are significantly more expensive than hard disk drives, they are not likely to pose a serious challenge in the near term.

Gross margins in the fiscal third and fourth quarter may fall from the fiscal second-quarter level, but the [fiscal 2010] figure should surpass management’s 22% to 26% target. The company is forecasting $2.9 to $3.1 billion in net sales for the fiscal third quarter and 90-94 cents in per share earnings. Long-term prospects are attractive as digital content grows in popularity and broadband Internet connectivity expands.

(The stock closed above $18 Monday—Editor.)

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