The Data Effect – STX and WDC

The amount of information requiring storage is growing rapidly, which should continue to fuel demand for storage for years to come. Secular trends toward increasing storage requirements–the creation, sharing, and aggregation of digital content, data backup requirements, and the increasing use of storage in consumer electronic devices–have been a boon for hard disk drive makers in recent years. Industry shipments have grown by double-digit rates in each of the past eight years except 2009.

Seagate Technology –

In general Seagate’s revenue, 65%-75% comes from original-equipment manufacturers like Hewlett-Packard, Dell, and EMC; the balance is from distributors that resell to smaller firms, as well as retail stores. The company is the largest producer of mission-critical enterprise drives. It enjoys a market share of 50-60% in the enterprise segment.

But STX fails to match the margins of its competitor-in-chief Western digital. Off late Seagate has placed increasing emphasis on becoming a leaner company in hopes of emulating the low operating expenses of Western Digital. Significant upside to current operating margin levels exists if Seagate can successfully lower its selling, general, and administrative and research and development costs.

Valuations of STX

Following are the historical earnings and stock price for Seagate –

Year

EPS

High ($)

Low ($)

2007

1.39

28

20

2008

2.7

26

3

2009

-5.13

18

2

2010

3.34

21

9

2011

1.24

18

9

2012

6.24

 

 

2013

8.74

You can see from the above table that earnings are estimated to explode in next couple of years if the company sustains a margin of 22-26%. Even after flooding inThailand that disrupted the data storage devices industry, Seagate was able to generate excellent margins and sell units at premium of 68$ instead of historical average of 60$.

Let’s look at relative valuations.

P/E 13
P/E 5 Year Range 3-17
Forward P/E 3
ROE 22%
Cash Flow/Share 3
R&D Expense of sales 8%
Beta 1.30

Even after rallying 70% year to date this stock has a forward P/E of 3.2. On the basis of historical P/E and based on industry trend I am looking at stock price of 40$ in next 12 months, consensus is 35$. This means that STX has 50% upside from current level. The 2012 earnings of at least 6$ is substantiated by the numbers that we saw in latest quarter. Seagate’s second-quarter revenue of $3.2 billion was at the high end of management’s recently revised outlook, and the 31.6% gross margin was well ahead of its historical margins thanks to favorable hard drive pricing. Impressively, Seagate generated $576 million in free cash flow during the quarter, which is roughly triple its average quarterly free cash flow generation and substantially higher than the $421 million generated in all of fiscal 2011.

Finally the icing on the cake is the 3% dividend yield. The management has excellent return on equity track record and has repurchased shares from time to time.

Chart Time –

When to buy – You can add STX around 26.9-27.1$ and double it up if it goes down to 50 DMA i.e. 25.5$. The stock has good support at 24.5$ as well. So unless we see Mayan calendar effect or Ben Bernanke stops printing $, I suggest that you stay put.

Enter Western Digital –

This is another behemoth in the HDD industry. Western Digital has operationally outperformed its peers in recent years, having the lowest operating expense levels while being the industry’s most successful company in the M&A field during the past decade. With the acquisition of Hitachi’s hard drive unit, the company will become the world’s largest hard drive manufacturer by both unit volume and revenue. The Hitachi acquisition gives WD a major presence in the mission-critical enterprise market. Successful share growth here is likely to increase the firm’s gross margin profile.

Valuations of WDC

Following are the historical earnings and stock prices for WDC –

Year

EPS

High ($)

Low ($)

2007

1.94

31

16

2008

4.38

40

9

2009

2.54

44

11

2010

6.05

47

23

2011

3.28

41

22

2012

6.56

 

 

2013

8.71

This paints almost a similar picture as STX.

P/E 10
P/E 5 Year Range 3-13
Forward P/E 5
ROE 15%
Cash Flow/Share 5.89
R&D Expense of sales 7%
Beta 1.22

The earnings upside gives this stock a forward P/E of 5.7. Hence the consensus target price of this stock is around 60$. This is based on the assumption that the supply chain disruptions will be relatively short-term in nature, and there will be a significant snap-back in revenue and operating profits in 2013 as the firm benefits from the effects of recent industry consolidation.

On the contrary, the imbalance between supply and demand should allow Western Digital to maintain average selling prices at or near $65 per unit, down moderately from $69 per unit obtained in the current quarter. Western Digital has not seen average selling prices above $60 since 2007, and the current favorable pricing environment allowed the firm to generate record gross margins of 32.5% in the current quarter versus an average gross margin of 20% earned between 2006 and 2011. But again this is a short lived phenomenon and the prices will decline to historical levels as the supply settles.

Chart Time –

The Stock recently broke out from a 7 week base on above average volume but it will face tough time going above 48-50$.

When to buy – You can buy some around 41.5-42$ and add to the position if the stock goes to 39-40 which will also be the 50 DMA and hence providing good support to the stock.

Devil’s Advocate

Although these secular trends remain intact, emerging substitute technologies pose an increasing threat.

Solid-state drives, which use NAND flash memory, are the primary threat to hard drive manufacturers. NAND has distinct performance advantages over disk drive technology, including faster read/write times and lower power consumption.

The second major technology risk is the cannibalization of HDD by Cloud technology. The latest optical drives used in cloud technology by companies such as EMC is faster and smarter. I have personally worked on TIER1 and TIER2 VMAX storage of EMC. These devices have lower I/O wait times and faster reads/writes than standard HDDs. The device is adaptive in nature and optimizes its performance on the basis of the data it reads and writes – it evolves.

The bottom line is HDD industry will see a decline but maybe towards the other half of this decade. SSD technology currently costs between 5 and 20 times more than a disk drive on a cost/gigabyte basis.

Don’t write of HDD companies as yet

Though SSD costs are falling quickly, HDD costs are falling as well. Disk drive reductions are predominantly driven by increasing areal density, or the number of gigabytes that can be stored on a disk platter. During 2011-12, annual areal density gains of 20%-30% are expected, which alone will drive almost similar annual cost reductions on a cost/GB basis. These will occur because of refinements to perpendicular media recording, the current (and aging) generation of disk (media) technology that has led to large areal density gains during the past few years. Heat-assisted magnetic recording is expected to take the reins from PMR by 2013, and as a result, it is expected that 30%-40% annual increases in areal density are likely to continue in future years. The resulting cost reductions should be sufficient to keep SSDs on the fringes of the mainstream computing market for at least a few more years, given that annual NAND cost reductions are expected to be in the 35%-40% range during the next few years.

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Back from the dead?

Last night I pointed out that the poster stock of 2009 bull,BIDU, might be in for a rally. So I looked around, there are quite a few 2009 stalwarts that are coming back from dead e.g GS. Latest to join the band wagon might be AMZN.

Even though the revenue continued to grow at brisk pace, AMZN was hit by margin contraction in last quarter of 2011. The company has raised its capital expenditure – it is adding Distribution centers and is working on a gaint head quarter in downtown Seattle.

Another Stock that might be up for rally – BJRI.

The uptrend continues!

Adding to their six week winnning streak, the Dow gained 160 points +1.23% in today’s session.  The S&P 500 which gained +1.40% closed at its highest level since May of 2008.  The NASDAQ closed at its highest level since November of 2000. All this happenened after Federal Reserve Chariman Ben Bernanke reassured the market that the horizon holds nothing but low interest rates till 2014.

Advancing stocks led by 3 to 1 on both the NYSE and NASDAQ. Volume increased on NASDAQ by 14% and on NYSE by 2%.

The trend is up and even the laggard small cap index is showing signs of life. But it still needs to take out the highs of 2011, which is just 2% away, before it advances further.

Chart of S & P 500.

To add to all the fireworks we saw some good breakouts –

BIDU, a famous pre crisis name, might be making a comeback. It can easily reach 168$. Set a stop loss at 139$.

One more stock that I have been eyeing for some time – SWI

With a 3 year grwoth rate of 62%, this might be good breakout. I agree that TTM P/E=37 is on the higher side but the revenue and earnings growth lend good support to it.

Year EPS High ($) Low ($)
2007 0.21
2008 0.43
2009 0.66 24 12
2010 0.78 24 12
2011 1.04 33 18
2012 1.15
2013 1.37
Last 4 Quarters EPS % Change Sales (million) %Change Fund Owners
Q4 0.21 31% 43 25% 284
Q3 0.22 29% 45 29% 347
Q2 0.31 48% 54 31% 390
Q1 0.29 21% 55 34% 419

SolarWinds has created a highly profitable business by developing high quality, low-cost software products to serve the needs of small and medium-size business users of network, storage and virtualization management tools. However, the firm faces tough competition from larger, well-entrenched rivals. SolarWinds provides network management solutions to more than 95,000 customers, ranging from small- and medium-size businesses to Fortune 500 companies. Revenue is highly concentrated in the U.S., which accounted for 72% of total company sales in 2010.

This trade has good reward to risk ratio. I set a stop loss at 36.7$.

Another good name that popped up today that I missed altogether – TSCO (Tractor Supply Company).

 

Year EPS High ($) Low ($)
2007 1.2 28 17
2008 1.1 23 13
2009 1.63 27 14
2010 2.25 49 24
2011 3.01 78 45
2012 3.51
2013 4.12
Last 4   Quarters EPS % Change Sales (million) %Change Fund Owners
Q4 0.24 71% 836 18% 491
Q3 1.23 18% 1178 11% 527
Q2 0.58 45% 977 18% 589
Q1 0.96 43% 1240 20% 641

Tractor Supply is the largest operator of retail farm and ranch stores in the United States. The company targets recreational farmers and ranchers, and has very little exposure to commercial and industrial farm operations. As of June 2010, the company owned and operated 967 stores in 44 states, which includes 27 Del’s Farm Supply stores. Stores are typically located in towns outside of metropolitan areas and in rural communities.   

Also keep an eye out for two possible break outs –

 

 

Some good reads –

Hedge funds drop bearish bets (BL)

Are Euro concerns over (REU)

Intel, Qualcomm get more pie (IBD)

Hunger Games rakes in $155 million (MW)

FaceOff – China data vs US data

And the winner is China PMI. The Dow ended lower for a third consecutive session dropping 78 points as concerns mount over China’s manufacturing index being down for the 5th month in a row.  The S&P 500 lost 10 points today and the NASDAQ lost 12 points. This was despite the fact that new jobless claims fell more than expected last week, while an index of leading economic indicators for February rose more than forecast.

China’s manufacturing activity shrank in March for the fifth straight month, while manufacturing in the 17-member euro zone contracted more than expected, led by declines in France and Germany. This took toll on sectors such as energy, materials and industrial.

But despite all this we are still in bull as long as we hang onto 1370 in S&P 500. This current mild weakness in the averages is not unexpected given the magnitude of the market move from October of last year.  It would not surprise me to see continued short term sideways action over the near term or even a drop of 2% points.

So if you look at charts above 1370 will act as pivot point. The reasons are – you have previous high support, 50 DMA and the trend line support. Moreover the breakouts did not disappoint today – look at LNKD, WDC, ALLT and GNC. Surprisingly LULU reversed even after not so weak guidance. LULU might have lost it’s momo status.

Good Reads. Tons of them today –

China & Eurozone factories shrink (REU)

Another day of Copper beating (BL)

Keystone XL – Again! (BL)

US Economy and Sentiment (BL)

Hunger Games (MW)

Oil lower amid talk of tapping reserves (FIN)

Gold in tandem with China as well! (REU)

My Take on Market.

At close the Nasdaq eked out a fractional gain. The S&P 500 fell 0.2% and the Dow Jones industrial average ceded 0.4%. A disappointing report on home sales Wednesday didn’t seem to affect the market much, but the market slid in the final half-hour to close mixed. Existing-home sales slipped slightly in February to an annualized rate of 4.59 million units, just below expectations for 4.60 million.

I noticed few things today that struck a chord somewhere –

Reversals

Almost all the breakouts reversed today, some gave in their gains. Look at ALLT, FRAN, LNKD, ASGN, IWM, etc. Ok! ASGN might be an exaggeration;)

Not Ready to Party

OIH, oil service companies, some industrials that sport cheap multiples, and small cap stock index seem to be reluctant to join the band wagon of Nasdaq and S&P 500. OIH, $RUT, and companies such as CAT, CMI, F, etc have underperformed SPY and QQQ. In fact they have been flat for almost 20 sessions. The oil service company phenomena can be explained by cheap natural gas prices but what are rest waiting for. China PMI!

Divergence

There is divergence between stock price and MACD, specially the some stocks that have been leading thus far e.g. FFIV, LULU, STX, URI, etc. But some leaders have been marching ahead like a freight train such as AAPL, PCLN, ISRG, CMG, etc. See Below.

Momo Stocks are missing in action

Lastly, there seems to be a dearth of good stocks to own. Of course there are oil service companies and industrials but all the high growth stocks are going sideways.

Hmmm!

I think we might go side ways for sometime. So the million dollar question is – should I take some (more) profits off the table? But again if we see a correction, it will be short-lived, creating more opportunities. After all the 800 pound Gorilla is on our side.

Is this a Joey Tribbiani moment? Can someone enlightem me?

Some good reads till I ponder about my next move –

Goldman is bullish (BL)

Keystone XL (BL)

Home Sales Fall but.. (REU)

Market take a breather.

Stocks pulled back today breaking the 3 session winning streak. Down gave up -.52%, while Russell 200, which had broken through the top of a month long trading range yesterday, gave it all back, losing -1.02%. Declining stocks led over by 2 to 1 on both NYSE and NASDAQ.

Builders broke ground on 698,000 homes at an annual rate, but the numbers came 1.1% below January’s 706K new constructiuon. This was not the biggest concern. Slowing Chinese economy took toll on stocks. Equities around the world were hit. The worst performers were Industrial and commodity shares as China raised fuel prices by the most in two years. BHP Billiton Ltd reported that the iron ore consumtion of 2nd largest economy had slipped.

On the brighter side Tech bell weather Oracle beat estimates after close.

Good Reads –

Housing Recovery (BL)

China, India may face sanctions (RUE)

Oracle beats (MW)

Saudi Pledges more Oil (BL)

And finally the Day Ahead

How to Profit from Housing Turnaround? – Part 1

So finally we are seeing a turnaround in the fortunes of Housing industry. The home sales have started to stabilize and it is applicable to existing home sales, new home sales and housing starts. This is reflected in the today’s news that home-builder sentiment remained at its highest levels in nearly five years. The existing home inventory is down by  20.6% year over year and it has been going down for almost 5 months. The existing homes sales have ticked up in 4 out of last 5 months. The new home construction has gone up from 300K to 550K in last few months. The Builders started construction of 698K homes in Feb 2012. Though this is 1.1% less than the 706K construction starts in Jan 2012, but the drop was expected.  This was confirmed by analyst at BMO Capital Markets.

The rise in home sales is in line with macro economic bullish uptrends. Let’s look at few of them.

1. The economy has added 1.2 million jobs in last 6 months. This is the fastest rate of job creation since 2006.

2. GDP growth rate seems to have firm footing now. The growth reported in last quarter started to return to its historical, pre crisis level of 3%.

3. Rents have started to creep up in almost all the metro areas. Infact there has been shortage of rental properties in few parts of the country.

4. The mortagage rates are at historically low levels.

5. And the most importantly – bargain home prices are driving hordes of renters to home ownership.

Now the question arises. Where all do we invest to generate wealth from this turnaround? I am not telling you what Mr. Buffett said few days ago – buy homes. But the approach towards selection of the investment vehicle has to be similarly meticulous, so that you don’t end up bidding higher price.