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No Surprises In Seagate's (NASDAQ:STX) Q1 Sales Numbers, Provides Encouraging Quarterly Guidance


Full Report / October 22, 2021
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Data storage manufacturer Seagate (NASDAQ:STX) reported results in line with analyst expectations in Q1 FY2022 quarter, with revenue up 34.6% year on year to $3.11 billion. Guidance also exceeded expectations with next quarter revenues guided to $3.1 billion, or 2.06% above analyst estimates. Seagate made a GAAP profit of $526 million, improving on its profit of $223 million, in the same quarter last year.

Seagate (STX) Q1 FY2022 Highlights:

  • Revenue: $3.11 billion vs analyst estimates of $3.1 billion (small beat)
  • EPS (non-GAAP): $2.35 vs analyst estimates of $2.21 (6.34% beat)
  • Revenue guidance for Q2 2022 is $3.1 billion at the midpoint, above analyst estimates of $3.03 billion
  • Free cash flow of $379 million, roughly flat from previous quarter
  • Inventory Days Outstanding: 50, down from 51 previous quarter
  • Gross Margin (GAAP): 30.6%, up from 25.7% same quarter last year

The developer of the original 5.25inch hard disk drive, Seagate (NASDAQ:STX) is a leading producer of data storage solutions, including hard drives and Solid State Drives (SSDs) used in PCs and data centers.

Seagate’s peers and competitors include Western Digital (NASDAQ:WDC), SK Hynix (KOSI:000660), and Samsung (KOSI:005930).

Memory Semiconductors

The global memory chip market has become concentrated due to the highly commoditized nature of these semiconductors. Despite the market consolidation, DRAM and NAND are subject to wide pricing swings as supply and demand ebbs and flows. This plays itself out in the business models of memory producers, where the large, fixed cost bases required to produce memory chips in volume can become very profitable during times of rising prices due to high demand and tight supply but also can result in periods of low profitability when more supply is brought online or demand drops. Read More There are two main types of memory chips: dynamic random access memory (DRAM) and Flash memory (NAND). In any electronic device where a processor or a graphics chip is conducting a task using data, it needs to read the data from where it is stored, known as memory. Smartphones, PCs, and data centers account for more than two thirds of memory demand. DRAM is “volatile” memory, it is a semiconductor that requires an electric charge to retain data – it is the type of memory commonly used in PCs. The advantages of DRAM are the speed at which a CPU/GPU can access the data and its long useful life. Unfortunately, “volatile” means it only can hold data temporarily when it is powered. By comparison, flash memory or NAND is “non-volatile” memory, which means that it saves data when power is removed, making it commonly used in almost every mobile device, along with USB flash drives. Its smaller form factor and greater storage capacity has made NAND-powered solid state drives (SSDs) the long term replacement for the original computing storage device, the hard disk drive.

Sales Growth

Seagate's revenue growth over the last three years has been slow, averaging 0.86% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $2.31 billion to $3.11 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

Seagate Total Revenue

This was a solid quarter for Seagate as revenues grew 34.6%, topping analyst estimates by 0.33%. This marks 3 straight quarters of revenue growth, implying we are mid-cycle for Seagate, as a typical upcycle tends to last 8-10 quarters.

Seagate believes the growth is set to continue, and is guiding for revenue to grow 15.7% next quarter, and Wall St analysts are estimating growth 3.78% over the next twelve months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) are an important metric for chipmakers, as the cyclical nature of semiconductor supply and demand impacts profitability. In a tight supply environment, inventories tend to be low, allowing chipmakers to exert pricing power, which helps increase gross margins. The inverse also applies, as rising inventory levels tend to foreshadow weakening pricing power and declining gross margins.

Seagate Inventory Days Outstanding

This quarter, Seagate’s inventory days came in at 50, 2 days below the five year average, showing no indication there would be an excessive inventory buildup at the moment.

Pricing Power

Seagate's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 30.6% in Q1, up 4.9 percentage points year on year.

Seagate Gross Margin (GAAP)

Seagate's gross margins have been trending up over the past year, averaging 28.4%. This is a welcome development, as Seagate's margins are below the group average, potentially pointing to improved demand and pricing.

Profitability

Seagate reported an operating margin of 20.1% in Q1, up 7.4 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.

Seagate Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 17%. Seagate's Operating margins are around the midpoint for the semiconductor industry, as its cost structure is appropriately managed.

Earnings, Cash & Competitive Moat

Analysts covering the company are expecting earnings per share to grow 21.2% over the next twelve months, although estimates are likely to change post earnings.

Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Seagate's free cash flow came in at $379 million in Q1, up 103% year on year.

Seagate Free Cash Flow

With a 11.4% free cash flow margin and $1.32 billion in free cash flow over the last twelve months, Seagate has an ability to convert revenues to free cash flow that is around the average for the semi group, which should provide sufficient liquidity to invest in the business even during downcycles.

Seagate’s strong ROIC of 37.1% implies its technological edge has generated a strong competitive moat, allowing the company to maintain growth while providing it with enough profits to invest in new products, carry out M&A, or engage in stock buybacks.

Key Takeaways from Seagate's Q1 Results

Sporting a market capitalization of $18.5 billion, more than $991 million in cash and with positive free cash flow over the last twelve months, we're confident that Seagate has the resources it needs to pursue growth business strategy.

We were very impressed by the strong improvements in Seagate’s gross margin this quarter. And we were also glad to see the improvement in operating margin. Overall, we think this was a strong quarter, that should leave shareholders feeling very positive. The company is up 1.76% on the results and currently trades at $83.7 per share.

Is Now The Time?

Seagate may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We cheer for everyone who is making the lives of others easier through technology, but in case of Seagate we will be cheering from the sidelines. Its revenue growth has been very weak, and analysts expect growth rates to deteriorate from there. And while its strong competitive moat allows it to invest in growth initiatives, unfortunately its lower gross margin indicates some combination of pricing pressures or rising production costs.

Seagate's price to earnings ratio based on the next twelve months is 10.1x, suggesting that the market has lower expectations for the business, relative to high growth semiconductors stocks. While we have no doubt one can find things to like about the company, we think there might be better opportunities in the market and at the moment don't see many reasons to get involved.

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