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Seagate Technology (NASDAQ:STX) Reports Q2 In Line With Expectations But Inventory Levels Increase


Full Report / January 24, 2024

Data storage manufacturer Seagate (NASDAQ:STX) reported results in line with analysts' expectations in Q2 FY2024, with revenue down 17.6% year on year to $1.56 billion. The company expects next quarter's revenue to be around $1.65 billion, in line with analysts' estimates. It made a non-GAAP profit of $0.12 per share, down from its profit of $0.16 per share in the same quarter last year.

Seagate Technology (STX) Q2 FY2024 Highlights:

  • Market Capitalization: $18.67 billion
  • Revenue: $1.56 billion vs analyst estimates of $1.55 billion (small beat)
  • EPS (non-GAAP): $0.12 vs analyst estimates of -$0.06 ($0.18 beat)
  • Revenue Guidance for Q3 2024 is $1.65 billion at the midpoint, roughly in line with what analysts were expecting
  • Free Cash Flow of $99 million, up 73.7% from the previous quarter
  • Inventory Days Outstanding: 80, up from 74 in the previous quarter
  • Gross Margin (GAAP): 23.3%, up from 13% in the same quarter last year
  • Announced Quarterly Dividend of $0.70 per share

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.

Seagates 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 Technology's revenue has been declining over the last three years, dropping by 10.8% on average per year. This quarter, its revenue declined from $1.89 billion in the same quarter last year to $1.56 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 Technology Total Revenue

This was a slow quarter for the company as its revenue dropped 17.6% year on year, in line with analysts' estimates. This could mean that the current downcycle is deepening.

Seagate Technology looks like it's on the cusp of a rebound, as it's guiding to 12.7% year-on-year revenue growth for the next quarter. Analysts seem to agree as consesus estimates call for 17.9% growth over the next 12 months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.

Seagate Technology Inventory Days Outstanding

This quarter, Seagate Technology's DIO came in at 80, which is 17 days above its five-year average, suggesting that the company's inventory has grown to higher levels than we've seen in the past.

Pricing Power

In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Seagate Technology's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 23.3% in Q2, up 10.2 percentage points year on year.

Seagate Technology Gross Margin (GAAP)

Seagate Technology's gross margins have been trending down over the last 12 months, averaging 18.6%. This weakness isn't great as Seagate Technology's margins are already far below other semiconductor companies and suggest shrinking pricing power and loose cost controls.

Profitability

Seagate Technology reported an operating margin of 8.2% in Q2, up 2.4 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.

Seagate Technology Adjusted Operating Margin

Seagate Technology's operating margins have been trending down over the last year, averaging 4.5%. This is a bad sign for Seagate Technology, whose margins are already below average for semiconductor companies. To its credit, however, the company's margins suggest modest pricing power and cost controls.

Earnings, Cash & Competitive Moat

Analysts covering Seagate Technology expect earnings per share to grow 473% over the next 12 months, although estimates will likely change after earnings.

Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Seagate Technology's free cash flow came in at $99 million in Q2, down 42.4% year on year.

Seagate Technology Free Cash Flow

As you can see above, Seagate Technology produced free cash flow of just $498 million in the last year, resulting in a measly 7.5% free cash flow margin. Seagate Technology will need to improve its free cash flow conversion if it wants to stay competitive.

Return on Invested Capital (ROIC)

EPS growth informs us whether a company's revenue growth was profitable. But was it capital-efficient? For example, if two companies had the same EPS growth, we’d prefer the one putting up those numbers with lower capital requirements (usually in the form of balance sheet debt and equity).

Enter ROIC, a pivotal metric showing how much operating profit a company generates relative to the capital it's invested in the business. ROIC not only gauges a company's ability to grow profits but also sheds light on a management team's ability to allocate its limited resources.

Seagate Technology's five-year average ROIC was 22.7%, slightly better than the broader sector. Just as you’d like your investment dollars to generate returns, Seagate Technology's invested capital has produced decent profits. The trend in its ROIC, however, is often what surprises the market and drives the stock price. Unfortunately, Seagate Technology's ROIC has averaged 33.1 percentage point decreases each year. This is a strike against the company and suggests its competitive advantage or profitable investment opportunities are shrinking.

Key Takeaways from Seagate Technology's Q2 Results

We were impressed by Seagate Technology's strong gross margin improvement this quarter. We were also glad its EPS and free cash flow blew past Wall Street's estimates. On the other hand, its inventory levels materially increased. In terms of product developments, the company launched its Mozaic platform, which marked an inflection point in its mass capacity storage capabilities. The Board also declared a $0.70 per share quarterly dividend payable on April 4, 2024 to shareholders of record as of the close of business on March 21, 2024. This represents a 3% dividend yield based on Seagate's current share price. Overall, we think this was a strong quarter that should satisfy shareholders. The market was likely expecting more, however, and the stock is down 4.3% after reporting, trading at $85.31 per share.

Is Now The Time?

Seagate Technology may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for everyone who's making the lives of others easier through technology, but in the case of Seagate Technology, we'll be cheering from the sidelines. Its revenue growth has been poor over the last three years, and analysts expect growth to deteriorate from here. And while its above-average ROIC suggests its management team has made good investment decisions in the past, the downside is its operating margins reveal subpar cost controls compared to other semiconductor businesses. On top of that, its gross margin indicate some combination of pricing pressures or rising production costs.

Seagate Technology's price-to-earnings ratio based on the next 12 months is 33.0x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.

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