Data storage manufacturer Seagate (NASDAQ:STX) beat analyst expectations in Q2 FY2023 quarter, with revenue down 39.4% year on year to $1.88 billion. On top of that, guidance for next quarter's revenue was surprisingly good, being $2 billion at the midpoint, 6.22% above what analysts were expecting. Seagate Technology made a GAAP loss of $33 million, down on its profit of $501 million, in the same quarter last year.
Seagate Technology (STX) Q2 FY2023 Highlights:
- Revenue: $1.88 billion vs analyst estimates of $1.82 billion (3.21% beat)
- EPS (non-GAAP): $0.16 vs analyst estimates of $0.09 ($0.07 beat)
- Revenue guidance for Q3 2023 is $2 billion at the midpoint, above analyst estimates of $1.88 billion
- Free cash flow of $172 million, up 53.5% from previous quarter
- Inventory Days Outstanding: 66, down from 94 previous quarter
- Gross Margin (GAAP): 13%, down from 30.4% 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.
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.
Sales Growth
Seagate Technology's revenue growth over the last three years has been unimpressive, averaging 0% annually. Last year the quarterly revenue declined from $3.11 billion to $1.88 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).
Despite Seagate Technology revenues beating analyst estimates, this was still a slow quarter with a 39.4% revenue decline.
Seagate Technology's revenue growth has decelerated for the last three quarters and the company expects growth to turn negative next quarter guiding to a 28.6% year on year decline, while analysts are estimating a NTM revenue decline of 5.52%.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business 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.
This quarter, Seagate Technology’s inventory days came in at 66, 8 days above the five year average, suggesting that despite the recent decrease the inventory levels are still higher than what we used to see in the past.
Pricing Power
Seagate Technology's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 13% in Q2, down 17.4 percentage points year on year.
Seagate Technology' gross margins have been trending down over the past year, averaging 23.5%. The weakness isn't great as Seagate Technology's margins are already below other semiconductor companies as is, reflective of weakening pricing and cost controls.
Profitability
Seagate Technology reported an operating margin of 5.77% in Q2, down 14.2 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.
Operating margins have been trending down over the last year, averaging 11.9%. Not a great indicator for Seagate Technology, whose operating margins are already a bit below average for semiconductors, driven by only modest pricing power and cost controls.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to grow 177% 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 Technology's free cash flow came in at $172 million in Q2, down 59.6% year on year.
Seagate Technology has generated $755 million in free cash flow over the last twelve months. This is a solid result, which translates to 8.07% of revenue. That's above average for semiconductor companies, and should put Seagate Technology in a relatively strong position to invest in future growth.
Seagate Technology’s average return on invested capital (ROIC) over the last 5 years of 32.9% implies it has a strong competitive position and is able to invest in profitable growth over the long term.
Key Takeaways from Seagate Technology's Q2 Results
With a market capitalization of $12.8 billion, more than $770 million in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.
We were very impressed by the strong improvements in Seagate Technology’s inventory levels. And we were also excited to see that earnings outperformed Wall St’s expectations. On the other hand, it was less good to see that the revenue growth was quite weak and operating margin deteriorated. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. The company is up 6.16% on the results and currently trades at $66.16 per share.
Is Now The Time?
When considering Seagate Technology, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in the case of Seagate Technology 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 high return on invested capital suggests it is well run and in a strong position for profit growth, the downside is that its gross margin indicate some combination of pricing pressures or rising production costs and its operating margins are below average vs. semiconductor peers.
Given its price to earnings ratio based on the next twelve months is 18.5x, Seagate Technology is priced with expectations of a long-term growth, and there's no doubt it is a bit of a market darling, at least for some. 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.
The Wall St analysts covering the company had a one year price target of $60.5 per share right before these results, implying that they didn't see much short-term potential in the Seagate Technology.
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