Seagate and Western Digital: Time to buy?

LOS ANGELES, USA: Investors who have cooled to Seagate Technology and Western Digital Corp this year may be missing out on a buying opportunity.

Stock of both looks cheap after a sell-down in 2010, hit by fears of oversupply, sliding margins and a seeming inability to respond to game-changing technology, analysts say.

Also Read: 11mn media tablets to be shipped in 2010: Survey

Growth rates should stay in double digits for several years, with worries about tablets cannibalizing PCs and the advent of new competition from cutting-edge solid-state storage technology overblown in the short term, they argue.

And a glut that is weighing on prices should dissolve as corporate and consumer spending rebound in the second half.

"Demand for storage will continue to drive digital content capacity requirements at a 50 percent year-over-year rate going forward," said Aaron Rakers, an analyst with Stifel Nicolaus, which has a "buy" rating on both companies.

Investor fears about Seagate and Western Digital were heightened when the companies reported lower-than-expected earnings and forecasts last month. That contributed to a near 50 percent market value loss so far this year.

But some say that with stock of the world's two largest vendors for PC storage trading at half their sector's average, investors should pile in now.

Seagate and Western Digital are trading at a SmartEstimate P/E ratio of 4.7 and 6.4, respectively, compared with a P/E ratio of 11.3 for the computer and peripherals sector, according to Thomson Reuters StarMine estimates.

"Broadening consumer weakness is a setback, but it is too early to call for a prolonged slowdown ahead of the 4Q enterprise spending cycle and the holiday season," JP Morgan's Mark Moskowitz wrote. His industry growth estimate "suggests a bumpy landing but not a nosedive."

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Buy Now, or Wait?

Fifteen of 27 analysts rank Seagate a "buy" and none rate it a "sell," according to Thomson Reuters data. Thirteen of 26 analysts rank Western Digital a "buy," and none rate it a "sell."

But in the longer term, analysts say both have to develop new technology to keep pace with solid state drives, which are faster and more rugged than hard drives, and challenge market leaders like SanDisk and STEC Inc.

The growing popularity of Apple Inc's iPad tablet has also raised questions, because they are viewed as potential PC surrogates. Shares of Seagate and Western Digital have fallen more than 40 percent since the iPad came out in April.

Seagate CEO Steve Luczo acknowledged on a call with analysts last month that iPads could cannibalize from notebooks. But he called the iPad a content-viewing device that will "increase the requirement for storage throughout the ecosystem."

"Investors are, I would say, worse than glass half-empty. Their view is it's half empty, broken and polluted," said Richard Kugele, analyst with Needham & Co. "They just don't want anything to do with PCs and their supply chain."

But some analysts see those threats as still being years out. The industry's prospects remain strong at least in coming years alongside growth in demand for storage of everything from digital versions of movies to medical imaging, they say.

Gartner forecasts global PC shipments will jump 22 percent to 376.6 million units this year. That translates to spending of $245.4 billion, which would be up 12 percent from 2009.

Hard drive demand is expected to grow to $36 billion in 2011 from $33.9 billion in 2010, according to Gartner. Demand is expected to hit $42.4 billion in 2014.

Also, SSD remains much more expensive than hard drives -- their main obstacle to wider adoption. One gigabyte of storage on a hard drive will typically cost 10 cents, but it will cost $1 to $2 on an SSD, said Fang Zhang, a researcher for iSuppli.

Seagate and Western Digital are working to develop their own solutions. Seagate Chief Financial Officer Pat O'Malley told Reuters this month that his company, which is focusing on the enterprise segment of the market, expects to see meaningful share of revenue from SSD in 2012.

Western Digital, which is struggling to overcome a reputation in the hard-drive industry for lagging Seagate in technology development, has gone after a different and already established market by selling SSDs embedded in telecommunications, medical systems and military equipment.

"When things are stable and gross margins are healthy and predictable, these companies generate cash flow really well, and right now there's a lot of negative sentiment in the drive market because of tablet computing," said Jayson Noland, analyst with Robert W. Baird & Co.

"People that are willing to be contrarian could do well, but these are stocks that require an iron stomach sometimes."