STX Seagate Technology Holdings PLC

Seagate Technology Plc (STX) is scheduled to announce its first quarter 2012 results on October 20, 2011 and the modest revision in analysts’ estimates reflect some key changes in the company’s future business prospects.

 Fourth Quarter Overview

The company reported decent fourth quarter 2011 results. Earnings per share of 28 cents surpassed the Zacks Consensus Estimate of 25 cents. Reported earnings, however, were below the year-ago quarter level.

Seagate reported revenues of $2.86 billion in the fourth quarter, down 7.9% from $2.65 billion in the year-ago period. The company shipped 52 million disk drives in the reported quarter. In the enterprise market, Seagate shipped 5.1 million drives for mission-critical applications and 2.7 million drives for business-critical applications, representing year-over-year increases of 8.0% and 46.0%, respectively.

In the fourth quarter of 2011, gross profit decreased to $551.0 million from $728.0 million in the prior-year quarter. Gross margin was 19.3% compared with 27.4% in the prior-year quarter. Operating income in the quarter was $190.0 million or 6.64% of revenues, down 50.0% from 390.0 million or 14.3% of revenues in the year-ago quarter. The decline in operating income was due to higher operating expenses (up 17.2% year over year).

Cash, cash equivalents, restricted cash and short-term investments totaled approximately $3.15 billion in the reported quarter versus $2.58 billion in the previous quarter. Accounts receivables increased to $1.49 billion from $1.39 billion in the year-ago period.

Agreement of Analysts

Out of the 17 analysts providing estimates for the first quarter, four analysts revised their estimates downward over the last thirty days. Out of the 16 analysts providing estimates for the next quarter, one analyst increased the estimate in the last thirty days while three analysts moved in the opposite direction. For fiscal 2012, six analysts made downward revisions while none of the analysts moved upward over the last thirty days.

Some analysts believe that that the outlook for the upcoming quarter was impacted by significant activities including better-than-anticipated pricing negotiations. Specifically, analysts expect enterprise pricing to be down 5.0%-7.0% sequentially, notebook to decline 3.0%-5.0%, while desktop remains flat.

Other analysts are of the opinion that STX’s current returns on enterprise and desktop are improving. However, some customers have complained of faults in select products shipped 3 years ago. Moreover, analysts also expect some share loss going forward. Finally, while rare earth pricing has declined significantly in the previous quarter, it should still see the full impact of higher prices before some moderation in the third quarter. In the given circumstances analysts believe the industry should sustain these higher costs.

Some analysts believe that a number of issues will restrain Seagate from achieving the year-ago gross margin level of 18.9%. For one, rare earth metal prices have not moderated much and will have a negative sequential impact. Others believe that yields would not improve much and may decline further. Mix of enterprise is also likely to be lower than expected, and utilization will be lower given the sequential decline. Thus, given all the headwinds, analysts expect the gross margin to remain flat (versus. 60bp increase previously).

Magnitude of Estimate Revisions

Since the fourth quarter earnings release, the magnitude of revisions has been modest. Overall, estimates for the upcoming quarter moved down to 31 cents from 32 cents in the last 30 days while the same reduced by 12 cents over the past 90 days.

For fiscal 2012, estimates have decreased from $1.58 to $1.49 over the last 30 days.However, estimates have dipped by 12 cents in the last 90 days. For 2012, estimates have gone down from $1.95 to $1.49 over the last 90 days, while it reduced by 9 cents over the last 30 days.

Recommendation

We believe that Seagate’s strong foothold in the Enterprise SSD market will enable it to generate better revenue growth in fiscal 2011 and beyond, which in turn will drive margins. Improving supply-demand balance in the HDD industry will also act as a positive catalyst.

We also believe that the company’s decision to buyback shares and pay out dividend will be welcomed by income-seeking investors. But weakness in the consumer segment, price erosion, rising demand for flash drives and competitive pressures from Western Digital Corporation (WDC) keep us on the sidelines.

Currently, Seagate has a Zacks #3 Rank, implying a short-term Hold rating.

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