Bullish on Seagate and Sandisk

Tremendous growth in digital content is driving the performance of storage vendors. Seagate recently crossed the milestone of shipping 1 billion hard drives and it expects to ship another billion over the next 5 years.

According to Gartner, more than 500 million drives were shipped last year. IDC expects the demand will increase to more than 600 million units by 2010. In this post, I will review the performance of Sandisk and Seagate.

On April 15, Seagate Technology (NYSE:STX) reported its Q3 results that missed revenue estimates but beat the earnings estimates. Analysts estimated $0.69 EPS on revenue of $3.25 billion. Earlier coverage is available here and here.

Revenue was $3.1 billion, up 10% y-o-y and down 9% sequentially with weakness in the mobile compute and consumer electronics markets. Sequential decrease was driven by a 14% decrease in the number of disc drives shipped due to seasonally slower demand and price erosion. These factors were partially offset by increased demand for storage of digital content and improved product mix.

Net income was $344 million, or $0.65 per share. Non-GAAP net income was $369 million or $0.70 per share. Restructuring charges and other asset write-downs amounted to about $20 million, of which $12 million were related to the planned closure of its Limavady, Northern Ireland operations. This closure is expected to complete by Q2 of fiscal year 2009, with additional restructuring charges of $55 to $60 million over the next three quarters. During the quarter, Seagate repurchased about 36 million of its common shares for $784 million. It has authorization to buy back additional shares worth $2 billion.

Seagate shipped 43 million units, up 8% while the industry growth rate was 16%. It maintained its lead in the enterprise market and increased its market share by 3% with 27% y-o-y and 1% q-o-q growth. It also leads the desktop and consumer electronics markets. Desktop shipments grew 12% y-o-y and declined 11% sequentially. Consumer electronics shipments declined 24% y-o-y and 34% q-o-q due to gaming product launches last year and also lower seasonal demand.

In the mobile market, its shipments were up 18% y-o-y and down 14% q-o-q. Delay in shipping the 250GB notebook drive and higher price has caused it to lose market share to Western Digital.

For Q4, Seagate expects revenue between $2.85 and $3 billion, and EPS of $0.37 to $0.41. It is currently trading around $22 with a market cap of around $11 billion.

Overall, I am very bullish on the storage sector due to the ballooning of digital media, and expect that the market leaders including Seagate will continue to have significant growth. The nature of the business has seasonality built-in, and as long as you understand that, it’s certainly a sector worth investing in.

On April 17, Sandisk (SNDK) reported Q1 revenue of $850 million, up 8%. Net income was $18 million, or $0.08 EPS, compared to net loss of $0.6 million, or $0.00 EPS in Q1 2007. Non-GAAP net income was $48 million, or $0.21 EPS. Sandisk missed analyst estimates of $0.26 per share on revenue of $810.9 million but its positive outlook on NAND pricing saw its shares rising about 7% over the week. Earlier coverage is available here and here.

In Q1, total megabytes sold increased 189% y-o-y and declined 9% sequentially. However, its average price per megabyte declined 61% y-o-y and 29% sequentially, caused by excess supply, seasonally soft demand and aggressive pricing. GAAP product gross margin was 18.4% versus 14.2% in Q1 2007 and 28.1% in Q4 2007.

Even at low prices, product revenue grew by 5% helped by growth in international sales and cards for mobile phones and cameras as well as cost reduction efforts. License and royalty revenue was up 30% to $126 million.

Region-wise, growth was strong in the United States (up 31%), Asia-Pacific (up 14%), and Europe and Middle East (up 31%). Japan saw a 55% decline due to the termination of the TwinSys venture with Toshiba.

In Q2, Sandisk expects a more moderate pricing environment and sequential growth in megabytes sold driven by seasonality and the continued expansion in average capacity. Revenue is expected to be between $875 million and $950 million and license & royalty revenue to be between $115 million and $125 million. It is currently trading around $29 with a market cap of around $6.5 billion.

Sandisk’s big growth opportunity could be the convergence device movement in which the power issue is paramount. Sandisk’s solid state memory devices have lower power requirements than hard drives, and are thus better suited to this market.

Even though hard drives (a market that Seagate leads) and solid state drives (a market that Sandisk leads) are competitive technologies, they have different price-performance-form factor dynamics. Hard drives are less expensive, and where form factor is not a big issue, there is no good reason to not use them. However, in the electronics miniaturization wave, solid state drives help tremendously, and will continue to have their place.

Both Seagate and Sandisk, thus, have bright futures ahead. You just have to find the right time to buy them.