Morningstar | Seagate Navigating Precarious Market Conditions With Solid Execution; Shares Fairly Valued
No-moat Seagate reported a solid fiscal third quarter, with the top line ending up within the guided range and the bottom line appreciably above guidance as well as consensus expectations. Weak market dynamics, anchored primarily by the slowdown in capacity expansion by hyperscale cloud vendors, continued to weigh on the firm’s results. Management conveyed confidence in a second-half calendar year rebound, as the confluence of a pickup in cloud spending and typical seasonal upticks in edge devices spurs demand for the firm’s hard disk drives (HDDs). We will maintain our $40 per share fair value estimate, and though shares responded favorably to the results, we view them as fairly valued at current levels. Consequently, we would recommend that prospective investors demand a wider margin of safety.Revenue of $2.31 billion represented a decline of 15% sequentially. Management attributed some of the softness in cloud demand to customers pausing their spending as they await high-volume production of Seagate’s new 16TB HAMR drives. We find this plausible given the firm’s HDD leadership, and management expects 16TB to be the highest revenue SKU within 12 months. Adjusted gross margins compressed 310 basis points sequentially to 26.6%, due to underutilization as the firm adjusts capacity to match demand conditions. Operating costs came down nicely during the quarter, leading to adjusted EPS of $0.83, well ahead of the $0.63-$0.73 guided range.
Management expects flat results sequentially for the June quarter, with revenue of $2.32 billion and EPS of $0.83 at the guidance midpoint, followed by sequential upticks as demand conditions recuperate. Though we see a myriad of secular tailwinds that lend credence to a rebound in cloud spending, we do not believe the firm will be a disproportionate beneficiary longer term, as we continue to view the structural shift to solid-state storage as an albatross for Seagate. As such, our negative trend rating remains intact.
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