Storage: The Short and the Long of It
By Monica Rivituso, SmartMoney.com - Stock Watch
EARLY TUESDAY MORNING, Salomon Smith Barney analyst H.
Clinton Vaughan issued a note cutting his growth estimate for
the data-storage industry. The move knocked 2% to 3% off the
stocks of three of the industry's top companies: EMC
(NYSE:EMC - news), Network Appliance (NASDAQ:NTAP - news)
and Brocade Communications (NASDAQ:BRCD - news).
No surprise there. With the exception of a brief rally in April
and May (along with the rest of the technology sector), the
three companies have been market whipping posts for much of
the past year. Since last fall, when EMC, Network Appliance and
Brocade each hit 52-week highs, they've plunged 75%, 91% and
73%, respectively. Salomon said to expect revenue growth of
10% to 15% this year, not the 15% to 20% the firm had been
talking about earlier. And that was enough to bring out the
knives anew.
So what, you say? We know: Analyst warnings and downgrades
are a dime a dozen these days. But we draw your attention to
this one because it illustrates a key point about technology
investing in this environment. When sorting through the rubble
that used to be the towering technology sector, it's always
important to remember one thing: You have to distinguish
between real trouble in an industry and problems brought on by
the broader economy.
Consider that while data storage may be undergoing a growth
slowdown due to the overall sluggishness of the GDP, the group
still has relatively healthy fundamentals. Contrast that with the
telecom-equipment business, where a huge inventory overhang
and massive broadband overcapacity haven't only slowed
business for companies like JDS Uniphase (NASDAQ:JDSU -
news) and Cisco (NASDAQ:CSCO - news) to a crawl but have
clouded the future miserably.
Yankee Group analyst William Hurley notes that the telecom
business is plagued by the sale of used equipment on the
secondary market. By contrast, he says, there isn't a huge
amount of storage equipment being resold, which indicates that
there's still a balance between what customers are buying and
what they need. ``As information continues to grow at a rather
rapid rate, information storage needs to keep pace with that,''
Hurley explains. ``But because it's a buyers' environment,
there have been some rather fantastic deals cut [for
equipment].''
What he means by a ``buyers' environment'' is that customers
of companies like EMC and Network Appliance have had the
upper hand at a time when economic sluggishness has slowed
overall spending. With the vendors anxious to cut a deal — any
deal — buyers can exact better prices and more aggressive
terms. So even if customers are still buying equipment, the
near-term ride for this industry will likely be a bumpy one,
according to Salomon's Vaughan.
He thinks the quarter will be another that's ``plagued with
preannouncements and downward revenue, margin and EPS
revisions.'' He predicts deteriorating economic conditions are
going to continue to affect the fundamentals of storage makers
in the upcoming months and make for a ``tough'' summer.
That said, however, Vaughan's overall outlook is still
encouraging — something we think Wall Street is ignoring.
Vaughan said he thinks the industry's long-term growth rate will
again rebound above 20% when the economy improves. There's
no lousy execution or weak management to worry about, he
insists, only difficult markets. ``We see many storage
companies exiting the economic pullback in stronger relative
positions due to their management teams' ability and
willingness to adapt to current economic conditions and, as a
result, take market share,'' Vaughan wrote.
There are other bright signs as well. One problem that has
lingered for the industry is that traditionally, storage products
haven't all worked well together. That meant customers who
adopted a smorgasbord of storage equipment might have
trouble managing their infrastructure. But Yankee Group's
Hurley notes that storage makers are starting to solve some of
the interoperability complexities, and that will make it easier
for customers to integrate existing systems with new storage
solutions. As companies like EMC, Network Appliance and IBM
(NYSE:IBM - news) succeed on this front, sales should improve
as well, Hurley predicts. ``The fact of the matter is that people
have not stopped or slowed their vociferous delivery of emails,
power-point presentations, aggregation of databases and the
like,'' he says.
With all of this in mind, EMC and Network Appliance look pretty
cheap at current prices. Based on Tuesday's close, EMC was
trading at about 33 times trailing 12-month earnings, versus its
five-year average of 57. Network Appliance was trading at 64,
versus a five-year average of about 140. Brocade is also off its
average, but still trades at a trailing P/E of 99 — pretty pricey
in our book. Will these stocks rise from here? There's no telling
about the short term. But over the long haul, this beaten-down
sector sure looks healthier than the market is giving it credit
for. |
