DBAB/Scribner - F4Q06 earnings preview - it should be messy:
Messy quarter due to Maxtor acquisition and integration
STX reports earnings tomorrow (8/8/06) with ~6 weeks of Maxtor (MXO) business
included in results. Consensus estimate are still mixed, with some including MXO
and some still STX standalone. We expect investors to focus on STX's core
business trends, with an eye to combined guidance. On the next page we
highlight our June Q estimates for the two businesses. Our estimates and
investment thesis remain unchanged from our 7/12/06 HDD preview.
Expect STX standalone to be in line, MXO to be weak
In Figure 1 (next page) we detail our expectations for both the STX and MXO
business. Our analysis post-earnings suggest Western Digital (WDC) gained about
a point of share in desktop this quarter and that Hitachi GST also gained about a
point, suggesting the MXO business fell off faster than most expected. TDK
commented on its call that its MXO business halved Q/Q and Alps saw revenue
decline 18% Q/Q on slower MXO business. At the same time, component makers
saw increases in their STX business, which we expect to be in line to slightly
higher, based on better-than-expected enterprise and Xbox sales.
Buyback will be key concerns for investors
Our discussions with investors suggest that many expect a significant buyback
from STX in the next few quarters. At its Analyst Day in June, management
suggested a buyback would be imminent and that it would be large. We estimate
anything below $1B could be done with STX’s existing cash, but that a buyback of
more than $1B would require additional leverage. We believe a buyback of more
than $1B would be viewed positively by the Street.
Buy Seagate into C2H06 seasonal strength
We believe Seagate’s shares will rally in C2H06 as investors shake off June Q
concerns and as new processors from Intel and AMD begin to ramp in August,
offsetting concerns about weak PC demand. In addition, Seagate’s market share
and technology lead make Seagate the best positioned HDD manufacturer
heading into CY07. Our price target implies STX trades at 14x our FY07 EPS of
$2.32. Risks to Seagate include miss-execution integrating MXO, market share
losses, and miss-execution ramping PMR-based drives.
Our detailed estimates for Seagate and Maxtor for F4Q06
Below we highlight our estimates for the June quarter broken out by Seagate and Maxtor.
We expect management to report only one combined number for the September quarter as
the company fully integrates Maxtor volumes into its business. Our estimates and model
include both Seagate and Maxtor unless otherwise noted.
Figure 1: STX and MXO business detail for F4Q06
Notes:
STX MXO STX-MXO
Standalone (6 weeks) combined
Income Statement
Revenue $2,163M $365M $2,528M STX standalone guide: $2.1-$2.25B
EPS $0.44 $0.00 $0.44 STX standalone guide: $0.42-$0.45
Gross margins 24.2% -40bps 23.8%
Operating margins 10.2% -40bps 9.8%
Units
Enterprise 3.45M 0.44M 3.9M
DT 16.4M 4.2M 20.6M DB estimate: ASPs fell 4.5% Q/Q
Mobile 3.3M - 3.3M
CE (3.5, 2.5, and 1.0-inch) 5.8M 0.4M 6.2M
Total 29M 5M 34M
Source: Deutsche Bank estimates
Valuation
Our $33 price target implies that Seagate trades at 14x our FY07 EPS estimate of $2.32.
Since its IPO, Seagate’s average FTM P/E has been 15x, with a median P/E of 13x and a one
standard deviation range of 7x-23x. Our 14x multiple is slightly higher than our 13x multiple
for Western Digital, as we expect Seagate to benefit from its technology lead. Historically
HDD stocks have traded together with a P/E range of roughly 8x-20x. We rate Seagate’s
shares a Buy.
Risks
The hard disk drive sector is inherently volatile and subject to market share battles and
aggressive price declines. While we believe market fundamentals are currently in check, a
decline in overall demand could lead to aggressive tactics by any one of the HDD vendors.
Risks include an unfavorable supply/demand environment and failure to achieve competitive
time-to-market or time-to-volume. Specific risks to Seagate include market share losses as a
result of the announced Maxtor merger, miss-execution in its lines of business, and miss-
execution in ramping its new PMR-based drives. |
