BofA takes the "It's so good it's got to get worse" attitude to an extreme in its downgrade today. And the analyst, Scott Craig, directly contradicts his report of just 3 weeks ago, following Seagate's recent Q1 report and CC. Back then, he said this: "We are raising our price objective to $19, based on 13x our normalized NOPAT of $1.50, less net debt of $1." Now he says this: "Our PO of $15 is based on 9 times our normalized NOPAT/share estimate of $1.90 minus $1 in net debt. We apply a multiple toward the midpoint of its normalized range, as fundamentals are close to peak levels." So a few weeks ago, he was modeling a PE of 13, now he models a PE of 9. Fascinating. More extended summaries of his comments then and now are below.
Here is the executive summary of what he wrote on October 20:
Solid quarter; Maintain Buy
Revenue of $2.7 billion was slightly ahead of the company’s pre-announcement
and our/street estimates of $2.6 billion. EPS of $0.58 ($0.03 tax benefit) was
significantly ahead of the street at $0.47, primarily on higher gross margins.
Seagate maintained share during the quarter, with unit growth of 14% Q/Q. We
remain buyers of the shares, and we believe the company’s above consensus
EPS guidance for F2010 lends credence to the leverage in the model and for
further upside EPS surprises.
Gross margins drive earnings upside
Gross margins expanded by 700bps Q/Q to 24.6%, driven by improved factory
utilization, Q/Q growth in TAM, benign pricing, and transition to higher margin,
new products. Importantly, Seagate delivered meaningful gross margin leverage
even without a snapback in its enterprise segment. The company expects F2Q10
margins at the high end of its target range of 22-26%. Inventories remain at low
levels, which should help drive growth and create margin leverage, near term.
F2010 guidance highlights quarter
Seagate expects F2010 revenues and EPS to be greater than $10.5 billion and
$2.20, respectively, compared to street of $10.5 billion and $1.90. Importantly,
guidance does not assume a snapback in enterprise growth or a meaningful PC
refresh, which likely leaves room for upside, in our view. The company alluded to
capacity expansion during F2010 (not official), likely in time for C2H10.
Raising EPS estimates; PO to $19
We are raising our F2010 and F2011 EPS estimates to $2.50 and $2.13,
respectively, from $2.16 and $2.07, on better revenues and faster than expected
gross margin ramp. Our F2010 and F2011 revenues move to $11.0 billion and
$10.8 billion, from $10.6 and $10.3 billion. We are raising our price objective to
$19, based on 13x our normalized NOPAT of $1.50, less net debt of $1.
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And here is what says now:
Downgrade to Underperform; fundamentals close to peak
We are downgrading Seagate to Underperform. Shares have been outperforming
(452% vs. 63% for S&P 500 since 03/09 and 67% vs. 24% since July, ‘09) and
industry fundamentals are near peak levels on many metrics (pricing, capex about
to pick up, HDD unit growth above demand). While the end demand environment
and possible inventory replenishment may drive the stocks higher near-term, we
believe the easy money in the cyclical HDD stocks has been made.
Capacity expansion a potential risk in 2010
In the past, HDD capacity expansion (capex) has driven pricing and margin
pressure. We expect the industry to begin adding capacity in C1H10 and for
Seagate and WD to continue to increase capex forecasts. The HDD industry
experienced better than normal pricing in C3Q09 (+2% Q/Q) and our channel
checks indicate flat pricing Q/Q in C4Q09 and likely in C1Q10, due to high
utilization, low inventory levels, and solid demand environment.
HDD units growing much faster than end demand
We expect HDD unit growth to significantly exceed end market growth near-term
and low inventory could create better than expected sales into early C2010.
However, HDD unit growth meaningfully above end demand is typically not
sustainable and combined with pending capacity expansion, usually has led to
increased risk for margins/pricing and hence the HDD stocks. HDD unit growth
was less than end demand in the downturn, driving favorable inventory levels.
PO of $15 on normalized earnings
Our F2010 and F2011 EPS of $2.50 and $2.12 compare to First Call of $2.22 and
$2.37. Seagate trades at 10x our normalized NOPAT estimate of $1.90 (mid
cycle earnings power). Our PO of $15 is based on 9 times our normalized
NOPAT/share estimate of $1.90 minus $1 in net debt. We apply a multiple toward
the midpoint of its normalized range, as fundamentals are close to peak levels. |
