Tom,
<<In the short run, Stitch, Chris is right - last after hours trade for MXTR was at 7>>
Yes, certainly in the short term, with a day or two as a window, but even after SEG profit taking today, and the big bounce in MXTR from their announcement, SEG outperforms the group. I'll let that stand in reply to Chris' comment that "You don't get it at all". <G>
In all seriousness I originally was trying to point out that there is a decision point approaching relative to the DD stocks. Maybe the following released by Morgan Stanley today says it better then I can:
For personal use only:
-FIRST SIGN OF POSITIVE HDD SEASONALITY - MAXTOR PRE-RELEASE.
Last night, Maxtor (14% market share) announced that it would lose $0.18 in
CQ4 vs. the First Call mean of a loss of $0.45.
-HEALTHY HDD MARKET IS NORMAL RESULT OF CURRENT PC TRENDS.
With a healthy PC market and low inventory, it is inevitable in our view
that disk drive market trends improve in CQ4. MXTR's unit results are in
line with our industry growth rate.
-WE WOULD NOT BE SURPRISED TO SEE MORE UPSIDES IN HDDS.
Last year, amid a tough industry environment most HDD companies posted
better results than the First Call mean.
-WE ARE CONCERNED THAT HDD PRICING WILL FALL AGAIN IN Q1.
On its call, Maxtor said that prices fell in Dec from Nov and indicated it
believes CQ1 will be seasonally slower. This is normal but will probably be
negative for the stocks.
-WE THINK THE STOCKS COULD TRADE WELL NEAR TERM & COOL IN Q1.
We keep looking for signs we have worked off over supply. We think this may
be a summer event but maintain that it might be too early today even though
trends in CQ4 are positive.
Investment summary and conclusion:
We believe that Maxtor?s (Not rated) report last night that it will beat its? CQ4 First call mean could cause some late in the year/early reporting season upside to additional drive stocks because we think that demand and pricing trends are good across the HDD industry for CQ4. However, we have been here before (the stocks had some similar buzz and a move up last year at this time) and we are concerned that any hint of renewed pricing pressure could send them back down later in CQ1. This keeps us cautious on the group.
One issue we think is important in this thesis is that Maxtor indicated on its conference call with investors last night that desktop pricing started to decline a bit in December from November and that CQ1 looks normal so far.
We expect that investors will look for players with positive desktop exposure such as Western Digital (WDC, Neutral) and Quantum HDD (HDD) in this environment but also note that Seagate (SEG, Neutral) typically outperforms the group during these periods.
Maxtor to beat CQ4 Estimates
Last night, Maxtor (MXTR, not rated) announced that it will beat its? First Call mean estimate of a loss of $0.45 in CQ4 owing to better unit demand and pricing. The company indicated that it believes EPS will come in near $0.18 barring any unlikely market changes late in the quarter.
Maxtor indicated that unit shipments will come in near 6.5MM (up roughly 12% Q/Q and 24% Y/Y) and that revenue will be ahead of the $589MM posted last quarter.
The company said that the main driver behind the upside was its positioning with solid 9.1GB and 10.2GB per platter desktop products. These are market leading capacity points and are in high demand. Maxtor?s positioning put it in a good position to enjoy favorable pricing in the seasonally strong CQ4 period.
Better CQ4?s are very normal in the disk drive market.
It is very normal to see a less severe pricing environment in CQ4 and therefore upside EPS surprises and better stock performance. This is due to the fact that CQ4 is always the biggest building quarter in the PC business. In fact, this CQ4 is actually less seasonally strong on a unit growth basis than last year in HDDs because the industry appears to finally be beyond its period of channel stuffing. We believe that total unit growth for the industry was in the 20% Q/Q range last year and have a 13% increase built into our estimate for this year. For Maxtor, the 12%+ Q/Q increase this year will likely come in better than the industry and is good (it also compares to a 23% Q/Q increase in units in CQ4:98).
We also think this is normal because we have seen it before. To make sure we checked back at the rate of companies beating our estimated EPS over the last two years and found that in both CQ4:97 and CQ4:98 a good majority of the HDD companies in the market exceeded expectations. We think that this is a normal result of the seasonal build. Last year, this caused a nice run in the stocks in the month of December (up about 9% in our disk drive average) and January (up about 9% in our disk drive average). Again, CQ4 is normal.
Our analysis says that there is a good chance that pricing gets tougher in CQ1 - this is typically not good for the stocks.
Our view is that the disk drive industry is changing and is getting closer to a better supply demand equilibrium but still hasn?t changed the supply situation enough to drive a sustained period of solid to rising pricing.
On its call, Maxtor commented that pricing in the month of December fell from November even though November was up from October. We think this is a very important point and like the odds that CQ4?s are seasonally strong in HDDs, this is typical. In CQ1:99, we witnessed a similar trend where pricing started to accelerate in the spring causing the stock to trade off 31% in February, 13% in March and 9% in April. While we doubt that the downside could be as severe this year we do think this is a reason to stay relatively cautious on the group medium-term (6 months) for now.
Moreover, we like to look to technology transitions that hold back supply. Right now we think the GMR transition is starting to gain steam and hit its stride. In our view heads are the biggest supply limitation in HDDs and with GMR hitting its stride we think it is unlikely that this component will hold back the market yet.
We do however think that there are some reasons to be hopeful that in C2H:00 we might move through capacity.
We continue to monitor the industry carefully, especially in light of the strong semiconductor stock performance in the last year. It would be terrific to be able to see the group trade up in a similar fashion. A review of statistics in a couple of the areas we study follows:
We like to look at is capex trends in HDDs - here there is some good news. The good news here is that capex as a percentage of revenue for the industry (including the figures for HMTT, HTCH, KMAG, MXTR, Quantum, RDRT, SEG and WDC) has been down near 10% for 5 quarters which is a more normalized figure (and it has been down in the double digits Y/Y for 6 quarters in absolute dollars). The bad news is that prior to that it was well above 20% for at least a year (and remembers pricing was higher then so revenue rates were higher making the 20% far greater in today?s revenue terms). We think that this caused oversupply and the industry needs to burn off this overcapacity before a longer-term environment for better pricing is created.
Secondly, we look at cash in the industry. Here too there is some good news. Cash balances hit an all-time high of $3B+ for the core U.S. based disk drive companies in CQ1:98 and are now down 18% to roughly $2.5B (the trend looks similar if we take out Seagate). Lower cash will drive consolidation at some point in our view. There is probably some room to go on this front, but we think that the trend is improving.
Thirdly, we look at players in the market. We continue to believe that the market needs to consolidate. On this front we are the least far along. There has been buzz in the market that consolidation might occur. However, we don?t think it will happen as fast as some might like. While our contacts indicate that some are smartly thinking about getting out of the space, we still don?t see any big moves near-term. We are hopeful that this will change longer-term as having 10 large players with good sized market shares is difficult in a business with some commodity characteristics.
Finally, we look at where we are in technology transitions. In the disk drive market, the big driver on the technology front is recording head technology. Typically if there are not enough recording heads to go around the industry goes into a far better period of profit. This time round the technology is very difficult but is being matched by a rapid ramp in GMR which we believe may be over the tough part of the ramp. The good news here is that with the lower capex rates we believe that sometime next year recording heads could be a limiting factor in the industry, which is probably healthy
Net net, there are positive trends...but it is too early to make us positive on the group. We are hopeful that at this time next year some of these factors will have continued to progress and will match with seasonally strong PC demand and the ramp up in some new lines of business at HDD players to drive some better stock performance.
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