[ The Disk Drive Sector: INVX, SEG, WDC ]
As the year closes we find more and more traders and investors looking for the beaten stock gems that have been mistaken for "stock market dogs." These issues experience added selling pressure at the end of the year due to tax-related selling-- and the bigger the loser, the more exacerbated the selling, it seems. There is a potential bright side, however: the so-called January Effect--a statistically proven market anomaly that takes place in January wherein issues experience sometimes-unexplainable appreciation in their stock prices--could find itself at work with these beaten down issues.
And when it comes to beaten down issues, one need not look further than the Disk Drive sector, with some of the major players being Innovex (INVX), Seagate Technology (SEG), and Western Digital (WDC).
What's Innovex's role in the picture? Let's remember that Innovex is the world's #1 producer of thin-film, lead-wire assemblies for computer disk drives. Its major customers include Read-Rite,Seagate, and Yamaha. That's where the relationship to the sector comes in.
I unfortunately am not including Applied Magnetics (APM) in this discussion for the sake of time, though its role in the sector is also significant (Applied Magnetics makes magnetic recording heads and head stack assemblies for computer disk drives; its stock has also experienced weakness, and has been met with an over 60% decline in market value as of this year.)
The weakness in the sector can be attributed to overcapacity. With inventories stacked, investors have been worried that pricing would
deteriorate and future earnings expectations would not be made. That indeed had been the case. Just look at the prices one can find in the hard disk category: I did some shopping just a few days ago for a hard disk drive to increase capacity for my computer, and was pleasantly surprised to be able to buy a 3.4 gigabyte HD for only $159. Where were these prices a year ago?
And an aside on Western Digital: some first-hand experience has shown me that Western Digital products are just not competitive enough price-wise; their HD's, while being the "the world's most recommended hard drive," are lying on the shelf while the Maxtors, Fujitsus, Samsungs, and others are getting sold for up to 30% below their prices. That's good for us consumers, but does not translate into good news when it comes to the bottom line for the company. There is just not any pricing power to be had in this market, and the economic consequences are quickly being felt by all those in the sector. One other aside: as I drove past their headquarters in Irvine tonight, I noticed that a couple letters from their logo were burned out and were not yet replaced. So it reads something like "Western Dig---l." I hope that is not a sign of the company's health.
Let's take a closer look at the company numbers for the entire group (balance sheet items and analyst growth projections are from Baseline):
Innovex (INVX) is the most fundamentally attractive issue (on a growth basis) out of the three I will be looking at. It has a price/earnings ratio of 8.9, 1% debt/capital, price/sales of 2.11, a price/book of 3.7, and a massive ROE of 55.7%. The company is projected to grow earnings by 16.2% on a compounded basis for the next 2 years. These growth numbers might be a little bit deceiving once you realize that the first year's growth is set at only 7.3%, while the rest of the projected growth is back-loaded, at 25.8%. Also, analyst estimates have been exceeded for the last 5 quarters (note that this figure reflects any potential earnings guidance made prior to the release of earnings, which makes this number potentially deceiving). It may perhaps be because of this relative health that it is being assigned the highest P/E ratio among the three (the others have P/E's of 7.7 and 4.8 for SEG and WDC, respectively).
Technically, almost everything I can throw at it tells me that this is one to stay away from. The short term, intermediate term, and long term trends are all pointing down (30, 50, 150 DMA); my other major indicators turned bearish in early September, and have not reversed. While the price is approaching support at the mid $18 range, there is still too much negative momentum in the share price, IMO, to make a safe short term entry.
Looking at Seagate Technology (SEG), the picture gets a little dimmer: a P/E of 7.7, 18% debt/capital ratio, price/sales ratio of 0.56, a price/book ratio of 1.4, and an ROE of 21.8%. Earnings estimates have fallen drastically short of estimates for the past two quarters, and due to recent disappointments, the company is expected to have their earnings reduced by 28.6% on a compounded basis for the next 7 quarters.
Technically, for very much the same reasons I've outlined for INVX, the stock is deemed unattractive. It has also approached support at the mid $19 range, but again, negative momentum remains a concern.
And finally, we come to Western Digital, with a P/E of 4.8, 0% debt/capital, price/sales of 0.3 (that's for real--it might be a good idea to refer to the excellent, recent remarks by Dave Horne for this one), a price/book of 1.9, and an impressive ROE of 46.8%. Earnings estimates (subject to the same previous warnings) have generally been met or exceeded, except for the one 2 quarters ago, where the company missed Wall Street numbers by a penny. The growth numbers are even more bleak than for SEG: for the next 7 quarters, WDC is expected to have their earnings be reduced by 43.6% on a compounded basis.
Perhaps the only good thing I can pull from the company's story is that since the bulk of its production comes from Asia, the recent currency devaluation will make the components cheaper for the company to create. Maybe that corporate logo did provide a little insight into the company after all.
The technical picture is equally bleak for Western Digital--and it is also finding some support in the mid-$14 range.
It is unfortunate that my little report today has left me as a bear in the disk drive sector. I know some fine people who work in the sector, but it is unfortunate that their good efforts are not being translated into healthier stock prices for their company. While the technical picture is overwhelmingly negative for the entire sector, there does seem to be some widespread support at current valuations, where the daring but possibly foolish trader could hope to squeeze a few points from a potential bounce due to the January Effect.
Currently, I would not recommend taking a long position until at least some strength becomes evident from some more technical indicators. Jumping the gun early could be hazardous to one's financial health-- patience is suggested for anyone interested in taking a long position in any stock within this sector.
Regards,
Rainier |
