Barron's hyping DDs again (they make a good case, maybe they are right this time)
May 7, 1998
There May Be Life in Disk Drives Yet
By Lisa R. Goldbaum
For the last few months, "disk drives" has been a term you couldn't use in
mixed company.
While most technology stocks have cruised through 1998 in high gear, makers
of the hard disk drives that store files on computers have been hobbling along,
as if on a flat tire.
When we last wrote about the sector on November 18, 1997 ("Disk Drive
Makers Look Cheap -- If You Dare"), market leaders Quantum, Seagate
Technology and Western Digital were saddled with excess inventories and
weak demand. We suggested at the time that these stocks were poised for a
rebound. That was premature, to say the least: a couple of the stocks went on
to fall more than 30% before they hit bottom.
But now Wall Street seems to be warming again to these technology
also-rans, and the stocks appear to be emerging from their comas. Seagate's
shares have risen from a 52-week low of 17 3/4 back in January to their
current price of nearly 28 -- a gain of almost 57%. Quantum has rebounded
over 43% from its low of 17 11/16 in January to about 25 « now. Western
Digital's stock has climbed about 40% from 14 1/2 in December to just under
20. (Incidentally, all these stocks still are cheaper than when we first wrote
about them.)
And of course, Wall Street analysts
have predictably tried to clamber
aboard this schooner before it sails. This
week, Hambrecht & Quist analyst Todd
Bakar boosted his recommendations on
Seagate and Quantum to Buy from
Hold. Earlier, Soundview Financial,
Goldman Sachs and Morgan Stanley
Dean Witter had upgraded Seagate,
too.
Why the sudden burst of optimism? For
one, investors have been salivating at the prospect of any kind of recovery in
this group, particularly since it's among the few bargains left in technology.
Even with their recent price surges, shares of Seagate, Quantum and Western
Digital are still well off their 52-week highs.
At the Hambrecht & Quist Technology Conference in San Francisco last
week, investors clearly were unnerved by the sky-high valuations of Internet
and network services stocks, and were looking for cheaper alternatives.
During a panel discussion, Michael Reabourne, managing director of British
investment firm Reabourne Ltd., said that "the disk-drive industry seems to be
bottoming."
Wishful thinking aside, the industry's prospects really may be improving. ". .
.The disk drive industry appears to have hit bottom in the March quarter with
sequential improvements expected to begin in the current period," wrote
analyst Bakar in a recent report that projected 12-month price targets of 35
for Seagate and 32 for Quantum.
". . .Downside potential from current share prices is somewhat limited. . .while
upside potential exists over the next 6-12 months if these companies can meet
or exceed expectations," he adds.
That's a big "if" -- particularly because
these stocks got into trouble precisely
because the companies missed analysts'
earnings estimates by wide margins.
Western Digital, for example, lost 51
cents a share in its fiscal third quarter
ended March 28th, falling short of
consensus expectations of a 45-cent
loss. The company admitted that, like
many of its peers, it is still suffering from
inventory gluts and weakened demand
in Asia.
But that third-quarter report wasn't all doom and gloom. In a concurrent press
release, Western Digital's CEO Chuck Haggerty said, "For the first time in a
while, we are beginning to see some signs of improvement in both industry
conditions and our desktop business."
Some industry experts also see those signs. Mark Specker, an analyst at
Soundview Financial, asserts that demand for desktop PCs should continue
growing at a good clip, and notes that inventory levels have been diminishing,
albeit more slowly than in the high end. This should benefit both Western
Digital and Quantum, both of which cater primarily to the mass market,
according to Specker.
Moreover, Western Digital recently struck a deal under which it will share
disk-drive technology with and buy hard-disk-drive components from IBM. If
the stock's recent rise is any indication, that already seems to have reassured
Wall Street, which tends to view that company as a technological laggard.
"Western Digital is back in the game because of this deal," argues analyst
Alexa McCloughan at International Data Corp.
And prospects look even better at the higher end of the market. A big product
transition in the server market from Intel's Pentium Pro microprocessor to its
new Pentium II chip beginning this quarter should spur new server sales as
businesses look to upgrade to the latest, most powerful machines.
As this demand increases, so will the need for high-end disk drives to put in
those machines. The biggest likely beneficiary: Seagate, which derives roughly
80% of its revenue from the high end of the market, according to Specker.
Moreover, inventory levels are shrinking faster at the higher end -- where
margins tend to be wider, anyway.
While the stocks are no longer the flaming bargains they were at the beginning
of the year, they still look pretty cheap relative to most of the tech sector.
Quantum, for example, trades at about 19 times the $1.33 per share analysts
tracked by Zacks predict the company will earn in the fiscal year ended
March 1999. That's a nice discount to its projected earnings growth for next
year of about 25%. Seagate and Western Digital are trading at roughly 24
times fiscal 1999 earnings projections -- about in line with their projected
five-year growth rates.
The next few quarters may prove bumpy for these companies, but later in the
year investors should have a more realistic sense of what they'll earn.
Meanwhile, holders of these stocks seem to have developed a thicker skin
when companies don't make their numbers: Western Digital's stock fell only
two points immediately after last week's disappointing earnings release -- and
has since regained some ground.
Disk-drive makers do face plenty of challenges. Asia remains very weak, and
demand appears to be growing fastest in the sub-$1,000 PC market, where
price competition is fierce and margins are wafer-thin.
Yet things are changing. We've been wrong on this before, but with inventories
tightening and demand increasing on the eve of a new buying cycle, disk-drive
stocks may finally be out of intensive care and on the way to recovery. |
