Miscellaneous Photography / iStock Editorial via Getty Images
We downgrade Seagate (NASDAQ:STX) on a hold since our previous buy rating in April. Since we offer stock advice, the demand environment for the company continues to deteriorate. STX is the “go-to” vendor for large-capacity data storage devices. The company has extensive experience in manufacturing large capacity hard disk drives (HDDs) and has expanded its laser focus to enterprise and cloud customers.
Our downgrade on STX is based on the belief that enterprise and cloud demand will decline in the coming quarters, particularly in the back half of the year (4Q22). We believe the STX cloud is deeply exposed and dependent for the data center markets, and the upcoming demand headwinds will take their toll on this. We recommend investors to wait for better demand dynamics before buying the stock.
stxgood days are behind
The storage component business, in general, can be divided into hard disk drives (HDDs) and solid-state drives (SSDs). The former run the business of HDD, STX. HDDs are devices that store data on spinning disks. Data continues to grow, and enterprises and consumers need to store it somewhere for later use. Seagate devices are an economical way to store large amounts of data. The following slide shows STX’s revenue by product line ($M).
Over the years, cloud providers (AWS, Azure, GCP, etc.) have driven business for the company. Enterprises are using the public cloud to store some on-premises data in the cloud. A lot of data is created natively in the cloud. This data needs to be stored for later reuse. Cloud providers store data in devices made by Seagate.
Last week at the Bank of America Global Technology Conference, the company said that “the company’s revenue is growing, and the massive potential will create future opportunities for this business.” STX has placed all its bets on the price-sensitive large-capacity market. STX is heavily exposed to cloud storage and will suffer due to the impending drop in demand.
Consumer spending is shrinking, and in turn, demand for the cloud will drop
We believe demand for the cloud will decline as consumer spending on PCs and smartphones continues to be cut. Consumer demand increased during the COVID pandemic, as shown in the IDC graph for smartphones. We believe consumer spending is now returning to pre-COVID levels. We are already seeing a decline in smartphone shipments across the globe. According to IDC, worldwide shipments declined 8.9% year-on-year in 1Q22. Same goes for PC. Chen Junsheng, president of Acer, which competes as the fourth-largest PC supplier, explained that the entire PC market has changed, and “supply exceeds demand.” With the decline in demand for PCs and smartphones, we are confident that cloud capex will be cut. Furthermore, many enterprises will be more prudent in deploying new applications until demand returns to normal. Imminent spending weakness and persistent inflationary pressures will reduce CAPEX by enterprises and cloud customers.
The “Other” Business Can’t Keep Up With Growth
STX’s “other” segments aren’t strong enough to meaningfully sustain the company’s growth through the coming storm. STX operates in two areas: the large-scale capacity storage and legacy markets, as shown in the slide. The large-scale storage area is a strong side of STX’s business and “supported by record nearline demand from cloud customers.” We believe cloud demand will decline and we do not believe the company’s older markets will be able to compensate for cloud customers. The legacy market has been in decline for some time. Seagate’s executive VP and CFO Gianluca Romano said legacy businesses used to make up 80% of the company’s revenue and now account for less than 35% of their HDD revenue. He described the company’s legacy market, saying, “It is declining and will continue to decline.” We are not optimistic about STX’s prospects without massive capacity revenue.
STX is trading near $78. Stock is cheap. On a P/E basis, STX is trading at 7.8 times C2023 EPS of around $10, while the semiconductor peer group average is 13.9 times. The stock is trading at 1.7x EV/C2023 sales versus 4.5x the peer group average. We believe the company will face demand headwinds in its cloud market. Though the stock is cheap, we do not expect it to perform well in the next few quarters due to sluggish demand. The following table shows the semiconductor peer group evaluation.
words on wall street
The market consensus is mostly neutral/hold on the stock. Of the 27 analysts, 13 are buy-rated, the other 13 are hold-rated, and one analyst is sell-rated. Despite the stock being cheap, analysts are confused about what to do with the stock. Selling price targets for STX remain optimistic. STX is trading at $77. The average sell price target is $100, and the average is $101, for a 30-31% increase. The following chart shows the sell-side rating and price target of the STX.
what to do with stock
Even though STX is cheaper based on valuation, we recommend investors to wait for a better entry point. In the near term, we expect the stock to be under pressure with impending demand decline. We expect demand to slow in all areas of its business: enterprise, cloud and consumer. Therefore, we are confident that STX stock will move below current trading levels. We look forward to an improved demand environment before we can recommend the stock again.