Seagate's Margin Explodes, but Sales Disappoint

Seagate Technology STX reported on Tuesday after trading that it earned $581 million on revenues of $3.2 billion. The company's diluted EPS of $1.32 were far above analyst estimates, thanks in part to a sharp increase in the company's gross margin to 31.6%. On a non-GAAP basis, the company's net income of $581 million represents an EPS of $1.32. Despite the strong earnings, the company's sales of 47 million drives were lower than in Q2 2011, when sales dipped to 48.92 million units from 49.22 million in the previous quarter. Analysts had expected good news. Revenue was expected to jump to $3.15 billion, while the company's own estimates were pinned to $3.2 billion after raising expectations in November and January from initial guidance of $2.6 billion. According to a Reuters poll, analysts were expecting EPS of $1.08, a rise of 227% on last year's results of 33 cents and almost as much from last quarter's results of 34 cents. Seagate has had a string of promising news lift the company's stock price. The biggest news for the company was its closure of a deal to buy Samsung's hard drive business for $1.4 billion, which Seagate sold to investors as the company's way to ramp up disk production and improve its product offerings. The company's move has raised expectations enormously, with many analysts raising price targets and maintaining buy or overweight recommendations. Brean Murray, for example, announced that it expects the stock to climb to $26 both due to higher sales volumes and recent buyback plans. The acquisition of Samsung meant that a jump in sales volumes was almost guaranteed, even if domestic PC sales are not been the best. Nonetheless, PC sales in the Asia-Pacific region have jumped by 11%, a benefit to Seagate now that it has a much larger share of the hard drive market thanks to its purchase of Samsung's HD division. Since Asia now accounts for a third of PC sales, Seagate may become increasingly dependent on that growth going forward. PC sales aren't the only engine for hard drive consumption, as strong sales of Microsoft MSFT Xbox and Sony SNE Playstations have increased demand of their internal hard drive and hard drive accessories. Now that Seagate has increased its hard drive production capacity, it should be able to win more contracts to supply Sony and Microsoft with the drives needed for their game platforms. Seagate is also hoping to benefit from increased hard drive consumption in the home entertainment sector with its FreeAgent GoFlex Media Player, which has been positively reviewed and received for over a year. However, it is a crowded market, and streaming solutions such as Apple AAPL TV, which has been selling strong despite scepticism from techies. Despite the competition in the media player hard drive market, Seagate has excelled in other divisions. The company's FreeAgent series has been popular with customers for years, and its aggressive growth in internal hard drive sales gave it a strong enough market position to buy rival Samsung's hard drive operations. The company's gross margin has steadily risen in the last two quarters, up from 19.1% in Q4 2011 to 19.5% in Q1 2012, while sales increased from 49 million drives to 51 million. Shares in Seagate have skyrocketed in the past month, up over 28% as analysts rose their estimates on the company thanks to a buyback authorization that would allow $1 billion in stocks to be bought back by the company along $900 million of stocks remaining to be bought back after the company authorized another purchase in November 2010. Seagate is holding to its commitment to buy back the shares authorized in November as early as June 2012. The company also recently increased its quarterly dividend to 25 cents a share, which has made it a strong dividend performer, even at its 52-week high of $21.23, which would make its dividend yield 4.71%. The dividend also means that it is the only major dividend-yielding stock in the sector, with the exception of LaCie LAC, whose dividend yield of 10.22% is as suspiciously unsustainable as it is enticing. Its jump in price has made the stock less appealing from a P/E ratio perspective, which is currently around 19. This is far lower than rival Western Digital, whose P/E is around 12.4 after a bearish day ate into monthly gains--although the stock is still up around 16.8% for the year.