Thursday, January 21, 2010

Hard Drive comparison. WD's results remarkably similar to Seagate (WDC, STX)

I wrote last night about Seagate's (STX) ridiculously good quarter, and how they likely have upside in their stock price.

Western Digital (WDC) beat the HELL out of estimates today and raised forward guidance, but in their case i think the stock has very little room to run.

WD reported 49.9million units sold, versus Seagate's 49.5million.  The difference is in the margins however, as Seagate reported about $18.50 per unit in gross margin dollars, while WD's gross profit per unit was about $14.  The difference is partially due to Seagate's higher proportion of enterprise versus consumer business. Go a bit further down the income statement and the companies' results narrow, as Seagate's operating costs are substantially higher than WD's, accounting for 11% of revenue versus 8% for WD.

The similarities end when looking at the companies' valuations.  Backing out WD's big net cash balance, they trade at almost 8times Free Cash Flow Per Share, versus just 5times for Seagate.  Giving both companies a 12% Free Cash Flow Yield would imply upside of 6% for WDC stock and over 60% for Seagate -- and that's if you don't back out Seagate's balance sheet cash, a perfectly reasonable action seeing as they cover their $40million quarterly interest payments about 15times over.  I would either buy Seagate or put on a pair-trade here, Long Seagate and Short WDC.

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