Disk Drives.. Value Stocks to Value Traps (WDC, STX, AAPL, SNDK)

Investors generally look to low price-to-earnings ratios to find “Value Stocks.”  The trick is to avoid companies which look like value but may actually be in a state of decline.  This is where value stocks become value traps.  In a fresh “value” screen of technology stocks and other stocks, the hard disk drive makers Seagate Technology PLC (NASDAQ: STX) and Western Digital Corp. (NYSE: WDC) have again surfaced.  Both of these appear to be value stocks.  They may just be value traps.

iSuppli recently put out some data that brings more cause for concern.  For starters, the shipments are expected to be lower in the first quarter than in the fourth quarter.  Some of this may be seasonal.  Some is due to the rise of the Apple Inc. (NASDAQ: AAPL) iPad (and now iPad2).  Some may be due to the cloud as well as the public is becoming more and more comfortable backing up data and storing it externally.  Another hit may come from the decline of netbook sales.  iSuppli also pointed out something we do not consider on the long-term: an oversupply of external drives in the fourth quarter.

Seagate Technology PLC (NASDAQ: STX) closed out 2010 at $15.03 and shares are down about 15% at $12.53 now versus a 52-week trading range of $9.84 to $20.90.  Its market cap is $5.7 billion.  Thomson Reuters has a consensus analyst price target objective of $16.29 and shares peaked above $28.00 back in 2007. The company’s estimates from Thomson Reuters for its June fiscal years are $1.21 EPS for 2011 and $1.88 EPS, giving a blended forward P/E ratio of only about 8… sounds cheap.  Revenue estimates are $10.59 billion for 2011 and $11.07 billion for 2012, indicating that the multiple of revenues is only about 0.5… also sounds cheap.

Western Digital Corp. (NYSE: WDC) closed out 2010 at $33.90 and shares are down more than 10% at $29.75 now versus a 52-week trading range of $23.06 to $45.09.  Its market cap is $6.9 billion.  Thomson Reuters has a consensus analyst price target objective of $38.15 and shares peaked above $45.00 back in early 2010. The company’s estimates from Thomson Reuters for its June fiscal years are $3.04 EPS for 2011 and $3.71 EPS, giving a blended forward P/E ratio of less than 9… also sounds cheap.  Revenue estimates are $9.3 billion for 2011 and $9.8 billion for 2012, indicating that the multiple of revenues is only about 0.7… also sounds cheap.

Here is the good news in what may be a cautious longer-term story… All of these pressures may be mitigated down the road.  Flash-drives are a huge risk, but it may be odd to consider that the companies will just let the market migrate away without participating.  SanDisk Corporation (NASDAQ: SNDK) lists both of these companies as competitors in hard drives and in solid-state drives.  We also showed all of the hidden tidbits in the SanDisk 2010 Annual Report.  The market is actually still calling for growth.  Seagate was actually believed to be going private, but that deal fell apart in 2010.

Both companies can buy shares back aggressively and could pay huge dividends if they choose as Western has $3.1 billion in cash with little debt and Seagate has close to $3 billion cash but carries over $2.3 billion in debt.  Due to a cleaner balance sheet and a better analyst target bogey, Western Digital seems in a slightly better spot even if its times-earnings and times-revenues multiples are a tad higher.   Apple Inc. (NASDAQ: AAPL) has many external drive sales for its computers in the Apple stores that skew more to Western Digital than Seagate.

Another huge risk here is that the cost of storage only has gone one way… South.  A few years ago it seemed almost deity-like to have a Terabyte of external storage.  Now that 1 Terabyte of storage can be bought for literally less than $100.00.

The caveat here in a value screen is that growth could easily get interrupted.  There are no assurances that the market won’t pass either or both companies by, nor that the companies will hit their sales targets.  When you see technology companies trade at multiples much lower than public electric utilities, you better know that “Value” is potentially a “Value Trap.”

JON C. OGG