Why I'm a Seagate Bull -- and Why You Should Be, Too

On the day that Seagate Technology released its earnings, the stock ticked up on a surprising earnings beat. The good times did not last, though, as the next day brought a precipitous drop based on weak guidance apparently not digested the prior day. As we've all known for the last few years, PC demand is shrinking -- this is not a new trend. Naturally, Seagate's PC hard drive business faces continued adversity moving forward. But taking the entire company into account, did Seagate deserve its double-digit drop this week? Let's take a closer look at the company's fiscal second quarter results to determine whether you should buy, hold, or sell shares.

In the past
Seagate, along with its competitor Western Digital , has a rather predictable cycle when it comes to earnings season. The company typically shows great free cash flow, strong growth in its cloud business, an aware and cautious management discussion, and tepid guidance due to PC demand. The stock takes a dive as analysts and investors decry the PC business, and then the stock later rebounds because, at its core, it's a beautiful, cash-generating business that consistently trades at bottom-level multiples.

Was this quarter any different? Well, yes and no.


The numbers
For the December quarter, the company hauled in about $3. 7 billion in revenue. That's a 14.7% climb over last year's same-quarter revenue of $3.2 billion. Not bad considering the company is facing "a challenging demand environment." Moving down the income statement, the company achieved net income of $492 million. So how did the boom in top-line revenue lead to lower profits? It looks like it was a combination of higher expenses and weakened margins. Costs and expenses were roughly 20 % higher than last year's, and gross margins look pressed at 27% versus 31 .6% the year before.

Now, keep in mind, a year ago the company was still experiencing pricing power due to the floods in Thailand that left competitor Western Digital with a supply issue. Seagate was able to dominate the market for some time, selling nearly 100 % of its products at full retail price. Naturally, as the environment normalized, those margins have clawed back some.

On the bottom line, EPS still managed to beat expectations at $1.33 per share.

All in all, the numbers look... fine. They aren't thrilling, yet it is nice to see the company able to boost sales in this environment. If they can get some of the costs under control, I believe Seagate can clearly establish itself as the market leader.

Market leader
On the investor end of Seagate, the company couldn't be more shareholder-friendly. Through the first half of its fiscal 2013, Seagate returned 95% of its operating cash flow and over 100% of its free cash flow to shareholders in the form of dividends (which seem to never stop rising) and share buybacks. In the December quarter, the dividend bumped up an enormous 19%. For income-seeking investors, this a great pick with the possibility of added capital appreciation.

When speaking solely of the business, Seagate, in my opinion, is the best in show. Yes, the company faces a serious issue in the PC business, but it has seen this coming and has taken the right steps to boost other parts of the business. Seagate has a phenomenal enterprise-level business that won't be going anywhere anytime soon.

The company has also taken steps to remain relevant on the storage application front. Seagate recently announced a deal with flash-storage company Virident where it will jointly create solid-state storage solutions.

CEO Steve Luczo did forecast weak demand looking forward, but this was to be expected. The company is still within its gross margin targets, its revenue targets, and its pledge to return 100% of free cash flow to shareholders for all of fiscal 2013. In the meantime, it is keeping capital expenditures to a minimum in order to cautiously navigate the post-PC world. Sure, it's not thrilling news, but I like a CEO who isn't blindly optimistic.

Foolish bottom line
Seagate it still a great business with plenty of opportunity looking forward. With the increased global data consumption and connectivity, storage solutions will only continue to increase at rates faster than ever before. There needs to be infrastructure for this. There also needs to be infrastructure for cloud applications and mobile platforms. This is the future of Seagate's business.

As senior Fool tech analyst Eric Bleeker noted, Seagate made the mistake of giving brutally honest guidance. Tech investors seem touchier these days with guidance more than anything else, even though there is almost always more to the story.

If you are a Seagate shareholder, don't worry about the near-term dip. If you are looking at Seagate, now may be a great time to jump in on the discounted stock -- trading at only six times forward one-year earnings.

More from The Motley Fool on STX 
While Seagate Technology pays a significant and growing dividend and seems able to generate the cash flow to support it, a global slowdown in demand for digital memory storage has begun to put pressure on margins. Is Seagate worthy of your investment consideration? The Motley Fool answers this question and more in our most in-depth Seagate research available for smart investors like you. Thousands have already claimed their own premium ticker coverage, and you can gain instant access to your own by clicking here now.

The article Why I'm a Seagate Bull -- and Why You Should Be, Too originally appeared on Fool.com.

Fool contributor Michael B. Lewis has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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