Argus Cautions Seagate May See Renewed Pressure Following Pre-Holiday Building Period

"Once the preholiday building period subsides, Seagate's HDD business will likely face renewed pressure. The HDD business is in secular decline as SSDs displace HDDs in the client (PC) space, and as the enterprise market continues its transition to all-flash storage and away from spinning disk," analyst Jim Kelleher wrote in a note.

Kelleher raised his FY16 non-GAAP earnings estimate to $2.08 per share from $1.68 and FY17 projection to $2.35 a share from $2.11. The revised FY16 estimate is above the $2.01 Street view, while FY17 estimate is below the $2.50 consensus.

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Kelleher, who remains Hold-rated on the stock, said he still sees the possibility of a dividend cut from Seagate, which represents a lingering risk. In October 2015, Seagate's board increased quarterly dividend by 16.7 percent to $0.63 per common share.

"We now believe the company may consider a dividend cut if margins deteriorate further, but this is not a given. Dividend costs are around $730 million annually, and cash flow coverage remains about 2–3-times the dividend payment," Kelleher said.

"Our annual dividend estimates are $2.43 for FY16 and $2.52 for FY17. However, our FY16 earnings estimate is now lower than our dividend estimate, and that is not sustainable."

Guidance

Last week, Seagate said it now projects fiscal fourth-quarter revenue of about $2.65 billion, up from its previous forecast of $2.3 billion. The company also projected a non-GAAP gross margin of 25.8 percent, up from its May guidance of 23 percent.

At these revised levels, revenue would be down 9 percent year-over-year, while non-GAAP EPS would be $0.45–$0.55, down 35 percent from the prior year at the midpoint of the range. The Street expects EPS of $0.46.

In addition to the restructuring actions announced on June 29, Seagate has announced plans to reduce its headcount by 6,500, as it further consolidates its global footprint. Since late June, Seagate has announced the elimination of 8,100 positions (17 percent of its workforce) as it begins to cut HDD manufacturing capacity by about 35 percent.

The company now expects an average selling price of about $67 per HDD, well above historical levels, as it focuses on enterprise drives and disengages from the low end of the client (PC) market.

The ongoing restructuring actions are expected to help Seagate operate within its targeted non-GAAP gross profit range of 27–32 percent by the December 2016 quarter (fiscal 2Q17).

"While Seagate reduces productive capacity and realigns its operating model, we believe that a Hold rating is prudent," Kelleher said.

At time of writing, shares of Seagate were up 4.71 percent on the day to $30.26.

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