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Seagate Downgraded to Strong Sell: Time to Offload It?

On Apr 16, 2016, Zacks Investment Research downgraded Seagate Technology Public Limited Company STX to a Zacks Rank #5 (Strong Sell). Going by the Zacks model, companies holding a Zacks Rank #5 are likely to underperform the broader market.

Most of the estimates for this storage solutions provider have been moving downward since it announced its preliminary results for the third quarter of fiscal 2016 on Apr 13, 2016.

Why the Downgrade?

Seagate, in its preliminary results, lowered its revenue and margin estimates for the third quarter of fiscal 2016 due to weaker-than-expected demand.

Seagate now expects revenues to be $2.6 billion, down from its earlier guidance of $2.7 billion. Moreover, non-GAAP gross margin is anticipated to be 23% as against its earlier forecast of 25.6%. The company cited weak demand and inventory declines for the guidance cut.

According to the company, “The difference in the Company’s revenue and non-GAAP gross margin from its forecast was driven primarily by reduced demand for traditional mission critical HDD enterprise products, reduced demand for the company’s systems and silicon products, reduced demand for desktop client products primarily in China, and the Company’s decision to not aggressively participate in the low capacity notebook market.”

Moreover, it expects hard disk drive (HDD) unit shipments in the quarter to be roughly 39 million. 

HDDs are primarily used by PCs and Seagate derives the bulk of its revenues from these. It is the second-largest manufacturer of HDDs in the U.S. with 40% market share. Therefore, the cannibalization of PCs by mobile devices will affect Seagate’s results.

According to the preliminary data released by Gartner, PC shipments in the first quarter of fiscal 2016 fell 9.6% year over year to 64.8 million units, the lowest level since 2007. The declining first-quarter fiscal 2016 PC numbers indicate long-term weakness in PC HDDs as well, which remains an overhang on Seagate’s financials.

In the last reported quarter (second-quarter fiscal 2016), Seagate’s revenues of $2.986 billion decreased 19.2% year over year from $3,696 billion. Moreover, Seagate’s non-GAAP gross profit plunged 26.6% year over year to $764 million. Also, gross margin contracted 260 basis points (bps) year over year to 25.6%.

A dull outlook for third-quarter fiscal 2016 and a dismal overall trend resulted in downward estimate revisions for Seagate. Over the last 30 days, eight out of 13 estimates were revised downward for fiscal 2016. The Zacks Consensus Estimate declined 10.1% to $2.48 per share over the same time frame.

Going forward, sluggish macroeconomic conditions, a flattish price environment and competition from Western Digital Corp. WDC and SanDisk Corp. SNDK remain near-term headwinds. Furthermore, continuing cannibalization of PCs by mobile devices could affect the company’s future performance.

A better-ranked stock in the technology sector is Lexmark International Inc. LXK, which sports a Zacks Rank #1 (Strong Buy).

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WESTERN DIGITAL (WDC): Free Stock Analysis Report
 
SEAGATE TECH (STX): Free Stock Analysis Report
 
LEXMARK INTL (LXK): Free Stock Analysis Report
 
SANDISK CORP (SNDK): Free Stock Analysis Report
 
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