Seagate Technology: Hard Drive Weakness Isn’t Over Yet (NASDAQ:STX)

While we like Seagate Technology Holdings plc’s (Nasdaq Stock Symbol: STX) Within the storage sector, we continue to rate the stock a Hold.We expect demand for hard disk drives (“HDDs”), STX’s primary revenue generator, to continue to weaken due to normalization PC demand post-pandemic and moderating cloud and enterprise storage spending. The stock is down nearly 30% since our release Relegation in mid-June. We expect more downside ahead and recommend investors to wait and see until HDD demand recovers.

The chart below summarizes our rating history for STX stock.

More Hard Drive Weaknesses Need Pricing

Most of STX’s revenue comes from its HDD product line, which accounted for 87% of total revenue in 1Q23. Our bearish sentiment on the stock is based on our belief that HDD demand will continue to weaken until 1H23. STX’s 1Q23 earnings report showed that HDD revenue fell 26% QoQ and 38% YoY to US$1.722 billion. We believe the plunge in STX HDD revenue is due to recent weak demand and customer inventory adjustments.

The table below outlines STX’s revenue by product line for the first quarter of 2023.

We don’t think the weakness is over yet. We expect STX to continue to underperform due to two factors:

1. Normalization of PC market demand

HDDs have traditionally been used in PCs and smartphones, but recently, both markets are replacing HDDs with faster, more instant solid-state drive (SSD) storage. HDDs are still widely used in PCs, so we attribute some of the decline in STX HDD revenue to weak demand in its PC market or traditional markets. STX’s traditional market capacity shipments fell 11% QoQ and 47% YoY in 1Q23. We think companies are feeling the pinch of normalizing PC demand in a post-pandemic environment. Gartner reported that worldwide PC shipments fell 19.5% YoY in 3Q22. We do not expect the same demand for STX in its traditional markets as it has during the pandemic. We also believe that SSDs are increasingly replacing HDDs in the PC space. We expect continued weak demand to sustain STX’s near-term revenue growth.

2. Align cloud and enterprise storage spending

Cloud and enterprise storage spending has been in the spotlight as STX’s fastest-growing end markets, but HDD sales in this segment are also declining. STX’s bulk revenue fell 25% QoQ and 21% YoY in 1Q23. We attribute normal demand for cloud and enterprise storage spending to the tough macroeconomic environment. We believe fewer customers are choosing to invest in cloud computing and storage spending as inflationary pressures and interest rates peak. Large volume shipments accounted for 88% of STX’s total shipments in 1Q23. Our bearish sentiment on the stock is based on our belief that STX will continue to see weak HDD demand in 1H23 from its bulk market.

The chart below outlines STX’s bulk revenue trend between 1Q22-1Q23.

not alone

STX joins the broader semiconductor peer group in feeling the pain of weak memory demand. In August, StorageNewsletter reported that HDD shipments fell 15% last quarter. While STX saw double-digit declines due to weak hard drive demand, so did its competitors. Toshiba (TOSBF, TOSYY) faced a similar decline, with shipments down 15% sequentially. Western Digital Corp (WDC) also saw weak HDD demand, with HDD revenue falling from $2.128 billion in 4Q22 to $2.014 billion in 1Q23. We expect global storage demand to remain subdued until macroeconomic headwinds ease.

Valuation

STX is relatively cheap, but we expect more downside for the stock. On a P/E basis, the stock trades at 15.2 times C2023 EPS of $3.52, compared with the peer average of 20.1 times. The stock trades at 1.9x EV/C2023 sales, compared to the peer average of 4.7x. While the stock is trading at a significant discount to its peers, we wouldn’t recommend investors buying the stock on a whim. We think weak HDD demand will persist and suggest investors wait and see until downside risks are factored in.

The table below outlines STX’s valuation compared to its industry average.

go to wall street

Wall Street agrees with our bearish thesis on the stock. Of the 26 analysts covering the stock, seven have Buy ratings, 18 have Hold ratings, and the rest have Sell ratings. The stock is currently priced at $53 per share. The median sell-side price target is $60, with an average of $58, implying a potential upside of 10-13%.

The table below outlines STX’s sell-side ratings and price targets.

What to do with stocks

STX stock has fallen nearly 53% and 30% year-to-date since we downgraded the stock. We believe STX is facing a slowdown in demand due to weaker PC markets in the post-pandemic environment and subdued cloud and enterprise storage spending due to macroeconomic headwinds. We don’t think HDD demand will recover in the short term and suggest investors wait for a better entry point from Seagate Technology Holdings Limited.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.