Zero Genie

Since I last caught up with Seagate Technology (NASDAQ:STX) and Western Digital (NASDAQ:WDC) at the end of April, Seagate stock has gained about 11.3% and Western Digital is up 19.7%. Year-to-date, Seagate’s stock price is up 39.3% and Western Digital has gains of 65.3%.

It’s worth reviewing the two, though, because a lot has changed for digital memory stocks in 2019. The cyclical demand slump that started the second half of 2018 is persisting, but share prices have been rallying in a big way on an anticipated rebound. It’s all hype at this point, but the two companies are optimistic — and one might have more reason to be so over the long term.

Seagate: A positive outlook after a not-so-bad downturn

Seagate recently wrapped up its 2019 fiscal year. And though its hard disk drive (HDD) business struggled along with the rest of the digital memory industry, its product kept it insulated from the worst of the downturn so far. To wit, though revenue was down 7% for the 12 months ended June 28, 2019, adjusted net income was still solidly in the black ($1.38 billion, good for a net profit margin of 13%), and earnings per share were only down 13% from the year prior.  

Image source: Getty Images.

Management sees the slump ending, with sales getting propped up again as businesses’ need for data storage is bringing HDD buyers back to the table. Though Seagate’s bread and butter product isn’t as advanced as some of its rivals (it’s an older and cheaper technology used in PCs, laptops, and data centers, versus NAND flash storage chips), the company is still increasing storage capacity and thinks there will be plenty of need for a value option for the foreseeable future.

Its 16-terabyte HDDs are now available, and a 20-terabyte option is coming soon. First-quarter 2020 revenue is expected to be down about 15% year over year, although an uptrend is back in play on a sequential basis. For the full-year period, the company expects to see meaningful sales growth over the just-finished year.

Seagate has been criticized for stubbornly sticking with HDDs, but its relatively shallow dip compared with some of its peers (see below) has proven it’s still a viable business model. Plus, it has stayed profitable all along and churns out more than enough free cash flow ($1.16 billion over the last 12 months) to cover its dividend — which currently yields 4.8% even after the stock’s rebound this year.

Western Digital: More optimism, but in a hole

Western Digital had a much rougher go of it during its 2019 fiscal year. The company makes NAND flash memory chips, a newer type of data storage. It has been far more volatile than HDD, getting hit with huge price swings as supply and demand ebbs and flows. NAND started to traverse its latest speed bump late in 2018, which sent Western Digital and its peers into a glut of oversupply. Pricing fell to compensate, profit margins deteriorated and then vanished, and the stock tanked.  

Fiscal-year 2019 sales dipped 20%, capped off by a 29% drop in Q4, and net losses for the year totaled $754 million — although on an adjusted basis, the company reported net income of $1.43 billion on revenue of $16.6 billion during 2019.

Given the situation, why the huge rally for the stock? As with Seagate, management said it believes the downturn has bottomed out. Demand for its memory chips in data centers, autos, and consumer electronics is picking up a bit and has provided a floor for pricing. But an all-out uptrend isn’t anticipated as of yet since Q1 2020 revenue could fall as much as 24% year over year, and unadjusted earnings should remain in the red. A stabilized outlook has nevertheless been good enough to give investors optimism.

Western Digital also pays a generous dividend, currently at 3.3% after the big surge in the share price. However, its falling trailing-12-month free cash flow of $671 million is nearing its total dividend payout of $584 million. If the bottom-line skid doesn’t ease up, its dividend paycheck to shareholders might need a haircut. Meanwhile, though, with business at least showing some early signs of an uptick, investors shouldn’t worry yet.

The winner is?

Three-year price change. Data by YCharts.

These two technology stocks both play in the digital memory sandbox — a cyclical industry that provides gut-wrenching turns up and down. Of the two, though, Seagate’s older and less volatile memory business makes it look like the better set-it-and-forget-it stock. It has trailed behind Western Digital’s gains this year by a wide margin, but over the last three- and five-year stretch, Seagate is the winner. Given the slower and steadier pace of the business and the bigger margin of safety on the dividend, I think Seagate will continue to be the winner over the longer term.