Seagate Technology PLC (STX) Stock Earnings Preview: Flat Is Good Enough

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It appears investors are expecting a boost to Seagate Technology PLC (NASDAQ: STX ) after earnings Tuesday afternoon, with STX stock up more than 4% in afternoon trading.

Is Seagate Technology (STX) Stock a Buy on This Dip?

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Seagate has beaten earnings three of the past four quarters, though the one miss was a big one. After the miss, STX stock plunged below $20, its lowest levels in over four years.

STX has roared back, however, doubling its post-earnings low, and there still could be more gains ahead after Tuesday's report.

Seagate Earnings Preview

Seagate remains cheap, trading at under 10 times is fiscal year 2017 consensus analyst estimates. That's despite impressive earnings growth at the moment: those same analysts are projecting a 32% increase in adjusted second-quarter earnings year-over-year. In the first quarter, STX almost doubled earnings, with non-GAAP EPS of 99 cents, up 83% over the prior-year 54 cents.

The catch for STX stock, however, is that sales are declining. Revenue has fallen year-over-year for eight straight quarters now, in fact. The earnings growth is coming largely from cost-cutting, including a layoff of 14% of Seagate employees in December. Given STX's single-digit earnings multiple, the market appears to assume that the profit growth will not only end, but reverse, in the second half of calendar 2017.

So what investors will be looking for in the Q2 report is whether Seagate Technology can stabilize sales and whether there's more room to improve earnings. If Seagate can answer "yes" to both questions, the multiple should expand - and STX stock should gain.

Can Seagate Stabilize Sales?

Click to Enlarge Analysts are expecting a 5.4% decline in revenue in Q2, which as noted would continue the recent trend.

Lower PC sales have pressured Seagate Technology revenue, particularly sales of Seagate HDDs. Seagate owns roughly 35% of that market , with rival Western Digital Corp (NASDAQ: WDC ) the leader in the space. But PC sales were above expectations in the fourth quarter, according to industry analyst IDC, declining just 1.5%. That could provide some help to STX's Q2 sales and profits.

At the same time, PC clients represented just 24% of shipments for Seagate in Q1, according to the company's conference call. Enterprise clients in HDD drove 41% of sales. And Seagate actually has walked away from some business, in an effort to protect margins, an issue that should minimize going forward.

So coming out of the Seagate earnings report for Q2, investors likely will look more toward Seagate's longer-term positioning. The bull case for STX stock relies on the company transitioning away from PCs to cloud revenue. Management has pointed out that cloud provider demand is a bit choppy, so investors may follow management commentary more than the short-term numbers.

CEO Steve Luczo said on the Q1 call that for calendar year 2017 (not STX's fiscal year), he expected mid-single-digit sales growth. Clearly, analysts remain skeptical. But if Seagate reiterates that guidance on the Q2 call, and can convince the market that revenue is stabilized, there's likely significant upside for STX stock.

Margins Should Expand

That's because Seagate margins should continue to improve - particularly if sales meet the company's expectations. The layoffs and the closure of a plant in Suzhou, China, have better matched Seagate's manufacturing capacity to its revenue. With utilization higher, margins should follow, and Seagate should benefit from mix as well.

The company guided for a modest improvement in gross margin in Q2, to around 30% or so, with a long-term target of 32%. With capacity utilization solid, and Seagate Technology focusing on higher-margin HDD sales, the 32% target seems achievable.

All told, there's reason to expect that Q2 should be beneficial for STX stock. Expectations seem low - which makes a beat more likely. In fact, if Seagate simply hits its guidance, its numbers should come in ahead of consensus estimates, which should propel the stock higher. Investors surely will be focusing on the post-earnings conference call as well, listening for commentary on the company's transition to cloud applications and its thoughts on the overall HDD space.

What's intriguing about STX stock from that standpoint is that it is cheap enough that Seagate doesn't have to post some incredible performance, either in Q2 or beyond. STX is valued at under 10 times EPS, as noted, and offers a dividend yield over 6%. Those are valuation figures typically assigned to declining companies.

All Seagate really has to do is stabilize sales. In fact, given potential gross margin expansion and the benefit of recent cost cuts, it simply has to keep those revenue declines low to keep profits flat going forward. Flat profits likely imply a 12 to 13 times multiple, and thus 25%-plus upside for STX stock.

So while the second-quarter numbers will be interesting, and may move Seagate stock, investors may want to focus on the longer-term question of where earnings are heading. If Seagate can show the ability to keep those earnings flat, Seagate stock will rise - both after the Q2 report and beyond.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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