Seagate Earnings: Slow Recovery for HDDs Is Underway, and We Maintain Our $55 Fair Value Estimate

We maintain our $55 fair value estimate for shares of no-moat Seagate Technology STX after the firm reported expectedly weak fiscal 2024 first-quarter results against a soft market backdrop. The hard disk drive market has been soft for seven quarters now, with large cloud customers delaying orders to work down existing inventories. For these largest cloud customers, we believe the market is past its bottom. We see a gradual sequential recovery through fiscal 2024 but still expect sales to decline for the year. We anticipate a greater rebound in fiscal 2025. In our view, consensus estimates for sales in fiscal 2024 and 2025 assume a sharper snapback to demand than we think is reasonable, and look high. We see the shares as overvalued.

September-quarter sales dropped 29% year over year and 9% sequentially to $1.45 billion. Mass capacity sales, which make up the vast majority of overall revenue, declined 26% year over year but rose 3% sequentially, which we view positively. Nearline drive sales into data centers are improving, with management noting particular progress in U.S. cloud customers. Contextually, shipments of these nearline drives remain more than 50% below their peak in the June quarter of 2022. Additionally, Chinese demand has been weak, which is affecting mass capacity drives for other applications like surveillance and the Internet of Things. In the other portions of the business, both systems and legacy hard drive sales were poor. We don’t see these as primary drivers for Seagate, but they are material enough to weigh on the top line.

Non-GAAP gross margin improved a modest 30 basis points sequentially to 19.8%. We attribute this mainly to pricing. Gross margin sits well below normal healthy levels of about 30% due to lower volume and factory underutilization charges. Underutilization in particular was about a 4-percentage-point gross margin headwind this quarter, which we expect to ease over the coming quarters as volume rebounds.