Seagate Technology (STX)

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May 25, 2016, 11:42 A.M. ET

Western: Barclays Ups to Buy; Flash Threat Less Dire Than Believed

By Tiernan Ray

Shares of storage vendor Western Digital (WDC) are up $2.17, or 5%, at $44.445, after Barclays’s Mark Moskowitz raised his rating on the stock this morning to Overweight from Equal Weight, writing that the shares have “adequately de-risked for three reasons,” namely the understanding of flash technology replacing disks, clarity about Western’s own production of flash, and investor comfort with Western’s stepped-up spending.

Moskowitz, raising his price target to $60 from $57, writes the stock, along with that of Seagate Technology (STX), is “washed out,” and given his target on Western is 42% from the current price, it’s a good time to buy because “It is our view that the incremental buyer historically needs to see 25% or more upside potential to build an Overweight position in an HDD stock.” (He has an equal-weight rating on Seagate, and a $25 price target.)

Moskowitz notes that disk drives will not be completely replaced by flash:

We do not expect HDDs to be completely displaced by SSDs over the next decade, but the rate of displacement in PC HDDs will make it hard for HDD vendors to grow. We expect HDDs serving PCs to exhibit increasing rate of displacement by SSDs, but there could be a slower displacement rate in the enterprise data center (due to higher price per gigabyte) – which is where the sturdier HDD profit pool resides. As it relates to relative pricing, enterprise HDD $/GB is $0.04, versus $0.40- 0.45 for SSD. With this gap in mind, we estimate SSDs to support approximately 60- 65% of PC units in 7-10 years, versus our estimate of 36% in C2017, and according to Gartner, 22% in C2015. Meanwhile, we estimate SSD units to support only 30-35% of units supporting servers and storage systems in the data center, versus our estimate of 22% in C2017, and according to Gartner, 17% in C2015. In our view, this overall framework implies HDDs still have an important long-term role in storage.

Moskowitz illustrates those trends of disk replacement with some graphs; here’s one (click on the image to see it larger):

(chart omitted)

Barclays Models flash versus hard-drive trends, May 25th, 2016.

On the other hand, Moskowitz also thinks that SanDisk, the flash company Western bought this year, is “on track” with its move to the next level of technology in NAND chips, something that’s been a perennial worry about the company:

Our research indicates that SanDisk is on track with its 3D NAND transition and should have a broad portfolio of consumer SSDs shipping by late C2016 and enterprise SSDs in 1H C2017. In such a case, SanDisk would be able to keep pace with the lead pack for flash solutions based on 3D NAND. Reason being, the technology is complex, and with manufacturing yields currently below optimal levels (>80%) across the industry, bits shipped on 3D NAND are not likely to reach critical mass (> 50%) for another 12-18 months. All of this means SanDisk has ample time to catch up. In our view, a successful SanDisk transition to 3D NAND sets the foundation for WD to deliver revenue growth at- or above-peer, which we think WD’s stock is not factoring.

Moskowitz also notes that a recent “reset” of industry expectations by Western was not as bad as feared:

The Mar-Q earnings season was a difficult one. We had braced for tough sledding after cutting most of our sector forecasts on March 18. The silver lining was that with HDDs the reset outlook was not as bad as feared. The projected quarterly TAM of approximately 95M units for the Jun-Q is not as severe as some investors or industry participants had anticipated. The run rate is not great, though, given the HDD industry had been built to serve north of 160M units per quarter just a few years ago. In any event, we think that if the Jun-Q can establish a bottom in quarterly shipments, then investor sentiment can start to improve. We think the reasonable duopoly is relatively intact, which attracted investors to the HDD stocks in 2012 to early 2015. Cyclical (weak PC and enterprise systems demand) and structural (SSD displacement risk) have since been discounted into the stock valuations, helping de-risk the stocks.
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http://blogs.barrons.com/techtraderdaily/2016/05/25/western-barclays-ups-to-buy-flash-threat-less-dire-than-believed/

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