Storing Up on a New Name

The disk-drive maker beat forecasts the last time it reported earnings on Oct. 30, and the company raised its revenue forecast for the next quarter. That mirrored results at related companies such as Western Digital (WDC:NYSE) and QLogic (QLGC:Nasdaq), which provide related hardware, and EMC (EMC:NYSE), which uses the technology in its data-storage products.

Therefore, we believe there's a story developing that will probably keep all of the stocks in this sector hot for quite some time. When you consider that enterprise spending is in its earliest stages of the economic cycle, we think the data-storage names are only starting to benefit from the cyclical forces taking shape in the global economy.

The secular trends are even more important because, despite all the hype about the Internet and e-commerce in the 1990s, it has really been coming of age in the last few years. Stocks such as Amazon (AMZN:Nasdaq), Baidu (BIDU:Nasdaq) or Priceline.com (PCLN:Nasdaq) have been going straight up for the past year. The same is also true for Visa (V:NYSE) and MasterCard (MA:NYSE).

The more customers and volume these companies attract, the more need they will have for data storage. This makes them poised to receive a huge boost from emerging markets, as millions of people in India, China and Brazil are getting their first credit cards, buying their first cars on credit and opening their first bank accounts.

Investors are starting to price precisely that kind of future into companies such as Seagate, but we don't think it's all the way there yet. Seagate's management has put a lot of work into cleaning up the company and its finances after last year's collapse. Its main issue was a heavy debt load after its acquisition of Maxtor in 2006. Like many companies that take on leverage to execute a merger, the decision produced a more volatile capital structure than what's usually seen in most technology stocks.

However, mergers can cram a lot of productive capacity and end markets under one roof, which can also pay big dividends when things go in the company's favor. This can result in synergies and economies of scale for years into the future.

The first step to setting this stage is cleaning up the balance sheet, which Seagate has been doing all year. Despite an improving corporate-bond market, management decided to pay down $465 million of debt in the past quarter rather than to roll it forward. The company has also largely spent what it has needed to do on capital equipment, and it has plenty of capacity ready to come back on line to suit demand.

The outcome is likely to be a business that will enjoy terrific operating leverage as large amounts of revenue pass straight through to the bottom line.

One final impetus that we think will drive the business is the fact that, when it forecast earnings of $2.20 a share for fiscal 2010, management didn't even factor in the likely PC upgrades resulting from Windows 7. Given all the positive feedback we're hearing about that operating system, we believe that will be a positive factor, and that it should be priced into the stock. We believe earnings could well exceed the $2.20 number.

We'd look to buy the March $14 calls (STXCN) on Seagate for $3.80 or less over the next three quarters, and we'd look to sell them for $1 or more. This stock has had a great run and might see a bit of a pullback, so if you watch the market closely, you may wish to see if it returns to the $16.20 area vs. its $16.72 close on Friday. Regardless of whether the shares experience choppy action, we believe that Seagate has got enough momentum to deliver the upside we're looking for long before March expiration.

Housekeeping note: We also wish to draw attention to a correction on the Open Positions page. Last week, we showed the Exxon Mobil (XOM:NYSE) April $65 calls (XOMDM) as purchased, when they had actually just missed our limit buy price of $8.75. So, we're removing them from the list. Secondly, we didn't show the Joy Global (JOYG:NYSE) April $43 calls (JQYDW) calls as purchased at $16, as they should have been. Thanks to everyone who contacted us about these mistakes, which occurred because of a data error on our end.

Many subscribers have probably also exited the Goldman Sachs (GS:NYSE) December $165 calls (GPYLM), which have returned near their cost-basis. We will leave the holding on the Open Positions page for now but recommend keeping a tight stop-loss. This play hasn't performed as we'd hoped it would, and the upside looks limited from here.

Regards,

Pete Najarian

Send email to pete.najarian@thestreet.com

DISCLOSURE: At the time of publication, Pete Najarian held no positions in stocks mentioned.