Hard-Drive Makers Have Growth in Store

Seagate and Western Digital are good candidates for long positions. Seagate is the down and cheap stock for the bottom-fishing value types, while Western Digital should be preferred by momentum and estimate revision investors. Both are too cheap with excellent fundamentals not to own, so I happen to be a shareholder of both.

I expect the Western Digital to continue to grow strongly and blow away analysts' earnings estimates. Assuming decent demand in the tech industry, WDC should make $5 per share in the fiscal year that begins this July. Wall Street is still at $4 for fiscal year 2009. I get that significant earnings surprise with 15% revenue growth, gross margins equal to this March quarter (22% and seasonally slow one) and normal operating expense ratios. I still believe investors and analysts underestimate the growth potential of WDC.

Seagate should have a great year in fiscal 2009 as well. I have well above Street estimates for it at $3.65 vs. current consensus of $2.90. Seagate should have 13%-plus revenue growth, expanding profit margins, huge free cash flow and a major share repurchase program.

My price targets for Seagate and Western Digital are $40 and $55 respectively, or price appreciation potential of 75% to 100%. That's only 11 times profits for each on fiscal 2009 numbers. Some may question that type for valuation for hard-drive companies. But I believe it's very achievable.

Just look at the valuations of other competive commodity industries such as steel or coal to see how much valuations can expand in newly consolidated cyclical growth industry. Many metal stocks trade for 13 times peak profits today, and coal stocks typically change hands at 15 to 18 times, so an 11 multiple for hard drives is very doable. Now all we need is for the hard-drive managements and sales forces to play nice for three more months! Come on, guys, give us shareholders a break!

The technology sector is known for a seasonal trade down into summer and up into winter. Since everyone knows this, it gets discounted earlier each year. My guess is that the hard-drive stocks are being restrained by this seasonality as well as macro concerns. But that will be over shortly.

In a couple of months, big money will be buying these stocks for both cyclical and seasonal reasons. The smarter ones are already establishing positions, like Ken Heebner, growth manager extraordinaire. His latest filings revealed a starter position in Western Digital. I would like to welcome Ken to one of the best set of valuations and fundamentals in the entire technology sector. One could do far worse than following him.