Hard Drive Makers Withstand Whipsaw Market

Seagate and Western Digital continue to enjoy strong demand.
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SAN FRANCISCO -- The rocky markets of late have failed to sink the fortunes of hard disk drive makers

Seagate

(STX) - Get Report

and

Western Digital

(WDC) - Get Report

.

While tech bellwethers

IBM

(IBM) - Get Report

and

Cisco Systems

(CSCO) - Get Report

have unnerved investors with talk of slackening hardware sales, the two storage purveyors are issuing robust financial guidance with no sign that demand is slackening.

The combination of strong demand, manufacturing efficiency and production discipline has dampened the effect of market volatility on shares of the hard drive makers. Seagate shares are trading at roughly the price at which they started the month when tech stocks began to falter. Western Digital shares have gained over 10%. By contrast, IBM shares are off more than 5%, and EMC shares have fallen almost 25%, over the same period of time.

In a conference hosted by Credit Suisse on Tuesday, Seagate's Chief Executive Bill Watkins said inventories are currently lower than the company had expected at the beginning of the quarter. He also said that Seagate's production facilities are "capacity-constrained," meaning that they are running at full tilt to meet existing orders.

Watkins' comments echo recent remarks from his counterpart John Coyne of Western Digital. In a post-earnings release conference call with analysts on Nov. 1, Coyne said, "Distribution and manufacturers' inventories combined are down year over year by some 11% exiting October." He also noted that Western Digital's "capacity is constrained relative to current demand."

For most of the year, analysts and investors have played up the surge in demand for drives used in personal computers, Internet servers handling more traffic, and

TiVo

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-like devices that store television shows and movies. Other factors have helped as well, such as the need for storing email to comply with regulatory mandates like Sarbanes-Oxley.

The results are evident in the companies' bottom lines. Seagate and Western Digital, which control about 57% of the hard drive market, have been swimming in profits over the past two quarters. Both companies surprised investors by preannouncing earnings sharply above analysts' expectations as well as management's guidance.

At Tuesday's conference, Watkins reiterated Seagate's guidance of a 13%-17% increase in revenue for the current quarter ending in December. But he and Chief Financial Officer Charles Pope also held out the tantalizing possibility that Seagate's profit margins may be even better than expected.

Pope told conference attendees that demand trends in the current quarter are similar to those observed in the September quarter, during which unit sales grew 17%, above the 15% that was expected. As in that quarter, hard drive sales are benefitting from continued demand for desktop computers, laptops and storage devices used in large businesses.

In addition to demand, the resilience of hard disk drive makers owes much to their efforts to change industry dynamics. Both companies have made acquisitions that have helped manage component prices, make manufacturing more efficient and temper price wars that bled them of profits in years past.

"We're going to see double-digit growth for a few years and should be able to maintain a profitable industry without getting into price wars if we're smart," said Watkins.

His comments were directed at Japanese rival

Hitachi

(HIT)

and Korean conglomerate

Samsung

. But even if these Asian companies were to force a price war, Watkins said that Seagate could still operate profitably while those companies sink into the red. Earlier in the year, for example, Hitachi's hard drive unit reported a $174 million operating loss despite the demand that boosting profits at Western Digital and Seagate.

"They can't fight us on cost without losing money," he said.

Increasingly, hard drive sales are coming from consumer electronics devices. In January, Seagate unveiled a consumer storage device to safeguard files on home computers. The company is also preparing a portable device that backs up data stored on cell phones.

Watkins said there is growing demand for sophisticated storage products used in surveillance equipment as well as in automobiles for storing movies and music files.

Also, the market for digital video recorders in homes is still in a growth phase, says CFO Pope, because few devices today are equipped to handle the high-definition content that studios are starting to produce.

Seagate shares were recently trading up 15 cents, or 0.5%, to 27.12. Western Digital shares were up 30 cents, or 1%, to $28.37.