Strong Demand Lifts Storage Stocks

Western Digital joins Seagate in boosting guidance.
Author:
Publish date:

SAN FRANCISCO -- Shares of hard-disk drive makers were flying Tuesday on signals that demand is increasing beyond expectations.

Late Monday,

Western Digital

(WDC) - Get Report

followed

Seagate

(STX) - Get Report

by unexpectedly

raising first-quarter revenue and profit targets.

Both companies have indicated that demand for hard-disk drives, especially pricier high-end devices with fatter profit margins, is healthier than anticipated. In late August, Seagate surprised investors

by raising its first-quarter financial targets.

Western Digital shares were recently trading up $1.22, or 5.4%, to $23.63. Seagate shares had gained 51 cents, or more than 2%, to $23.36.

Analysts and investors have largely attributed

strength in the hard-drive market to sales of personal computers. This thesis gained credibility after

Intel

(INTC) - Get Report

, the world's largest maker of PC microprocessors, raised its guidance on Monday. Intel also lifted its gross profit margin targets, suggesting that it's selling more of its expensive chips for high-performance computing.

On Tuesday, equity research firm BWS Financial said the rosier outlooks from Western Digital and Intel also bode well for PC component makers like

Marvell Technology

(MRVL) - Get Report

. Western Digital is one of Marvell's largest customers, according to BWS.

BWS does not have a business relationship with the companies it covers, and does not own shares in them.

Marvell shares were recently trading up 20 cents, or 1.2%, to $16.73.

Late summer and early fall typically marks the strongest season for computing devices and components. The trend stems in part from back-to-school purchases, which tend to favor sales of portable laptops carrying higher prices and better profit margins. This boosts a broader shift in PC purchases toward laptops over desktop units.

But the amount by which Western Digital and Seagate raised forecasts suggests that demand far exceeded the companies' internal forecasts.

Investors have been waiting for computer purchases to accelerate as users upgrade to devices running

Microsoft's

(MSFT) - Get Report

newest Vista operating system. That trend may finally be gaining traction, says Tony Trzcinka, a portfolio manager with Pax World funds. Pax owns about 425,000 Seagate shares.

The demand for high-performing computers -- using premium components from Seagate and Western Digital -- may be showing up in gross margins. Both companies are expecting wider gross margins than they have reached in previous quarters.

Sales of higher-end drives may indicate some firming of pricing power after years of successive price cuts to compete with each other and Asian rivals like

Hitachi

(HIT)

and

Fujitsu

.

The strength in gross margins may also stem from better control over component costs. Seagate has spent years bringing component production in-house, cutting out the premium it once paid to suppliers. Western Digital has followed this model with its recent acquisition of

Komag

, a maker of so-called media used in producing hard drives. Seagate already produces about 85% of the media it uses in its drives.

The demand for disk drives should remain healthy for years as more are needed in servers and storage devices running Internet sites and email services that consumers use to store and exchange memory absorbing photos, music files and documents. Also, the content on mobile gadgets like

Apple

(AAPL) - Get Report

iPods also gets backed up on storage devices using hard drives.

Hard drives are also used in digital video recorders that record and playback television shows. And stronger hard drives will be needed to store high-definition broadcasts that media companies are producing.

But demand and pricing power won't put an end to the cyclical nature of hard drive purchases. What's more, a shift in sales to drives for consumer electronics ties Seagate and Western Digital more tightly to volatile factors that affect consumer spending like employment, housing prices and interest rates.

Analysts and investors, however, say that the recent pricing power will help Seagate and Western Digital negotiate prices from a higher base, making gains in their profitability and cash flow more sustainable.