STX is retracing from its 2020 high – is it a good time to buy?

As a value-focused investor with more than a bit of a contrarian bent, I tend to get nervous when stocks keep making one new high after another, and I like it when I see stocks trading at or near historical lows. That’s pretty different than the mindset of most investors that focus on growth first, and I understand why – one of the most basic rules around trend analysis states that stocks tend to follow the direction of the next longer trend. That means, in part, that in the short term, a stock is more likely to go up if it has already been going up for at least a few months. If the stock has been going up for a year or more, then the rule should hold even more strongly.

The contrarian part of my investing system revolves around what a stock should be worth at any given time. I like to try to identify what I think represents a fair value for a stock. That mindset differs a bit from straight growth investing, because it uses a stock’s underlying fundamental strength, mixed with historical valuation metrics, to arrive at that “fair value” price. It is an attempt to smooth out the volatility that often exists in stocks as they swing from extreme high to extreme low and consider price movement in a more objective fashion than simply assuming that because a stock has been going up or down, it is going to keep moving that direction. If a stock is trading at a discount relative to historical valuations, with a strong book of business underneath, there is a strong argument to be made that the stock should trade higher than it is right now, and that is where the meat-and-potatoes of my investing strategy lies.

I’ve written a lot in this space about the fact that Tech has outperformed the rest of the market throughout the pandemic – and is expected to continue to do so. In fact, the sector seems to be one of the few sectors that many analysts seem to believe is destined to succeed no matter what the economy does in the near-term, or to what extent COVID-19 continues to exert its influence into the new year. The longer pandemic pressures persist, cloud-based, remote networking and work-at-home Tech companies will remain a prime focus for investors looking for bullish trading opportunities. If you start to think in post-pandemic terms, the picture still remains pretty bullish, as enterprise demand should stabilize and rebound and investors begin to shift more and more of their attention to the next wave of big tech, which will be in 5G networking and the resulting increase in products and services revolving around the Internet of Things (IoT). These are elements that are already in place in the economy, but that I think will get a lot more focus once the health crisis does eventually fade. That doesn’t mean that you can simply buy any Tech stock you want – but it does mean that if you’re careful and selective, you can still find some good opportunities.

Seagate Technology (STX) is one of the biggest providers of storage technology solutions. Where many of its competitors, like Micron (MU) and Western Digital Corporation (WDC) have emphasized innovating in the emerging flash, NAND, and SSD memory space, STX has stayed fixed in traditional disk drives. To some analysts, that view isn’t very favorable, since demand in traditional PC’s has dropped and is expected to continue to do so. Even so, the truth is that truly high-capacity storage – the kind required for network and cloud servers, where the tech sector has seen the most growth over the last few years, and especially since early 2020 – is still only practical with traditional disk storage technology. That is where STX has shifted its greatest focus, and where analysts continue to expect to see growth. The work-at-home dynamic certainly played a role in helping STX’s stock drive nearly 41% higher to around $55 by early June of last year after hitting a March low at around $39; from that point the stock dropped sharply back to a low in late July around $44. From that point, STX staged a strong, new upward trend that peaked in mid-December at nearly $67. The stock has faded back from that point, however is now sitting just a little below $60. Could this bullish retracement be a good opportunity from both a technical and fundamental standpoint to buy this stock, and could it still be a useful value despite its increase over the last ten months? Let’s find out.

Fundamental and Value Profile

Seagate Technology public limited company is a provider of electronic data storage technology and solutions. The Company’s principal products are hard disk drives (HDDs). In addition to HDDs, it produces a range of electronic data storage products, including solid state hybrid drives, solid state drives, peripheral component interconnect express (PCIe) cards and serial advanced technology architecture (SATA) controllers. Its storage technology portfolio also includes storage subsystems and high performance computing solutions. Its products are designed for applications in enterprise servers and storage systems, client compute applications and client non-compute applications. It designs, fabricates and assembles various components found in its disk drives, including read/write heads and recording media. Its design and manufacturing operations are based on technology platforms that are used to produce various disk drive products that serve multiple data storage applications and markets. STX has a current market cap of $15.3 billion.

Earnings and Sales Growth: Over the last twelve months, earnings declined by -17.5% while sales dropped nearly -10.25%. In the last quarter, earnings dropped almost -23%, while revenues decreased by about -8%. The company’s margin profile is generally healthy, but like most companies right now has shown signs of deterioration; over the last twelve months, Net Income was 10% of revenues, but declined slightly to about 9.6% in the last quarter.

Free Cash Flow: STX has generally healthy free cash flow of a little over $1 billion over the last twelve months. This number has decreased steadily from a high point in September of 2018 at around $2.1 billion. At the stock’s current price, this also translates to a Free Cash Flow Yield of about 6.55%.

Debt to Equity: the company’s debt to equity ratio is 2.27, an elevated number that suggests STX is highly leveraged. The company’s balance sheet indicates their operating profits are more than sufficient to service their debt, with $1.66 billion in cash and liquid assets and a little over $4.1 billion in long-term debt.

Dividend: STX pays an annual dividend of $2.68 per share, which translates to an annual yield of 4.46% at the stock’s current price. Not only is that remarkable for a tech company, most of which don’t pay any dividend at all, but this is also well above the industry average. It is also worth noting that while competitors like WDC have suspended their dividend payout to preserve cash, STX has increased their dividend from $2.52 about a year ago, and $2.60 in the quarter prior.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $30per share. That means that STX is clearly overvalued right now, with about -51% downside from its current price. Its actual bargain price is even lower, at a little below $23.50. It is also worth noting that this measurement has declined from the last quarter of 2020, when my analysis offered a fair value target of $38.25.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend from a March, bear market low at around $39 to its December peak at around $67. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s drop from that peak is appearing to gain bearish momentum as the new year begin, with no clear level of support before $56 where the 38.2% retracement line sits, about $4 below the stock’s current price. Immediate resistance appear to be at around $62.50 based on a short-lived peak at the end of December. A push above that point may see the stock retest its 52-week high, but for now the stock’s clearly bearish momentum makes that possibility in the near-term very unlikely. A drop below $56 could see additional downside to about $52, below the 50% retracement line and where previous pivot high activity can be seen.

Near-term Keys: STX has some interesting fundamental metrics working in its favor right now; despite those strengths, however, the stock is clearly overvalued. That means that if you want to work with the stock on a long-term basis, you’re doing it strictly on the basis of its growth prospects. The fact is that most analysts aren’t overly bullish on the storage segment’s long-term prospects right now, as declining consumer trends in the space provide a big counter and major headwind to the strength of enterprise demand, which is expected to narrow into 2021. STX also operates in a highly competitive space, which keeps constant pressure on pricing and narrows profit margins. Altogether, and given the stock’s current bearish momentum, I think that means that the best probabilities for a stock like STX lie in shorter-term trading strategies. If the stock can reverse its current momentum, a bounce off of support anywhere between its current price and $56 could offer a signal to consider buying the stock or working with call options, using $62 as a good profit target. The stock’s current momentum could also act as a signal right now to think about shorting the stock or buying put options, with a profit target at $56 on a bearish trade that could extend to around $52 if bearish momentum remains strong.


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