Seagate Slashes Q3 View on Lower Demand, Shares Plummet

Seagate Technology Public Limited Company STX, in its preliminary results announced yesterday, lowered its revenue and margin estimates for the third quarter of fiscal 2016 due to weaker-than-expected demand. Following the announcement, the company's shares plunged more than 6% in after-hours trading yesterday.

Seagate now expects revenues to be $2.6 billion, down from its earlier guidance range of $2.7 billion. Moreover, non-GAAP gross margin is anticipated to be 23%, as against its earlier forecast of 25.6%. The company cited weak demand and inventory declines for the guidance cut.

According to the company, "The difference in the Company's revenue and non-GAAP gross margin from its forecast was driven primarily by reduced demand for traditional mission critical HDD enterprise products, reduced demand for the company's systems and silicon products, reduced demand for desktop client products primarily in China, and the Company's decision to not aggressively participate in the low capacity notebook market."

Moreover, it expects hard disk drive (HDD) unit shipments in the quarter to be roughly 39 million.  

HDDs are primarily used by PCs and Seagate derives the bulk of its revenues from these. It is the second largest manufacturer of HDDs in the U.S. with 40% market share. Therefore, the cannibalization of PCs by mobile devices will affect Seagate's results.

According to the preliminary data released by Gartner, PC shipments in the first quarter of fiscal 2016 fell 9.6% year over year to 64.8 million units, the lowest level since 2007. The declining first quarter 2016 PC numbers indicate long-term weakness in PC HDDs as well, which remains an overhang on Seagate's financials.

In the last reported quarter (second-quarter fiscal 2016), Seagate's revenues of $2.986 billion decreased 19.2% year over year from $3,696 billion. Moreover, Seagate's non-GAAP gross profit plunged 26.6% year over year to $764 million. Also, gross margin contracted 260 basis points (bps) year over year to 25.6%.

To counter these negatives, the company is focusing on the enterprise side, where it could gain higher-margin business. Synergies from acquisitions and product innovations are the other growth catalysts. We believe that this will boost margins and reduce Seagate's dependence on the PC market.

Moreover, the company should benefit from the strength in its hybrid drives. Also, Seagate's cloud-based applications have attracted customers' interest.

However, sluggish macroeconomic conditions, a flattish price environment and competition from Western Digital Corp. WDC and SanDisk Corp. SNDK remain the near-term headwinds. Furthermore, continuing cannibalization of PCs by mobile devices could affect the company's future performance.

The company is scheduled to report its full first quarter results before the market opens on Apr 29.

Currently, Seagate carries a Zacks Rank #3 (Hold). A better-ranked stock in the technology sector is Lexmark International Inc. LXK, which sports a Zacks Rank #1 (Strong Buy).

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