Hard times for hard disks - Seagate trumps Western Digital
Western Digital, the world’s largest producer of HDDs, has been forced to stop production in Thailand while factories of the the world’s second largest producer of HDDs, Seagate, are unscathed (Chart 1). This creates a short-term competitive advantage for Seagate since it can continue production and sell at higher prices as HDD world supply dries up and demand increases towards Christmas (prices for HDDs have already gone up more than 10%).
Global HDD production is basically divided amongst Western Digital, Seagate, Hitachi and Toshiba. Western Digital and Toshiba have 60 percent and 50 percent of their HDD production in Thailand respectively. They both face heavy problems as the factories are filled with as much as 1.5 metres of standing water and more rain is expected due to the weather phenomenon La Niña.
Share price performance has been poor for Western Digital since the rain started (Chart 2). However, at first Seagate took the hardest hit but recovered later once companies such as Acer, Samsung, Honda and Sony announced that their earnings would be negatively hit by the flooding and the analysts realised that Seagate’s production facilities were not threatened by the flood. Perhaps the initial overreaction on the share price was due to the fear of the floods impeding production and a relatively weaker historic EBIT-margin for Seagate compared to Western Digital would mean it was risking taking a heavy hit (5 Year average EBIT-margin: Western Digital 10.1% and Seagate 8.4%). During the same period, the share prices of Hitachi and Toshiba have been minimally impacted by the flooding since they only have limited exposure to HDD production (even though Toshiba has 50 percent of its HDD production capacity affected, see Chart 1).
When the flooding started, Seagate saw its Earnings per Share revised downwards while Western Digital’s problems were not yet identified (Chart 3). Seagate’s EPS for 2011 and 2012 was affected initially whereas later on (again when companies started to announce that earnings would be impacted by floods) Seagate’s EPS was revised upwards. At the same time, Western Digital, that had its EPS more or less unchanged at first, eventually saw its EPS for 2011 absolutely slaughtered by analysts when they finally realised that the majority of the company was literally under the weather.
Seagate’s potential could already be reflected in the 12-month forward P/E of 9.3 compared to Western Digital’s 12m forward P/E of 6.4. As it looks now both Seagate and Hitachi have the potential to drastically increase their revenue from HDD sales (Seagate believes it can boost its sales volumes from 50m units to 60m and 70m units in Q4 2011 and Q1 2012 respectively), and this is clearly reflected in the valuation of Seagate. However, there are some ‘dark clouds’ on the sky that pose a significant risk.
Nidec can potentially crash Seagate’s party
The Japanese firm Nidec Corp, which supplies electrical motors used in HDDs to 70-80 percent of the world’s HDD manufacturers, also has plants in Thailand hit by the floods. All the large HDD producers buy components from Nidec, so a shortage of electric motors for the hard drives means that producing at full capacity will be very difficult. Other HDD component suppliers in Thailand facing problems to some extent include TDK, Hutchinson Technology, Furukawa and MMI. The final outcome will depend on the suppliers’ ability to get production up and running and/or the HDD producers’ capacity to source components from other suppliers.
All in all, Seagate has big potential to take advantage of the current situation in order to maximise profits and growth before the competitors can get their production back to full capacity. However, given the uncertainty of Nidec’s and other suppliers’ abilities to deliver vital HDD components, this opportunity can fade away as quickly as it appeared.