Healthy outlook for data-storage makers

Malcolm White, vice president with Signature Global Asset Management, a division of CI Investments Inc. in Toronto, and portfolio co-manager of Signature Global Science & Technology Corporate Class fund, likes both the hard-disk drive (HDD) and SSD subsectors. He says that even with the run-up in share prices in 2013, multiples are still low for companies in this industry. Thus, he believes, there’s more share-price appreciation to come – assuming the industry remains stable.

White believes the HDD and SSD markets will experience valuation multiple expansion because industry consolidation is expected to push up margins over time. He considers both SK Hynix Inc. of Inchon, South Korea, and Western Digital Corp. (WD) of Irvine, Calif., to be attractively priced.

Analysts with J.P. Morgan Securities LLC in New York also are enthusiastic. They have “overweight” ratings on Hynix, WD and Micron Technology Inc. of Boise, Idaho. The J.P. Morgan analysts also have an “overweight” rating on Intel Corp., which is also a major player in this sector.

In addition, analysts with UBS Securities Asia Ltd. in Hong Kong have a “buy” rating on Hynix. And analysts with UBS Securities LLC in New York have a “buy” recommendation on Micron.

HDDs, which are commonly found in desktop PCs, have moving parts. Data is stored and retrieved using rapidly rotating disks coated with magnetic material. SSDs are a newer form of storage typically used in tablets, smartphones and, increasingly, PCs. SSDs contain no moving parts, as data is stored in and retrieved from microchips.

Most SSDs use “negated ‘and'” [NAND] logic-based flash memory, which retains data directly on a semiconductor, typically in mobile devices. SSDs also can be built using dynamic random-access memory (DRAM), which stores data separately; these typically are used in PCs.

Besides SSDs’ use in retail products, they also are used in enterprisewide networks, says Jeremy Yeung, vice president with Signature Global Asset Management and White’s portfolio co-manager for the Signature Global fund: “SSDs have a significant performance advantage over the traditional HDDs, which is why [chief information officers] are deploying enterprise-grade SSDs in their data centres.”

A few years ago, the SSD and HDD space, says White, “was very unloved. There was oversupply and companies had to respond to price pressure from customers.”

Then, in 2011, he adds, a major flood in Thailand took a significant amount of capacity out of production. The flood was the catalyst for the industry to rethink the way it was structured. Thus, Cupertino, Calif.-based Seagate Technology PLC acquired South Korea-based Samsung Group’s HDD business, then WD purchased Hitachi Global Storage Technologies Inc. of San Jose, Calif.

This industry consolidation allowed data-storage manufacturers to negotiate lucrative contracts with their clients, resulting in higher prices, more certainty on margins and the ability to manage supply rationally.

Yeung expects to see “increased alliances between HDD and SSD technologies. For example, WD has been acquiring a lot of companies with intellectual property in the SSD industry.”

Here’s a look at the four of the key companies in more detail:

– sk hynix inc is a “pure” SSD play, says a UBS Securities Asia report, as it’s the second-largest DRAM and fourth-largest NAND microchip producer. DRAM microchips account for about 70% of revenue, with NANDs at about 25%. With supplies now tighter for DRAMs than NANDs, this positions SK Hynix well – particularly because it’s adding to its DRAM capacity.

“Among major tech names, we believe SK Hynix has the highest earnings visibility, given its multi-year growth story,” says a J.P. Morgan report, adding that as the company’s debt declines, it will be able to “potentially consider various shareholder return measures.”

The J.P. Morgan report’s price target is 45,000 Korean won (about $42) a share; the target in a UBS Securities Asia report is 49,000 won ($46). SK Hynix’s 698 million outstanding shares closed at 39,050 won ($37) on Feb. 14. (All figures are in U.S. dollars.)

Net income was 2.9 trillion won ($2.6 billion) on revenue of 14.2 trillion won ($12.8 billion) for the 12 months ended Dec. 31, 2013, vs a loss of 159 billion won ($140 million) on revenue of 10.2 trillion won ($9 billion) in the corresponding period a year earlier.

– micron technology inc. has a 50% exposure to NANDs vs 45% to DRAMs. Nevertheless, a UBS report has a “buy” recommendation on this stock: “We believe there remains further upside potential in Micron’s earnings due to gross margin expansion initiatives.” (The report also mentions the possibility of a quarterly dividend “further in the future.”)

However, a J.P. Morgan report rates Micron stock “neutral.” This report agrees that the firm’s margins are likely to improve and adds that in the longer term, Micron is increasing product diversification, which “should dampen revenue/earnings volatility” and position the company to do well in markets that require multiple types of data storage.

The UBS report’s price target is $28 a share; the J.P. Morgan report’s price target is $24. Micron’s 1.1 billion outstanding shares closed at $25.08 on Feb. 14.

Net income was $1.8 billion on revenue of $11.3 billion in the 12 months ended Nov. 28, 2013, vs a loss of $1.2 billion on revenue of $8 billion in the corresponding period a year earlier.

– seagate technology plc is an HDD manufacturer. A J.P. Morgan report says Seagate should do well as end-user markets rebound and notes that Seagate “continues to exhibit sustained discipline” in pricing and production.

Although the report has a “neutral” rating on the stock, with a $55 price target, it recommends buying the stock on weakness – and Seagate’s 336 million outstanding shares have dropped since the report was issued on Jan. 28, closing at $50.14 on Feb. 14.

Net income was $1.6 billion on revenue of $14 billion in the 12 months ended Dec. 27, 2013, vs net income of $3.2 billion on revenue of $16.3 billion in the corresponding period a year earlier.

– western digital corp. A J.P. Morgan report is enthusiastic about WD, giving it an “over-weight” recommendation. Not only does the report say that WD’s operating margins are likely to improve through 2014, it suggests the quality of the financial results and “sturdy” shareholder returns “are likely to keep long-term investors interested in the stock.” That’s particularly so as the dividend is likely to increase now that WD has finished its wave of mergers and acquisitions.

J.P. Morgan’s 12-month price target for WD’s stock is $110. The 236 million outstanding shares closed at $86.71 on Feb. 14.

Net income was $1.1 billion on revenue of $15.3 billion in the 12 months ended Dec. 27, 2013, vs net income of $2.1 billion on revenue of $15.6 billion in the corresponding period a year earlier.

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