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Seagate Technology PLC (STX), Western Digital Corp. (WDC): Are These 2 HDD Stocks a Buy?

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Are These Analysts Right With These Industry Calls?

A bullish industry call

Seagate Technology PLC (NASDAQ:STX) and Western Digital Corp. (NASDAQ:WDC) both traded considerably higher on Thursday, after a Longbow analyst said he believes hard disk drive (HDD) shipments bottomed in the first half of 2013.

Seagate Technology PLC (NASDAQ:STX)

He said that channel checks indicate “relatively stable” pricing and that cloud-driven enterprise is offsetting PC weakness. Moreover, he believes that shares are undervalued based on $2 billion of free cash flow for each company.

If the HDD market is seeing these improvements and pricing is becoming stable, then there’s no doubt that it is an undervalued space. Seagate Technology PLC (NASDAQ:STX) trades at just 8 times next year’s earnings with a price/sales of 1.04. Western Digital Corp. (NASDAQ:WDC) trades at 7.8 times future earnings and just 0.90 times sales. Both metrics are far below the S&P 500 and technology sector; by about 50%.

Despite being so cheap, both stocks have doubled in value over the last year, as both have grown through acquisitions in the HDD space. Clearly, Longbow believes that both could trade significantly higher. Yet, if I had to choose one, it’s Western Digital Corp. (NASDAQ:WDC).

An indications of a clear winner in the space

These two companies, Western Digital Corp. (NASDAQ:WDC) and Seagate Technology PLC (NASDAQ:STX), operate in the same space, are valued similarly, and have seen nearly identical performance. For the most part, investors have gravitated towards Seagate because it pays a much higher dividend and is one of the most shareholder friendly companies in the market; returning almost 100% of its free cash flow back to shareholders in dividends and buybacks.

But what worries me about Seagate Technology PLC (NASDAQ:STX) is that the company seems to be standing still, maybe even falling behind, while Western Digital Corp. (NASDAQ:WDC) strives forward. Six months ago, both Western Digital and Seagate Technology had a 43% stake in the HDD market. This means that combined, these two companies controlled more than 85% of the market.

Yet, during the most recent quarter, Seagate Technology PLC (NASDAQ:STX) pegged its market share at 41% (down from 43%) and Western Digital’s share grew one percentage point to 44.4%. Considering the fact that Seagate actually has a greater market capitalization ($1.3 billion greater), I think that this growth could bode well for Western Digital Corp. (NASDAQ:WDC)’s stock moving forward.

Not to mention, Seagate Technology PLC (NASDAQ:STX) carries a premium compared to Western Digital because it is the more effective of the two companies; and also because it attracts more dividend investors. Western Digital and Seagate Technology have operating margins of 15.67% and 17.67%, respectively. But because Seagate’s margins are higher, there is also less room for improvements.

This was seen during Seagate Technology PLC (NASDAQ:STX)’s most recent quarterly report, as Seagate’s gross margin was flat while Western Digital’s rose 50 basis points year-over-year. So while I do agree with Longbow that these stocks are cheap, and that the PC market may have bottomed, I do think that Western Digital Corp. (NASDAQ:WDC) is the most promising stock for the future.

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