Editor’s Note: This article was originally published last month.
At the Ira Sohn conference on Wednesday, Jim Chanos gave a presentation on being short Seagate Technology PLC (NASDAQ:STX). Chanos has been negative on the entire PC industry citing the explosion in smartphones and tablets are eroding PC sales.
Cyclical and/or overly dependent on one product
Hindsight drives expectations
Marquis management and/or famous investor(s)
Appears cheap using management’s metric
Regarding PC’s, he presents that PC sales numbers peaked in 2012 and has reversed into a decline in sales from the first quarter of 2013.
Here is a summarized version of his short thesis on Seagate Technology PLC (NASDAQ:STX) and then I’ll get into some numbers to poke and see whether there are any signs of a failing industry.
Stock price is inflated due to higher prices. Chanos cites that hard drive prices are approaching 10% of PC prices.
PC industry operates on thin margins and as sales and prices come down, the price of hard drives is not sustainable. Chanos cites that Toshiba has announced its hard drive margins will be drop by half this year.
Pricing will come under pressure from competition of digital storage space
A Dangerous Short?
I have learned not to short, or claim a company is overpriced, based on stock price alone. Same thing applies to Seagate when looking at these numbers. You wouldn’t know that judged on the latest figures that Seagate is at all time highs. Even at these levels, these ratios are within value stock ranges.
Since Chanos is not claiming Seagate Technology PLC (NASDAQ:STX) to be a good short because it is overpriced, but rather than business is bound to fail due to a fall in margins and drops in sales, let’s analyze those two areas.
Analyzing the Margins
The easiest thing to do is to draw a simple graph depicting the gross, operating and net margins.
Let’s just say for the sake of giving Seagate the benefit of the doubt, that the recession in 2009 is an anomaly. If this is the case, the operating income of Seagate from 2003-2008 was averaging 9.2%. In the last three years and TTM, it has jumped to 15.6% and Chanos’ question comes into mind.
Are the price of hard drives sustainable?
Seagate Technology PLC (NASDAQ:STX) now offers SSD which comes at a higher price point, but it is bound to come down further in price. There is competition from digital storage which offers the convenience of accessibility from anywhere.
Physical storage is a commodity business with no moat so I find it difficult to believe that prices can stay high enough to maintain the current margins.
Does the DuPont Analysis Show Anything?
Taking it one step further, does the DuPont analysis point to any signs that the growth and increase in business performance is coming from anything other than improvements in margins?
See the 3 step and 5 step DuPont analysis below.
Looking over the golden years, the increases in ROE were due to
increase in margins
increase in asset turnover
reduction of interest
reduction in leverage
From a business and operational perspective, Seagate is on fire. They are doing everything right.
So far, Chanos certainly isn’t shorting Seagate Technology PLC (NASDAQ:STX) based on fundamental deterioration. He is taking a top down approach by believing that the downfall of the PC industry will cascade into the hard drive space.
Inventory Analysis and Interpretation
Since the ROE didn’t show anything strange, let’s take a look at Chanos’ angle of sales set up to fall.
One of the leading indicators of sales is inventory and the way to do that is to analyze the details of the inventory to predict whether the company is expecting a boom or bust in sales.