In the most recent one-year period, shares of Seagate Technology (STX) are up 67.5%. I believe Seagate can trade higher based on better margins and top-line growth. It's time to ride this beast higher.
Last night on CNBC's "Mad Money with Jim Cramer," Jim suggested investors should continue to ride the tiger for technology stocks such as Seagate, Micron (MU) and Western Digital (WDC) . After this year's performance, Seagate definitely has the eye of the tiger!
On Tuesday, Seagate reported second-quarter earnings of $1.38 per share, $0.30 better than expected. Revenue fell 3.1% to $2.89 billion. Importantly, gross margin rose 300 basis points to 31.8%.
Seagate was able to get its operating expenses as a percentage of revenue down to 16%. The lower expenses drove operating margins to a recent high of 16%. Just three quarters ago, the company sported an embarrassingly low operating margin of just 6%.
Net income jumped 38% sequentially to $412 million. Nine months ago the company had net income of only $66 million.
The company's recent efforts to contain costs really helped to grow margins. The company was confident in its ability to remain within the high end of its gross margin target range of 27% to 32%. Management also said operating margins of 13% to 15% were realistic.
Besides cost reductions, Seagate focused on selling enterprise drives for high-end servers instead of low-margin hard drives for consumer personal computers. By keeping its percentage of enterprise drives over 37%, the profits really flowed.
The average capacity per hard drive was 1.7 terabytes, which was flat with last quarter. Average capacity per drive was up 30% year over year. Higher capacity drives carry higher prices and better margins.
Management anticipates first-quarter revenue of $2.7 billion, which is about $100 million more than previous guidance. The first quarter is typically seasonally weak.
For the year, the company expects earnings of at least $4.50 a share and revenue growth of 2.8%. Those estimates are materially better than investors were expecting.
I think Seagate can trade higher simply because the company has strong top- and bottom-line momentum. Looking at the company's guidance, it seems analysts will need to increase their earnings estimates throughout the year. In terms of valuation, the hard drive industry usually trades between 6x and 12x times forward estimates. With the rebound in operating margins and strong demand, I can see Seagate trading as high as the mid $50s.