Most investors buy tech stocks not for income, but to get exposure to cutting-edge companies and fast sales growth that will drive share prices higher. After all, many tech companies plow their earnings back into research and development to find the "next big thing." However, a small group of tech companies actually do pay solid dividends -- like Seagate Technology (STX) .
Now, Seagate and other tech firms that actually pay decent dividends usually have all of an income stock's hallmarks -- sufficient cash flow to fund ongoing operations, enough EBITDA to continually pay dividends and fairly solid balance sheets. In fact, the only drawback compared to "traditional" income stocks like consumer staples is that tech companies that pay dividends usually have more business and market risk simply because they're in a higher-risk sector.
As for Seagate, it doesn't have the hottest new technology around, but does supply a key tech component -- storage drives. STX is one of eight publicly traded storage-device makers, but it's very inexpensive. The stock has just an 8.5x trailing 12-month price-to-earnings ratio and a 7.6x forward P/E multiple.
Best of all, Seagate boasts a 5.4% dividend yield and a very healthy 61% payout ratio, which means the dividend seems safe. Seagate's dividend rate is also some 200 basis points above the 10-year U.S. Treasury yield, so the stock should attract plenty of buyers. Still, it only closed Friday at $46.81, down 25% from Seagate's 52-week high.
On the downside, Seagate's primary risk is that its storage drives don't really have any kind of brand loyalty. If a competitor develops better ones, rest assured that Seagate will lose customers.
Seagate's gross income has also declined from $13.7 billion in fiscal 2014 to $11.1 billion in fiscal 2018, while net margins have dropped some 90 basis points over the same period. However, the firm's gross margins have risen about 200 basis points since then, while its operating margin has added some 250 basis points.
Enough Cash to Pay Dividends
Of course, what income investors ultimately care about is cash flow -- or more specifically, whether a company generates sufficient cash to fund its interest payments and dividend payouts. For Seagate, the answer to both questions is "yes."
The company's interest-coverage ratio (which measures interest payments relative to EBITDA) was a very healthy 9.5x in fiscal 2018. Similarly, the firm's dividend- coverage ratio (dividend payments vs. EBITDA) was an impressive 3.1x.
I also see little to be concerned about with Seagate's balance sheet. For example, the firm's accounts receivable as a percentage of current assets are at their lowest level in five years, indicating to me that the company isn't liberalizing credit terms to pump up sales.
Yes, Seagate reported a high inventory as a percentage of assets in the firm's latest 10-K, but its inventory-to-current assets ratio has been this high before and likely just represents an ill-timed delivery. Lastly, STX's debt-to-asset ratio is a decent 45%.
The Bottom Line
Add it all up and I view Seagate Technology as a solid company that income investors should consider. While STX's earnings picture has been mixed over the past five years, management has improved gross and operating margins, while EBITDA looks more than sufficient to cover interest and dividend payments.
The balance sheet is also solid, while cash flow is strong enough to fund ongoing operations. And most importantly, Seagate's high dividend yield looks more than sustainable given the company's current financials.
This article was originally sent Oct. 3 to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this each day from Hale Stewart, Chris Versace, Jonathan Heller and others.)