Disk Drives: Fundamentals Weakening, Valuations Cheapening

So, my headline doesn’t quite rhyme,� but you get the idea: the Street is faced with a serious conundrum when it comes to the disk-drive stocks. On the one hand, estimates are coming down, and there are worries that both the June and September quarters could disappoint. And on the other hand…the stocks sure do look cheap.

The deterioration of hard-drive fundamentals in recent weeks has driven a slew of analysts to bring down their EPS estimates and price targets, and we got another dose of that today:

• Wedbush analyst Kaushik Roy repeated his Neutral ratings on both Seagate (STX) and Western Digital (WDC) today, chopping his STX target to $20, from $23, and reducing his WDC target to $42, from $48. Roy notes that pricing in the June quarter was slightly more aggressive than in the March quarter; ergo he trimmed his estimates. For the June quarter, he goes to 84 cents from 87 cents for STX, and to $1.44 from $1.48 for WDC. On the other hand, he writes that “if people are short” the two stocks, he recommends covering, with both stocks down around 20% since mid-April. But he adds that he will monitor the pricing and supply/demand environment before getting more positive on the stocks.
• Gleacher & Co. analyst Dinesh Moorjani repeats his Buy rating on Seagate today, but trims his target to $22, from $24, and cuts his estimate for the quarter to 71 cents from 85 cents. His view is that a reset of expectations is now behind us, and expectations for the September quarter have become overly cautious.

Rodman & Renshaw analyst Ashok Kumar writes that he thinks the total available market in the quarter for the drive makers was at or below the guidance level of 156-161 million units offered by both STX and WDC; he adds that the competitive environment “turned aggressive” towards quarter end, with OEM pricing down high single digits, and channel prices down double digits. Kumar thinks it is too early to buy the stocks, writing that he looks to turn more constructive once supply and demand are back in balance.

Meanwhile, the stocks trade at remarkably low P/E multiples, even for the historically low multiple drive industry: STX trades for 4.3x expected June 2010 EPS, while WDC at 5.2x.

In today’s trading:

• STX is down 32 cents, or 2.2%, to $14.66.
  
• WDC is down 31 cents, or 1%, to $32.38.