Tuesday, October 24, 2006

FTN Midwest Securities on HDD's

- People at FTN Midwest Securities have issued a nice summary on HDD names:

Firm notes that with six drive makers producing notebook drives, the segment continues to be one of the most dynamic and competitive segments of the HDD market.

Although demand is solid and notebook shipments are expected to be up 25-30% in 2006, notebook drive pricing has remained aggressive in 3Q. The desire by relatively new entrants STX and WDC to gain share and Asian incumbents, particularly Hitachi GST, to stem share losses has led to aggressive price declines.

Outside of the overall strength of the notebookmarket, the biggest takeaway from their perspective is WDC design wins and the likely share gains in 3Q and 4Q that go along with them.

With fundamentals improving entering the seasonally strong CY4Q and Seagate (NYSE:STX) shares trading at historically low levels (8x FTN's CY07E of $2.66), they believe this to be an attractive entry point for investors. Firm is maintaining their BUY rating on STX and $31 price target. They believe that STX will disproportionately benefit in the long term fromthe Maxtor acquisition as well as underlying growth in the utilization of hard drives. Longterm catalysts for growth are 1) a more stable pricing environment particularly in the enterprise and desktop segments, 2) increased scale via share gains, 3) product depth, and leading technology position. They also believe that downside is relatively limited at these levels. Using STX’s two year low sales multiple, they estimate that downside is limited to $17 (.81x FY07 sales estimate).

FTN is also bullish on Western Digital (NYSE:WDC) given share gains in the desktop segment and the significant strides it has made to close the technology gap with announced volume production of 160 GB per platter desktop drives and 80 GB per platter, PMR based, notebook drives. Firm believes that the long term positives with this story clearly outweigh the shorter term negatives and are maintaining BUY rating and $24 price target. WDCshares are currently trading at 8x CY07E of $2.01, a discount to its mean forward year multiple of 12x. Using WDC’s two year low sales multiple, they estimate that downside is limited to $11 (.48x FY07 sales estimate).

Although they like the risk reward proposition with HDD OEMs, the firm is less bullish on theircomponent suppliers who could feel the negative impacts of the excess inventories
accumulated throughout 2006 into the historically strong December quarter. Despite the recent sell off of Komag (NASDAQ:KOMG), they would remain on the sidelines as the draw down of excess drive inventories could potentially overlap with 2007 challenges including industry wide and company capacity additions, the loss of Maxtor’s enterprise business, and the potential negative impacts of adoption of 160 GB per platter and PMR. Additionally, share gains by Samsung whose media procurement model does not includeKOMG remains a concern.

They are also uncomfortable recommending Hutchinson Technology (NASDAQ:HTCH) at this point. Firm continues to be concerned that HTCH may lose share as STX transitions acquired revenue streams to its procurement model which they believe favors HTCH competitor Magnecomp. They also believe that new component reducing advances in technology including 160 GB and PMR could hurt HTCH if weakness with higher cap drives persists.

Overall, FTN's checks in Asia indicate that drive demand and sales were generally inlinewith expectations for the quarter. Unlike US and European distributors, Asia distributors continue to see excess inventories.

Channel pricing appears to be more aggressive in Asia than in the US or Europe. Expectations for 4Q remain positive with contacts having “good” visibility for October and November order. Solid but not robust PC demand was complemented by strong gaming console orders reinforcing our thesis that end market demand is not the major stumbling block for the HDD industry. Ongoing market share battles continue to be a cause for concern but contacts see improvements in inventory andpricing indicating that the worst should be over.

Notablecalls: Nice little summary for the investment types out there. None of this stuff is outright actionable but it sure does help with the overall picture. This is also about the first time I have highlighted FTN Midwest on this page. Welcome to the club, guys! Hope to see more of you here.

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