Options Trade – Seagate Technology (STX)
Friday, January 11, 2013

Negativity Drives STX To A Positive Position!

**OPTION TRADE: Buy the STX Mar 2013 33.000 call (STX130316C00033000) at or under $2.50, good for the day. Place a protective stop limit at $1.00 and a pre-determined sell at $4.50.

by Ian Harvey

January 11, 2013

Introduction

It is generally not thought of strong growth potential, in today’s market atmosphere, when looking at hard disk drive manufacturers. However, Wall Street was caught off guard earlier this week when Seagate Technology (NASDAQ: STX) boosted its fiscal second-quarter sales outlook from $3.5 billion to $3.6 billion.

Business Summary

Seagate Technology, an American company, is one of the world's largest manufacturers of hard disk drives. They design, manufacture, market, and sell hard disk drives for enterprise storage, client compute, and client non-computer market applications worldwide.

Incorporated in 1978 as Shugart Technology, Seagate is currently incorporated in Dublin, Ireland and has its principal executive office in Cupertino, California.

Seagate has been a leader in the development of the hard disk drives since releasing the 5 MB ST-506 drive in 1980, the first 5.25-inch hard drive. They were a major supplier in the microcomputer market during the 1980s, especially after the introduction of the IBM XT in 1983. In 1989, they finalized the purchase of Control Data Corporation's Imprimis division, makers of the well-regarded Wren product line. This gave Seagate access to the Wren's voicecoil-based technology. In 1991, they introduced the 7,200 RPM Barracuda line, which remains their high-end offering to this day. They purchased Maxtor in 2006.

The company’s products are used in enterprise servers, mainframes, and workstations; desktop and notebook computers; and digital video recorders, gaming consoles, personal data backup systems, portable external storage systems, and digital media systems. It also provides data storage services, including online backup, data protection, and recovery solutions for small and medium-sized businesses. The company ships external backup storage solutions under its GoFlex, Backup Plus, and Expansion product lines, as well as under the Samsung brand name; and network attached storage solutions under its GoFlex Home and BlackArmor product lines. Seagate Technology Public Limited Company sells its products primarily to original equipment manufacturers, distributors, and retailers.

STX Report

STX is not officially scheduled to release its full Q2 report on Jan. 28, however, Seagate released information early:- solid unit sales figures drove revenue, with Seagate shipping about 58 million drives in the quarter. Additionally, the company reported adjusted gross margin of 27% and said it paid $1.1 billion in share redemptions and dividends during the quarter.

STX shares jumped 6.6% on the news to close at their highest point in more than four months. For a broader perspective, Seagate added 85% in 2012, making it the second-hottest tech stock in the S&P 500. What’s more, investors already have gotten more than 8% gains out of STX in 2013.

Shares of Seagate traded up 4.65% during mid-day trading on Wednesday, hitting $32.855 and closed Thursday at $33.68. Seagate has a one year low of $18.39 and a one year high of $35.71. The stock’s 50-day moving average is currently $28.63. The company has a market cap of $12.403 billion and a P/E ratio of 4.13.

Seagate last announced its earnings results on Wednesday, October 31st. The company reported $1.45 earnings per share for the quarter, missing the analysts’ consensus estimate of $1.70 by $0.25. The company’s quarterly revenue was up 32.8% on a year-over-year basis. Analysts expect that Seagate will post $5.18 EPS for the current fiscal year.

Rebound

Technically, the most recent leg of STX’s rally began after the shares rebounded from support near $25 in late-November, pushing the stock past former resistance at $33. Shares have since added more than 32% along support at their 10- and 20-day moving averages. What’s more, the stock’s 50- and 200-day trendlines are on the verge of a “golden cross” — a bullish technical formation that could bring a wealth of buyers to the table – which will be beneficial to this options trade!

Negativity a Plus

Despite STX’s strong price action and solid fundamentals, there is a wealth of negative sentiment levied against the shares. For instance, 19 of the 23 analysts following the shares still rate them a “hold” or worse. Additionally, the consensus 12-month price target for STX rests at $29.50 — a discount of 13.5% to the stock’s close at $33.46 on Wednesday.

However, this is changing very quickly as seen by several analysts’ adjustments recently, as noted in one such report on Wednesday by FBN Securities…..

“We retain our Outperform rating and raise our price target from $33 to $35 to reflect Seagate Technology's slightly positive results and positive data points from our checks.

Tuesday night, Seagate (ticker: STX) preannounced fiscal-fourth-quarter (ended December) revenue of at least $3.6 billion (higher than the prior guidance of approximately $3.5 billion), gross margin of more than 27% (in line with prior guidance of gross margin being at the low-end of the 27% to 32% range) and total unit shipments of 58 million (higher than our prior 57.3 million units).

Checks indicate that Seagate's enterprise segment did very well. Channel checks indicate that Seagate's enterprise drive units and pricing were quite strong. We believe that Seagate may have increased its enterprise unit market share to over 50% in the December quarter from about 47% in the September quarter. We hear that enterprise drive pricing, which often decline by about 3% to 5% quarter-over-quarter in the December quarter, were roughly flat quarter-over-quarter. We increased our fiscal-second-quarter enterprise shipments for Seagate from 6.3 million to 7.5 million units.

Our checks indicate that hard-disk-drive (HDD) price declines have not been unhealthy recently. For example, checks indicate that pricing for a 1-terabyte desktop drive in the channel is around $65-$66 (higher than preflood pricing of $55 and down only modestly from $67 at the beginning of September), and pricing for a 500-gigabyte mobile drive in the channel is around $55 (versus $59 in October). Furthermore, we hear that channel inventories are low at around three to four weeks. We hear that Seagate has been slightly more price aggressive than Western Digital (WDC). For example, Seagate is pricing a 1-terabyte desktop drive currently at around $65-$66, roughly $2 lower than the $67-$68 price that Western Digital is charging. In early October, Seagate was pricing a 1-terabyte desktop drive at $67-$68, roughly $3 lower than the $71 that Western Digital was charging.

Although Seagate previously expected the calendar-fourth-quarter HDD market total addressable market (TAM) to be 140 million units, subsequent data points suggested a lower TAM of perhaps 138 million-140 million units. We now think that the market may have delivered 140 million units, and see the possibility of a calendar-first-quarter TAM of roughly 140 million units, flat quarter-over-quarter.

A slight negative is that the company exited the quarter with 358 million ordinary shares outstanding, higher than the prior guidance of about 350 million ordinary shares outstanding.”

Also, STX has been the subject of a number of other recent research reports. Seagate had its target price upped by Barclays Capital from $28.00 to $30.00 in a report issued on Wednesday. They currently have an equal weight rating on the stock.

Also analysts at Bank of America reiterated a neutral rating on shares of Seagate in a research note to investors on Wednesday. They now have a $34.00 price target on the stock.

Separately, analysts at RBC Capital raised their price target on shares of Seagate from $29.00 to $32.00 in a research note to investors on Wednesday. They now have a sector perform rating on the stock. Finally, analysts at Zacks reiterated a neutral rating on shares of Seagate in a research note to investors on Friday, December 28th. They now have a $32.00 price target on the stock.

Five research analysts have rated the stock with a buy rating, fourteen have given a hold rating, three have assigned an underweight rating, and two have given a sell rating to the stock. The company presently has an average rating of hold and a consensus price target of $29.27.

Negative to Positive

Further negativity is evident among short sellers. Specifically, the number of STX shares sold short has more than doubled from 22.2 million shares in September to more than 48.5 million shares in the most recent report … though that report’s data was as of Dec. 14. That said, this sizable short position accounts for nearly 15% of STX’s total float, and it would take nearly five days to repurchase at the stock’s average daily trading volume.

In layman’s terms, STX could be ripe for a short squeeze if the shares see follow-through buying in the wake of this week’s earnings news.

Options traders aren’t prepared for a rally. In fact, the put/call ratio for the January and February series of options arrives at a beefy 2.64, meaning that put open interest more than doubles call open interest in the front two months. Drilling down, we find that the most active strikes are the January 22 put, with 5,639 contracts, and the February 31 strike, where 7,961 puts reside.

Given the wealth of pessimistic sentiment despite the stock’s strong technicals and fundamentals, STX appears to offer a golden opportunity for a contrarian option play.

Allowing time for bears to unwind their positions, the following trade is recommended…..


**OPTION TRADE: Buy the STX Mar 2013 33.000 call (STX130316C00033000) at or under $2.50, good for the day. Place a protective stop limit at $1.00 and a pre-determined sell at $4.50.



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Options traders win because they are successful.



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