Is Seagate Stock a Sell? 1 Analyst Thinks So

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Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

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Seagate Technology (NASDAQ: STX) investors have endured a rough ride this past year. Up an impressive 33% over the past 12 months, shares spiked in January as signs of a resurgent market for PC hard drives began to appear -- then jumped even higher on analyst upgrades in April. The enthusiasm quickly waned, however, and today, Seagate stock is actually trading barely above where it began this year.

And one analyst thinks things will get worse before they get better.

Barclays downgrades

This morning, British megabank Barclays Capital announced it is pulling its "equalweight" rating on Seagate shares, and downgrading Seagate stock to "underweight." As StreetInsider.com (requires subscription) explains in a write-up on the re-rating this morning, Barclays believes "upside for the stock is limited." The analyst has three main reasons for thinking this way, and two of them involved Seagate rival Western Digital (NASDAQ: WDC).

Western Digital could win

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Western Digital, as you may have heard, is involved in a high-stakes, $1.1 billion lawsuit with its flash memory partner Toshiba. Toshiba is trying to sell its part of a joint venture between the two companies, but Western Digital is trying to block the sale.

Toshiba says Western Digital is engaging in unfair competition with it, and has stolen "trade secrets." Litigation is ongoing, but Western Digital has told the court that Toshiba's claims are "frivolous and without merit." The litigation hasn't had much effect on Western Digital's stock price (which has surged) so far this year. Barclays' worry with respect to Seagate is that if things go well for Western Digital, that company's shares could outperform Seagate's by an even wider margin, "de-coupl[ing]" them from Seagate's valuation, and leaving Seagate shares in the dust.

Logically, if that happens, the smart move would be for investors to dump Seagate shares and buy Western Digital instead -- which is just what Barclays seems to be advising.

The "12 TB transition"

At the same time, Barclays worries that companies are beginning to transition to buying larger and larger hard drives, specifically 12 terabytes and up. Seagate is preparing to sell 12, 14, and even 16 TB hard drives -- but no sooner than next year. Meanwhile, Western Digital has already announced its own hard drives of these sizes. If Western Digital beats Seagate to market with its products, Barclays thinks Seagate could "miss the 12TB transition, ceding high-margin market share to WD," reports StreetInsider.

The trouble with Seagate stock, specifically

Nor are all of Seagate's problems Western Digital-related. One of the reasons that Seagate stock is up so much over the past year (over 29%), despite its recent relapse, is that its profit margins have been surging as the company cut operating costs. Data from S&P Global Market Intelligence show that Seagate's operating profit margins surged from just 1.8% in Q1 of last year, to 7.6%, then 10.8%, then 13.9% over the ensuing quarters.

Last quarter, however, Seagate's operating profit margin slipped back to 11.7%, and this has Barclays worried that "most of the excess costs at Seagate have been purged from the system." If profit margin growth stalls, that would remove a big reason for thinking the stock still has upside -- and could give investors even more reason to prefer Western Digital stock over Seagate.

The upshot for investors

Is Barclays Capital right about all of the above worries? They certainly sound like valid concerns to me.

That said, priced at 16 times earnings and with a projected 19% annual earnings growth rate, it's hard to see Seagate shares as expensive today. The more so when you consider that S&P Global data show Seagate generating $1.5 billion in annual free cash flow -- an amount twice what the company reports as GAAP net income, and a sum that gives Seagate stock a price-to-free-cash-flow ratio of just 8.

With a cheap share valuation and a 6.3% dividend yield to cushion any further worries about its business, I see a lot of risk already baked into Seagate's share price. Barclays may say it's time to sell it, but at these prices, I still think Seagate stock is a buy.

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Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital. The Motley Fool has a disclosure policy.