Better Buy: Seagate Technology vs. Qualcomm

Seagate (NASDAQ: STX) and Qualcomm (NASDAQ: QCOM) produce key components for the PC and mobile markets, respectively. Seagate is the second-largest maker of HDDs (hard disk drives) in the world after Western Digital (NASDAQ: WDC), and Qualcomm is the world's top maker of mobile chipsets and modems.

Seagate's stock tumbled nearly 30% over the past 12 months, due to slow PC sales, sluggish enterprise demand, and competition from flash memory-based SSDs (solid-state drives) -- which are smaller, faster, more power efficient, and less prone to damage than platter-based HDDs.

Meanwhile, Qualcomm's stock rose more than 10% as the introduction of new chips and a legal settlement with Apple (NASDAQ: AAPL) offset concerns about the saturation of the smartphone market and regulatory probes. Qualcomm clearly held up better than Seagate, but will that trend continue throughout the rest of the year?

Comparing their core businesses

Seagate generated 92% of its revenues from HDD sales last quarter. The rest came from sales of SSDs, other enterprise data storage solutions, and other products. Enterprise orders accounted for 39% of its sales, 32% came from the non-PC consumer electronics market, and 20% came from the PC market.

Unlike Western Digital, Seagate focuses on selling higher-capacity HDDs to enterprise and cloud customers instead of expanding its SSD business. This strategy insulates Seagate from volatile NAND (flash memory) prices, but lower NAND prices also reduce SSD prices and make them attractive alternatives to HDDs.

To mitigate that risk, Seagate pivoted away from drives with less than 1TB of storage (which directly compete against SSDs) and focused on sales of higher-capacity HDDs to cost-conscious enterprise customers.

Qualcomm generated 74% of its revenues from its chipmaking (QCT) business last quarter. That unit produces its Snapdragon mobile SoCs (system on chips), which bundle together a CPU, GPU, and modem in a single module. It also sells stand-alone modems to smartphone makers that use first-party CPUs (like Apple).

Qualcomm's wireless licensing (QTL) business generates most of its remaining revenues. This unit, which owns the world's largest portfolio of wireless patents, collects licensing fees from every smartphone maker worldwide. This higher-margin business generates more pre-tax profits than the QTL unit.

Qualcomm traditionally supports the growth of its lower-margin chipmaking business with its higher-margin licensing business. However, that business model is now threatened by regulatory probes (including a recent FTC ruling against the company) that claim that Qualcomm's licensing fees are too high and that it leverages chip-and-license bundles to lock out competing chipmakers.

Seagate could be approaching a cyclical bottom

Seagate's revenue growth turned negative over the past two quarters, and its gross margins steadily contracted due to slow PC sales (partly caused by Intel's ongoing chip shortage), slower orders from data center customers, and competition from cheaper SSDs. Seagate expects its revenue growth to stay negative in the fourth quarter, and analysts expect its full-year revenue and earnings to decline 7% and 13%, respectively.

However, Seagate expects demand from cloud customers to rebound and for new high-resolution surveillance cameras to boost sales of its higher-capacity drives. It also expects the recent launch of its new 16TB drives to significantly boost its sales throughout fiscal 2020 (which starts on June 30).

That's why analysts expect Seagate's sales to dip just 2% next year as its earnings rise 2%. Those growth rates are anemic, but they're reflected in the stock's forward P/E of 9.

Qualcomm still faces uncertain headwinds

Qualcomm's revenue growth stayed negative over the past three straight quarters, mainly due to declining smartphone shipments and Apple's suspension of its licensing payments. But with a settlement now reached with Apple, Qualcomm expects its GAAP revenues to nearly double annually in the third quarter.

Wall Street expects Qualcomm's revenue to fall 9% this year as its earnings (buoyed by big buybacks) improve 5%. For fiscal 2020, which starts on Oct. 1, analysts expect its revenue and earnings to rise 17% and 37%, respectively -- which are solid growth rates for a stock that trades at 13 times forward earnings.

However, the recent FTC ruling (which Qualcomm is appealing) could derail that turnaround by forcing it to reduce its licensing fees. That headwind, along with Qualcomm's significant exposure to the Chinese market amid an escalating trade war, is weighing down its stock.

Seagate has more potential than Qualcomm

I'm not a fan of either stock right now, but Seagate's downside seems more limited as it approaches a cyclical nadir with a single-digit P/E ratio and a forward yield of 5%.

Qualcomm also pays a decent forward yield of 3%, but it faces too many uncertainties. If it tries to appease regulators by cutting its licensing fees and halting its practice of bundling chips and licenses, its main profit engine could sputter out. But if it remains defiant, it could be slammed by more probes and lawsuits.

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Leo Sun owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.