Seagate Technology

Seagate Technology shattered its own records for gross margin (52.7%) and operating margin (44.6%) in its fiscal fourth quarter and issued first-quarter guidance that suggests the artificial intelligence-driven storage cycle is still accelerating.

Why it matters: While there has been much turmoil in AI stocks for the last month, these results showed things are fundamentally fine, as we are seeing the most profitable period in Seagate's history. Current-quarter results beat our expectations, and the outlook is even stronger. Most eye-popping to us was that revenue is expected to accelerate even more on an absolute dollar basis next quarter compared with the current quarter. As we model implied gross margin based on the guidance, we think incremental gross margin should remain above 80% next quarter. Management's commentary was also exceptionally bullish; planning now extends into calendar 2029, with the majority of 2028 already allocated. Meanwhile, demand is expanding to neocloud and enterprise deployments, all bullish for demand.

The bottom line: We are raising our fair value estimate by 3% to $700 for no-moat Seagate. Shares peaked above $1,000 recently and have fallen back below $800. Our fair value estimate implies a 10 times forward P/E multiple in 2029 (on 2030 earnings). We view this as a reasonable peak multiple on earnings, which seem to be gaining visibility. Seagate's data center pricing growth was incredible. We calculate it accelerated to 10% in the fourth quarter from 6% last quarter. If Seagate can maintain the current sequential growth pattern, which first-quarter guidance seems to imply, we could see annual pricing growth approach 20%. Seagate remains tricky to value, as it is truly subject to the AI cycle. We still view the hard disk drive makers as having no moat. If supply were to exceed demand, we would expect material pricing erosion, but for now, Seagate has a clear path to an earnings compound annual growth rate above 30% for years.

Our fair value estimate is $700 per share. This implies an adjusted fiscal 2027 price/earnings ratio of 20 times, although we expect high earnings growth will allow the company to grow back into a midteens multiple by 2027 (on 2028 earnings). In our experience, Seagate’s stock can swing wildly, along with its revenue and margins, depending on the HDD cycle. While HDDs have historically been quite cyclical, a key part of our thesis is that the industry will go through a more stable supercycle of AI-related storage demand. We assume the pricing environment and overall HDD demand are generally positive for at least the next five years. We also assume the HDD industry has some indefinite staying power in the data center ecosystem. If we reach a point where HDDs are replaced even in data centers, there would be downside to our fair value estimate.

We expect Seagate to increase its data center revenue at a compound annual growth rate of 33% from fiscal 2026 through 2031, with slower growth in the non-data center business. Data center growth is linked with AI-related demand, which we expect to be driven by multimodal storage demand (like video), AI agents, and the eventual proliferation of AI in many industries. This leads to an overall revenue CAGR of 30%.

We expect Seagate’s gross margins will be structurally higher than in the past, driven by steadier data center demand and more disciplined pricing and supply management from the HDD industry. Surging AI and cloud storage demand is leading to an upcycle for the HDD industry currently, with higher exabyte shipments and improved pricing driving gross margins higher. We expect gross margin of roughly 58% in fiscal 2027, up from 18% in 2023, 23% in 2024, and 35% in 2025. While we previously believed that gross margin in the high 30s would represent a cyclical peak, we now believe gross margin can hit 60%, if not higher, by 2028. This is driven by pricing gains from HAMR shipments (pricing per terabyte does not deteriorate to the same degree as it has in the past, allowing Seagate to capture more of the economics) combined with more predictable demand from data centers and more discipline in supply from the HDD makers. We assume a 20% increase in pricing in 2027 for data center HDDs and mid-single-digit increases thereafter.

We think operating margins will continue to improve as the firm gains operating leverage by shipping an increasing amount of exabytes, therefore generating more revenue while maintaining roughly the same unit shipment amounts. We see Seagate hitting operating margins north of 50% as favorable pricing and high-capacity HAMR rollouts enable the firm to grow revenue on a fixed cost base. Part of our thesis is that margins are structurally higher and more stable. If margins started to swing wildly again, driven by supply overtaking demand, there would be downside to our fair value estimate, as that would call into question the permanence of the structural changes we anticipate.

We do not think Seagate possesses an economic moat. Seagate is a leader in the hard disk drive market. HDDs etch data onto spinning magnetic discs and have been around in one form or another since the 1950s. While the HDD market has high barriers to entry, given the massive capital investment required along with the technical expertise needed to design and manufacture industry-leading HDDs, we find the industry is not amenable to moats because HDDs are commodities with minimal pricing power. This leads to occasionally brutal business cycles and erodes economic profits. We find this is the case, even though the industry is a functional oligopoly. We also have some worries about the tail risk of obsolescence due to the potential for better-than-anticipated development for SSDs. These two factors—lost economic profits during cyclical downturns and obsolescence tail risks—lead us to our no-moat rating. The market is shifting toward more stable demand from data centers, and if we combine this with more disciplined pricing from the primary HDD providers, it could lead to a structurally better margin and return environment for the industry. We would need to see more evidence of this before awarding a moat to Seagate, although the industry could be at the start of a new phase.

The HDD market is an oligopoly—but practically a duopoly—with Western Digital and Seagate each controlling roughly 40% of the market and Toshiba at less than 20% share. HDDs serve two distinct market segments: consumer drives for computers and gaming and mass-capacity enterprise drives for data centers. The former segment is undergoing a rapid decline, as solid-state drives built with NAND flash take over the consumer market. Compared with HDDs, SSDs are smaller, more durable, more energy-efficient, and much faster. They are also more expensive, which has historically been the bottleneck to full-scale adoption. However, the price discrepancy between HDD and SSD technology has been narrowing over time as flash technology advances, and as SSDs now present an overall better value proposition for consumer devices than HDDs, the share of HDDs in these devices has fallen.

For mass-capacity enterprise drives (also known as nearline drives), the cost discrepancy between HDD magnetic recording technology and flash is material. Western and Seagate are constantly improving areal storage density and implementing new technologies like heat-assisted magnetic recording to drive cost per HDD gigabyte down further at large capacity points. As a result, enterprise SSD cost per terabyte is still roughly 6-7 times more than a comparable HDD. On a total cost of ownership basis, the difference is still likely 3-4 times. With projected improvements in HDD capacity through 2030, getting to drives with 50 TB or more of storage, we expect this gap will remain, keeping HDDs the more attractive option for data center nearline storage for the foreseeable future. Mass-capacity HDDs hold the vast majority of data in a data center, and only “hot data”—newer data that is expected to be accessed frequently—gets stored on enterprise SSDs for quicker access.

While we do not have any immediate concerns about HDDs' technological obsolescence in the data center, product road maps generally only extend to 2030, and there is always the tail risk of better-than-expected SSD developments after 2030 or even unforeseen hiccups in HDDs' own future development road map. As such, our first key concern is the tail risk of obsolescence for HDDs over the next decade, even if we view this risk as unlikely for the near to medium term.

Beyond this key tail risk, we think competition with Western Digital erodes economic profits. End customers don't care which brand of HDD they use, and HDDs are interoperable, meaning customers can use HDDs from any manufacturer. As such, the market is driven by supply and demand. While companies like Seagate can earn economic profits in times of tight supply, when supply inevitably expands and prices fall, it leaves the firm vulnerable to economic losses. Given the cyclical nature of the industry, the potential for economic losses during a cycle, and the lack of any pricing power at the product level, we believe a no-moat rating is appropriate.

This is a bit counterintuitive because we think both Western Digital and Seagate possess significant intangible assets in the design and manufacture of mass capacity HDDs. These are complex technologies that require heavy investment and technological know-how, and in this sense, barriers to entry are high in the HDD industry. But the remaining players in the industry are unable to translate these intangible assets into any pricing power, so they struggle to generate long-term economic profits. If the industry stabilized, and players were more disciplined on pricing, we think this would be the path toward moats in the industry.

Competition in nearline HDDs occurs primarily on the basis of capacity expansion and lowering the total cost of ownership for customers. Western Digital and Seagate are constantly developing higher-capacity drives for enterprises; both have road maps for producing 36 TB drives and beyond, with long-term goals of reaching 100 TB or more. This continues a constant pattern for the industry where both key players generally make similar technological progress and then compete on price to sell their HDDs. Even as the industry sells more storage over time (the number of terabytes shipped increases every year), because technological progress makes these bytes cheaper and more efficient, the cost per terabyte consistently goes down each year. This is a classic sign of a commodity industry.

While we still expect prices per terabyte to decline over time, they could start declining at a slower rate than in the past as the ongoing artificial intelligence boom could be driving a structural shift in the industry, where demand from data centers is more stable and predictable than previous end markets the HDD industry focused on, and where the Seagate and Western Digital oligopoly becomes more disciplined on supply and pricing. While the industry has technically been consolidated with three players since roughly 2012, it may not be until now, with the shift toward data center demand, that the industry finally realizes the benefits of its consolidation. This will be a key development to keep an eye on.

Regarding technological development, there have been instances where one side of the duopoly beat the other to a capacity node. For example, Seagate was the first to ship 16 TB drives and won enterprise market share from Western Digital in 2020 (fiscal 2021) because of it. Nonetheless, Western Digital has caught up, and market share has stabilized since. We generally believe the two firms will maintain technological parity over the long term and expect any initial product advantages will likely even out and stabilize over time as the other side catches up.

Demand for data center buildouts is only increasing, driven by long-term structural trends such as AI and Internet of Things. This could prolong the current upcycle and make it more durable than previous cycles.

Advancements in higher-capacity HDDs and new technologies like energy-assisted recording should expand Seagate’s gross margins.

The HDD industry will be more disciplined on supply and pricing than in the past, which will reduce the cyclicality of the industry and warrant a higher valuation for Seagate.

The HDD market is commodity-like and cyclical, leaving Seagate vulnerable to market pricing declines that can shrink the top line and sink margins. In HDD downturns, these stocks can crater.

The risk of HDD obsolescence, driven by displacement by SSDs, will always hang over Seagate. As more end markets phase out HDDs, the company is set to almost exclusively rely on the nearline storage market.

If there is any leveling off in data center demand for HDDs in the near term, or tariffs hurt demand or supply chains, the industry could be set for another brutal business cycle.