By Richard Stice Like many other tech sectors, the data-storage group has been under pressure of late, as information-technology spending remains in a slump. Wall Street had become hopeful that demand would be boosted by the continued growth of storable data and a renewed focus on backup and data replication following the September 11 terrorist attacks. IT spending doesn't seem to be picking up as early as previously expected, however.
Companies remain cautious, as industry indicators have been mixed as to whether an economic recovery is under way. As a result, many corporations are either using existing equipment for longer periods of time or focusing on more cost-effective methods to store critical pieces of information.
In this environment, companies that efficiently manage their operations and offer products in the desirable, lower-end technology realm have been able to generate more consistent sales and earnings than their peers. Two data-storage stocks fitting this description, Imation (IMN) and Storage Technology (STK), were recently upgraded by Standard & Poor's to a 4-STARS ranking, or accumulate. We expect the stocks to outperform the broader market over the next six months to a year.
SHARPER FOCUS. Imation makes removable data-storage products that provide expanded capacity, transportability, management capabilities, and security at a lower relative cost than fixed data storage. Imation customizes its offerings to meet the specific capacity range a user may require, from data to fill a single book to the equivalent of thousands of libraries.
The company recently streamlined operations to focus the bulk of its resources on the data-storage industry. At the end of 2001, Imation completed the sale of its color-proofing and -software business for $50 million in cash. As a result, data-storage-related revenues now account for nearly 90% of the company's business.
This shift in strategy enabled Imation to report solid first-quarter results. In fact, while many of its competitors experienced substantial decreases in revenue, it posted a 15% increase in data-storage sales. Moreover, by concentrating its efforts within fewer segments, Imation has been able to more efficiently manage its expenses. This is reflected in operating margins, which more than doubled in the first quarter, to 8.6%, from 3.9% in the year-ago period.
SERVICES GROWTH. Imation's strong results have pushed up its shares by 39% so far this year, to about $30, easily outdistancing the major indexes. We believe the stock can climb even higher, given that the company's financial position is solid, with nearly $11 per share in cash and short-term investments. On a valuation basis, the stock trades at a discount to its peers and the broader market in terms of price-earnings and p-e-to-growth ratios.
Storage Technology constructs a broad range of storage products for digitized data, including business-continuity and disaster-recovery plans. Revenues are divided into two segments: Storage products -- including tape, disk, and network offerings -- accounted for 66% of sales in 2001. Storage services -- including maintenance, integration, and storage consulting -- made up the rest.
Storage Technology has been able to combat the tepid IT spending environment through growth in its services unit, as well as stringent cost-control efforts. In the first quarter, revenue from the services business was up more than 6%, helping offset the decline in storage-products sales that dragged down overall revenue slightly. This improvement implies that companies have decided to extend the life cycle of existing equipment, which inevitably results in increasing maintenance costs.
HEALTHIER MARGINS. Earnings and margins have also benefited from an operations overhaul. In October, 1999, Storage Technology announced a broad restructuring program that included layoffs, a reduced emphasis on weaker business units, and modifications to its sales model. The results have been impressive, particularly in light of the ongoing end-market weakness. Gross profit margin, which was under 40% at the end of 1999, reached 44% in 2001, and we see it staying in the 44%-to-45% range in 2002.
The changes also helped Storage Technology return to profitability in 2001, after posting a 75-cent loss per share in 1999 and a much-narrower loss in 2000. We are forecasting 2002 EPS of 80 cents, a 25% rise from 2001.
Still, the shares have been volatile recently and are trading at around $20.80, a few cents above where they started the year. On a valuation basis, we think the stock is compelling, since it trades at a discount to its peers in terms of p-e, p-e-to-growth, and price-to-sales measurements.
Given the valuation, as well as Storage Technology's focus on the low-end of the storage market and its significantly improved operational structure, we expect the stock to beat the broader market over the next six months to a year. Analyst Stice follows computer storage and peripherals stocks for Standard & Poor's