A Stellar Opportunity in Storage Stocks

S&P says the industry's stock-price momentum and positive fundamentals signal additional upside. Among its top picks: EMC and Western Digital

The S&P 1500 Computer Storage & Peripherals subindustry index has seen an improvement in its rolling 12-month price performance over the past few weeks. Year to date through Sept. 7, the Computer Storage & Peripherals subindustry index gained 7.3%, vs. a 2.8% rise for the S&P Composite 1500 index, which consists of the large-cap S&P 500, MidCap 400, and SmallCap 600 indexes.

Take a look at the accompanying chart, which shows this subindustry index's rolling 12-month price performance compared with that for the S&P 1500. Any point above 100 indicates sector outperformance vs. the S&P 1500 over the prior year, while points below 100 show sector under-performance. The red line is a rolling nine-month moving average, while the two green bands indicate one standard deviation above and below the index's longer-term mean relative strength.

There are 13 companies in the S&P Computer Storage & Peripherals subindustry index. Seven have S&P STARS rankings, of which four have 4 STARS (buy) or 5 STARS (strong buy) designations: EMC (EMC; $19; 5 STARS), Network Appliance (NTAP; $27; 4 STARS), QLogic (QLGC; $13; 4 STARS), and Western Digital (WDC; $22; 4 STARS).

Worldwide Storage

Jawahar Hingorani, who covers the group for S&P Equity Research Services, has a positive fundamental outlook for the Computer Storage & Peripherals subindustry, as more companies have seen a pickup in enterprise spending heading into the second half of 2007. The rising popularity of virtualization, driven by a need to be more efficient and lower costs, is driving the increased implementation of storage software, says Hingorani.

According to research firm IDC, the worldwide storage software market is expected to increase at a compound annual growth rate (CAGR) of 11.2% until 2011, driven by storage replication software and archiving/HSM (hierarchical storage management) software. These trends reflect the increasing importance of business continuity/disaster recovery strategies, and the compliance- and risk-management-driven need for a long-term storage strategy for certain information, particularly in data mining, analytics, and re-use in the context of archiving.

IDC also predicts a 2006-2011 CAGR of 57% for disk storage, with internal storage increasing at a 47% CAGR from developments in the server market, while external storage capacity increases at nearly a 62% CAGR, driven by data protection, archiving, and fixed content generation. However we see revenue growth offset by declining prices per gigabyte of storage.

On the Periphery

Hingorani thinks storage component growth will continue to be driven by the Internet Small Computer Systems Interface (iSCSI) storage area network (SAN) being the fastest growing interconnect segment of the market; IDC forecasts the segment will rise from $558 million in 2006 to $6 billion in 2011, and should represent a quarter of the external disk storage systems market.

S&P also thinks computer peripherals, such as add-on storage devices, printers, and monitors, will continue to experience slow to flat growth, due to the lower priority being placed on them by IT managers. Hingorani sees sales from faster growing overseas markets being characterized by intense competition and pricing pressures. The printer market consists of the non-impact segment, including laser, inkjet, and thermal printers, and a declining market for impact printers. Storage peripherals should benefit from the overall demand for storage, especially from small to midsize businesses, and for personal storage devices by individuals, according to the analyst.

So there you have it. Based on the group's strong relative strength, combined with favorable overall fundamentals, we believe this subindustry index has additional price appreciation potential.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of subindustries in the S&P 1500), along with a stock with the highest S&P STARS (tie goes to the highest market value).

Subindustry Company S&P STARS Rank Price (9/7/07)
Auto Parts & Equipment Johnson Controls (JCI) 3 $110
Commodity Chemicals Lyondell Chemical (LYO) 3 $46
Computer Hardware Apple (AAPL) 4 $132
Construction & Engineering Jacobs Engineering (JEC) 5 $66
Construction & Farm Machinery Trinity Industries (TRN) 5 $36
Consumer Electronics Harman International Industries (HAR) 3 $113
Diversified Metals & Mining Freeport-McMoRan Copper (FCX) 3 $90
Fertilizers & Agr. Chem. Monsanto (MON) 3 $70
Footwear Nike (NKE) 4 $55
Internet Retail Amazon.com (AMZN) 2 $85
Oil & Gas Equip. & Svcs. Schlumberger (SLB) 5 $97
Steel Nucor (NUE) 4 $54
Technology Distributors Ingram Micro (IM) 4 $19
Tires & Rubber Goodyear Tire & Rubber (GT) 3 $26

Source: Standard & Poor's Equity Research

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