Gamble of the week: hi-tech supplier to blue-chip companies

published 11 July 2008

I've recently set up a "business-type" broadband network at home. This allows my family's PCs instantaneously to share, back-up and save files (music, for example) on to a central server, thus efficiently managing all our digital content.

This is a trend being replicated in millions of households worldwide, and one that is proving to be a rich seam of growth for the networked storage industry: according to research house IDC, demand for disk storage systems is set to rise by an average of 57% until 2011.

Xyratex (Nasdaq: XRTX)

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One beneficiary of all this is Xyratex, which has its headquarters in Britain, but is listed on Nasdaq. It operates at the heart of the sector, with around 14% of the market, and supplies data-storage products to more than 50 blue-chip companies including Network Appliance, Seagate, Western Digital and Dell.

Turnover in the second quarter of this year was up a massive 25% on last year and CEO Steve Barber encouragingly commented in June that, despite "economic conditions being uncertain... we continue to see good underlying demand for our products, and believe that the industry will remain strong". For the full year Wall Street is predicting full-year revenues and underlying earnings per share of $1.1bn and $1.14 for 2008 respectively, rising to $1.3bn and $1.91 in 2009. The stock trades on undemanding p/e ratios of 13.8 and 8.2, and there is a healthy cash balance of $54.6m as at the end of May.

There are risks. Firstly this hi-tech industry is notoriously competitive with short product lifecycles, slim margins and intense pricing pressure even for the most able operators, such as Xyratex, which has protected its proprietary technology with over 400 patents. Next, the firm would be hit hard in the event that one of its top three customers (which in aggregate account for around 75% of turnover) decided to transfer business to a rival. The group has also recently experienced some softness in its smaller division (representing 13% of revenues), which provides test equipment to the cyclical hard-disk drive market although the board is "cautiously optimistic" that normal buying patterns are slowly returning. Lastly, the company is also exposed to a weaker American currency its turnover is dollar based, but someof its costs are based aboard.

Nonetheless, with global demand for data storage showing no signs of slackening, I think the outlook looks bright.

Recommendation: SPECULATIVEBUY at $15.7 (market cap $460m)

Paul Hill also runs a share-tipping service, Precision Guided Investments

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.