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EMC's Downside Risk
Data storage firm EMC (NYSE:EMC) is in an enviable situation due to its leading position in the industry, an improving economy and a secular demand trend supporting its hardware sales, service revenues and virtualization data capabilities. A major stock run left the shares fully valued, but they are worth keeping an eye on to see if they fall back to more reasonable levels.
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Recent Sales and Profit Trends
EMC kicked off the first quarter of its fiscal year with a bang as revenues increased 23% to $3.9 billion. Product sales grew a robust 25.9% to account for 63.7% of total sales. The rest consists of services, which witnessed a 19.5% sales increase. Management attributed the gains to pent-up demand from late 2009 and the migration of customers to virtual data infrastructure - infrastructure that is provided by VMware (NYSE:VMW) and is majority-owned by EMC. EMC spun off 20% of VMware in 2007 and consolidates VMWare's results in its financial statements. (Learn more about financial statements, see: What You Need To Know About Financial Statements).
Reported net income grew 92% to $372.7 million, or just under 10% of sales. Earnings improved 70% to 17 cents per diluted share as expense growth was held well below top-line expansion.
Outlook
EMC expects full-year sales to grow 17.6% and reach $16.5 billion. It is calling for consolidated non-GAAP diluted earnings per share to be $1.18 per diluted share.
Bottom Line
Sales at EMC have expanded at a double-digit annual clip over the past five years and are set to accelerate as business customers start spending again in sympathy with an improving economy to maintain and upgrade vital IT networks. A secular trend toward increased storage and server spending also bodes well for EMC and rivals such as NetApp (Nasdaq:NTAP) and Hewlett-Packard (NYSE:HPQ) for the foreseeable future.
Unfortunately, a rapid rise in the share price from around $10 per share in just over a year has left the valuation far from bargain-basement levels. At a current price of $18, the stock is already pricing in about 9% annual free cash flow growth over the next decade. In other words, if EMC can continue growing at a double-digit pace, the shares are undervalued but already discount a majority of this growth and therefore possibly have a fair amount of downside risk over the next three to five years. On the flipside, a lower share price could stoke the interest of a rival, such as HP or SAP (NYSE:SAP), to acquire EMC for access to its lucrative business.
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Recent Sales and Profit Trends
EMC kicked off the first quarter of its fiscal year with a bang as revenues increased 23% to $3.9 billion. Product sales grew a robust 25.9% to account for 63.7% of total sales. The rest consists of services, which witnessed a 19.5% sales increase. Management attributed the gains to pent-up demand from late 2009 and the migration of customers to virtual data infrastructure - infrastructure that is provided by VMware (NYSE:VMW) and is majority-owned by EMC. EMC spun off 20% of VMware in 2007 and consolidates VMWare's results in its financial statements. (Learn more about financial statements, see: What You Need To Know About Financial Statements).
Reported net income grew 92% to $372.7 million, or just under 10% of sales. Earnings improved 70% to 17 cents per diluted share as expense growth was held well below top-line expansion.
EMC expects full-year sales to grow 17.6% and reach $16.5 billion. It is calling for consolidated non-GAAP diluted earnings per share to be $1.18 per diluted share.
Bottom Line
Sales at EMC have expanded at a double-digit annual clip over the past five years and are set to accelerate as business customers start spending again in sympathy with an improving economy to maintain and upgrade vital IT networks. A secular trend toward increased storage and server spending also bodes well for EMC and rivals such as NetApp (Nasdaq:NTAP) and Hewlett-Packard (NYSE:HPQ) for the foreseeable future.
Unfortunately, a rapid rise in the share price from around $10 per share in just over a year has left the valuation far from bargain-basement levels. At a current price of $18, the stock is already pricing in about 9% annual free cash flow growth over the next decade. In other words, if EMC can continue growing at a double-digit pace, the shares are undervalued but already discount a majority of this growth and therefore possibly have a fair amount of downside risk over the next three to five years. On the flipside, a lower share price could stoke the interest of a rival, such as HP or SAP (NYSE:SAP), to acquire EMC for access to its lucrative business.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Ryan C. Fuhrmann
Ryan C. Fuhrmann, CFA, has a background in portfolio management, overseeing assets for high-net-worth individuals and covering a broad array of industries from a generalist perspective. An active student of investing, he focuses on communicating his ideas as an investment writer and learning from the financial community. Ryan is also actively involved with the CFA Institute. Feel free to visit his website at www.rationalanalyst.com.
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