Investors should have been well-prepared for EMC Corporation (NYSE:EMC) to disappoint with its fourth quarter results and 2013 guidance, as seemingly every sell-side analyst downgraded the stock in December or January. While near-term bears are likely right that the storage market is going to get more turbulent, EMC remains the market leader and an uncommonly responsive company to emerging/changing trends. EMC doesn't look like a stock that's going to ring up sizable gains in the first half of 2013, but long-term investors can find a lot to like here.
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Fourth Quarter Not As Bad As Feared...
EMC delivered what was, on balance, a pretty solid quarter and more than one sell-side analyst apparently felt the need to validate a prior downgrade by sniffling about how a "safe stock" like EMC should have delivered more.
Revenue rose 8% as reported, leading to a tiny beat relative to the average sell-side estimate. Storage revenue rose 6%, with 5% growth in products. High-end product revenue rose 6% (and 14% sequentially), while mid-range product revenue rose 5% (and 22%). As previously reported, VMware Inc. (NYSE:VMW) revenue rose 22% for the quarter (EMC is the majority owner of VMware).
Profits also improved a bit more than expected. Gross margin (non-GAAP) improved about a point and a half from last year (and two points sequentially), with GAAP gross margin up a little less. Non-GAAP operating income rose 13% and 29%, respectively, with GAAP operating income up about 11%. Relative to sell-side estimates, EMC picked up about 3 cents on the gross profit line, lost about a penny through SG&A, and netted out a 2 cents per share beat on the operating line.
...But Guidance Was a Bit Soft
Relative to at least the worst fears, EMC's guidance revision really wasn't that bad. Yes, management did come out with lower numbers, but an incremental difference of $100 million on the top line and 6 cents on the bottom line is not a huge problem in my book. Moreover, most of this looks like a flow-through from VMware's guidance as opposed to a serious issue in EMC's storage markets.
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Speaking of storage, it looks like EMC gained still more share from International Business Machines Corporation (NYSE:IBM) and Hewlett-Packard Company (NYSE:HPQ), even though both of those companies appeared to fight very hard on price this quarter. We'll have to see how NetApp Inc. (Nasdaq:NTAP) fared a bit later, but I'd be surprised if they didn't more or less hold their own even though EMC is going after the mid-range market pretty hard.
Looking down the road, I can see 2013 being a little shakier for the security market. Oracle Corporation's (Nasdaq:ORCL) Exadata finally looks ready for primetime and the ongoing growth of enterprise flash storage could muddy the waters a bit. In other words, I think storage demand is likely to be fine, but corporate IT buyers now have more choices to mull over, and that may hurt EMC in the interim (particularly on the high-end).
Still Positioned to Win the War
While EMC could see a bump or two in 2013, I still believe the company is basically a steamroller in the storage market. IBM, HP and Dell Inc. (Nasdaq:DELL) cannot seem to gain much traction, and IBM doesn't seem willing to buy its way back into the market.
On the flash side, I think EMC is an underrated threat. The company is going to be rolling new flash-based array and PCIe products this year, and I think Fusion-io Inc. (NYSE:FIO) is going to have a difficult time competing head-to-head over the long term. Likewise, I wouldn't sleep on the company's efforts in application services and storage management tools. I don't necessarily believe that the company's new Pivotal joint venture with VMware is going to be "the next VMware," but EMC management has a knack for anticipating customer needs, and app services and tools should be a sizable ongoing opportunity.
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The Bottom Line
EMC is likely looking at a few "show me" quarters were it needs to reestablish its growth credentials and show that it can withstand newer rivals like Exadata and Fusion-io. Moreover, investors probably need some time to digest the idea that storage demand is not going away - companies like Facebook Inc. (Nasdaq:FB), Amazon.com Inc. (Nasdaq:AMZN), and Google Inc. (Nasdaq:GOOG) can't grow with it. Last and not least, VMware needs to stabilize - I suspect that many investors use EMC as a back door into VMware, and the growing worries about growth there have probably chased away at least some of those investors.
EMC can't outgrow the storage market forever, but I see the company posting a long-range revenue growth rate near 5%. While I think the company can still pick up some additional operating margin, I don't know that the cash conversion cycle can get all that much better. Accordingly, I look for free cash flow (FCF) growth only a bit ahead of revenue - in the 5 to 6% range. Even so, that supports a fair value in the high $30s - well above today's price and most sell-side targets.
While EMC likely won't be the most rewarding stock to own over the next six to 12 months, I think the long-term value here is pretty compelling to patient investors.
At the time of writing, Stephen D. Simpson owned shares of EMC since 2012.