The share price of EMC Corporation (EMC) has declined by 19% over the past 12 months and is trading near its 52-week low at $22.62. The stock is worth a look at the current level based on the following 7 reasons:
1. EMC shares are cheap based on the firm's solid financial performance relative to that of NetApp (NTAP), the company's closest comp. According to the chart show below, EMC's 2-year consensus revenue, EBITDA, and EPS growth estimates are below NetApp's figures. Similarly, EMC's 5-year EPS growth estimate is also slightly below that of NetApp. On the profit side, however, EMC demonstrates a better performance as the firm's various profit margins and capital return metrics are considerably above the comp's benchmark. In terms of debt and liquidity, EMC carries a lower debt load. The firm also has a much higher free cash flow margin. Due to the low leverage and robust profitability, EMC's interest coverage is completely healthy. Both the company's current and quick ratios are below NetApp's, though they remain within a healthy range on an absolute basis.
To summarize, EMC's weaker near-term growth potential would likely be the primary drag on the stock valuation. But given the company's superior profitability and liquidity performance, I wouldn't expect the stock to trade at a discount to NetApp shares. Nevertheless, the current price multiple at 12.4x next 12-month EPS is 10% below NetApp's 13.8x. Even after accounting for EMC's lower 5-year EPS growth estimate, the stock's 5-year PEG is still at an 8% discount, suggesting market has likely not given enough credits to the company's strengths and thus the shares are undervalued on a relative basis (see chart above).
2. EMC's forward P/E multiple is currently trading at a 16% discount to the same multiple of S&P 500 Index, which stands at 14.8x now (see chart below).
The large market discount presents a great entry opportunity provided that 1) EMC previously traded at a premium over the market level in 2012 and the market discount has just reached its deepest level; 2) EMC's 5-year earnings growth rate at 12.9% is still significantly above the average estimate of 8.2% for the S&P 500 companies; 3) the company continues to produce healthy profits and robust free cash flow; and 4) EMC commands a significant market share in the external disk storage market and the figure is still rising (discussed later). In addition, EMC's 5-year PEG ratio is 47% below the 1.8x average for the S&P 500 Index, further evidencing the compelling valuation.
3. The year-long price downtrend is largely driven by the market's lower consensus revenue, EBITDA, and EPS estimates. However, despite the continued drop in share price, the consensus estimate trend appears to have stabilized over the past few months, implying an increasing cheaper valuation and that market sentiment is likely recovering (see charts below).
4. VMWare (VMW) represents approximately 50% of EMC's value. The company's consensus EPS and EBITDA estimates for 2013 and 2014 as well as its 5-year EPS growth rate have all experienced upward revisions over the past few months (see charts below).
The higher estimates are mainly driven by the firm's lay-off plan and higher margin achieved through the creation of Pivotal.
5. Sell-side analysts remain very bullish on EMC. Of the total 40 ratings compiled by Thomson One, there are 12 strong buy and 21 buy ratings. The average price target at $29.5 is almost 30% above the current share price.
6. There is a technical bottom at around the current share price which has repetitively supported the share price since 2012 (see chart below).
7. According to a March research note released by Piper Jaffray, Gartner data suggests that EMC continues to capture market share in the external disk storage market (sourced from Thomson One, Equity Research):
"According to Gartner, EMC continued to gain market share for the third consecutive quarter in 4Q12 and has grown share 150 bp since 4Q11. NetApp has sustained modest sequential declines in market share over the past 3 quarters, but the company is still the only vendor other than EMC to increase market share on a y/y basis in Q4 (10.6% vs. 10.5%)…In addition to the sequential gains in Q4, EMC also increased share on an annual basis in 2012 by 170 bp. EMC's cumulative market share has grown +520 bp since 2010, with the majority of the 2011/2012 share gains likely attributable to Isilon."
Bottom line, the shares of EMC are oversold given the significant deviation between the company fundamentals and stock valuation. Hence, investors should consider buying.
All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.