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EMC Corporation (EMC) is a leading provider for hardware, software and services for enterprise network storage. EMC holds 80% ownership of outstanding shares in VMWare (VMW), the largest global vendor providing virtualization software for server operating systems. Since the announcement of "the Pivotal initiative" on March 13, both EMC and VMW had been declining. A quick preview of EMC and VMW's upcoming earnings and fundamental analysis will be presented in this article.

Analysts' Calls and Earnings Preview

BMO Capital analyst Keith Bachman commented on EMC and VMW heading into earnings, where VMW reports on April 23 after the market close and EMC reports on April 24 before the market open. The analyst sees in-line results for EMC with the same 2013 EPS guidance of $1.85. The analyst maintained an outperform rating with a price target of $35 on EMC and a market perform rating and a price target of $85 on VMW. Keith Bachman stated,

We think that investors have embedded pronounced negative sentiment in storage stocks, such as EMC. Therefore, we believe that, by both EMC and VMW hitting numbers this year, EMC's stock will move higher.

Earnings Preview for EMC

Analysts currently have a mean target price of $29.51 for EMC, suggesting 27.86% upside potential based on the closing price of $23.08 on April 16, 2013. Analysts are estimating an EPS of $0.39 with revenue of $5.42B for the current quarter ending in March, 2013. For 2013, analysts are projecting an EPS of $1.86 with revenue of $23.47B, which is 8.10% higher than 2012. In the last 4 quarters, EMC had 1 negative earnings surprise and 2 positive earnings surprises.

Earnings Preview for VMW

Analysts currently have a mean target price of $97.36 for VMW, suggesting 24.10% upside potential based on the closing price of $78.45 on April 16, 2013. Analysts, on average, are estimating an EPS of $0.70 with revenue of $1.18B for the current quarter ending in March, 2013. For 2013, analysts are predicting an EPS of $3.23 with revenue of $5.22B, which is 13.30% higher than 2012. In the last 4 quarters, EPS had 4 positive earnings surprises.

Fundamentally, both EMC and VMW will be compared to its peers. EMC will be compared to its competitors in the industry of data storage, including Seagate Technology (STX), Western Digital (WDC) and SanDisk Corporation (SNDK). VMW will be compared to its peers in the industry of software infrastructure, including Microsoft Corporation (MSFT) and Oracle Corporation (ORCL).

EMC

Western Digital

SanDisk Corporation

Industry Average

Market Cap

$48.57B

$12.52B

$13.90B

N/A

Revenue Growth (3 Year Average)

15.7

18.7

12.3

5.9

Operating Margin, %, ttm

18.3%

15.5%

13.8%

12.0%

Net Margin, %, ttm

12.6%

13.3%

8.3%

8.9%

ROE, ttm

13.2

29.4

5.8

13.7

Debt/Equity

0

0.2

0.1

0.2

P/E

18.5

6.2

32.9

23.4

P/E 5 Year Average

23.1

7.4

12.4

N/A

Forward P/E

11.2

6.1

13.8

14.3 (S&P 500's average)

Source: Morningstar

EMC has the higher revenue growth compared to SNDK and the industry average. EMC has the highest operating margin among 3 companies. EMC has a healthy balance sheet, with a total cash of $6.17B and with a total debt of $1.71B. EMC also generates a strong operating cash flow of $6.26B with a levered free cash flow of $4.68B. From the valuation perspective, EMC provides a cheap free cash flow (P/FCF of 9.65) and is currently undervalued (P/E of 18.5) compared to the industry average of 23.4. EMC's current P/E is also below its 5 year average P/E of 23.1.

VMware

Microsoft

Oracle

Industry Average

Market Cap

$33.60B

$242.66B

$158.20B

N/A

Revenue Growth (3 Year Average)

31.5

8.0

16.9

8.2

Operating Margin, %, ttm

18.9%

26.9%

38.4%

36.6%

Net Margin, %, ttm

16.2%

21.2%

28.5%

28.3%

ROE, ttm

14.2

22.6

25.3

30.4

Debt/Equity

0.1

0.2

0.4

0.3

P/E

44.6

15.8

15.2

36.8

P/E 5 Year Average

65.8

12.6

18.2

N/A

Forward P/E

21.3

9.0

11.2

14.3 (S&P 500's average)

Source: Morningstar

VMW remains a solid growth story with the revenue growth (3 year average) of 31.5, which is much higher than the industry average of 8.2. Microsoft provides the most value and trades at an attractive Forward P/E of 9.0. Oracle, on the other hand, offers a superb mix of growth and income. VMW also has a solid balance sheet with $4.64B of total cash with a small total debt of $450M. VMW also generates a steady cash flow of $1.90B with a levered free cash flow of $1.34B. From the valuation perspective, VMW's high P/E is justified by its much higher revenue growth as compared to its peers.

Technically, although EMC is on the long-term downtrend since October, 2012, it is approaching its long-term support around $23, as seen from the chart below.

(click to enlarge)

Source: Finviz.com

VMW continues to be on the long-term downtrend since September, 2012. VMW is hanging above its 50-day MA. It is crucial to see if VMW can hold above its 50-day MA to determine its short-term direction.

(click to enlarge)

Source: Finviz.com

Bottom Line

While both EMC and VMW had been declining the past few months, both are trading near major support levels. Based on the negative sentiment baked in for the storage market, EMC and VMW should not surprise on the downside. The key development to watch is the progress on the cloud end and "the Pivotal initiative". For now, there is more upside potential than downside risk as we head into earnings.

Note: Investors and traders are recommended to do their own due diligence and research before making any trading/investing decisions.

Disclosure: I am long ORCL. I have no positions in any other stocks mentioned, but may initiate a long position in MSFT, SNDK, EMC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: EMC And VMWare: More Reward Than Risk