Sun: Operating Margins Expanding

I wonder how many stories like this I’ll be writing today: stocks that got crushed in Tuesday’s sell-off that suddenly look a lot more interesting than they were the day before.

Laura Conigliaro, hardware analyst at Goldman Sachs, today raised her rating on Sun Microsystems (SUNW) to Buy from Neutral, following a sell-off in the stock and a presentation by the company at the Goldman Sachs technology conference in Las Vegas.

“Sun probably helped its cause most by clearly articulating its road map while also highlighting opportunities for upside,” Conigliaro wrote in a research note. “In fact, our sense is that Sun’s 10% operating margin target for fiscal 2009 is a milestone rather than an endpoint.”

In part, the call is about valuation.

With the stock having closed below $6 yesterday – the level we have been suggesting as our trigger – we are adding Sun Micro to the Americas Buy List. Sun’s stock is not exactly inexpensive on current estimates but rising margins and estimates will bring down the multiple over time.

Conigliaro notes that changes in Sun’s channel inventory management have been “suppressing” near-term revenue. She says Sun is moving to “a sell through model” for indirect sales, “providing one area for re-acceleration once channel inventory, around 4 weeks, down from 6 weeks in December, is taken to zero in the back half of [calendar] 2007. She says gross margin upside should come from higher storage revenue and software, “with stable systems gross margin allowing overall corporate gross margin to drift higher versus the company’s plan of flat gross margin, driving earnings leverage.”

On the expense side, she finds, “Sun’s more positive posture toward partnerships, such as the one with Fujitsu to lower SPARC development costs, should yield additional leverage to its cost cutting initiatives.”

Adds Conigliaro: “Post June 2007 earnings, we would look for Sun to begin to use some excess cash for buybacks.”

In pre-market trading, Sun this morning was up 18 cents at $6.18; the stock fell 29 cents in yesterday’s big sell-off.

SUNW 1-yr chart