In this article, I will run you through some financial and valuation metrics for EMC Inc. (EMC) as I believe that the shares are trading at an attractive price and the firm enjoys decent profitability, robust liquidity position, solid market leadership, and industry-wide tailwinds. Although your further research is warranted, I believe this article will serve as a helpful introductory for identifying an undervalued investment opportunity.
Introduction - EMC is a leading technology company providing software, hardware, and services for corporate network storage. The firm generates approximately ~52.7% revenue from the US market, ~28.3% from EMEA, ~13.2% from Asia Pacific, and ~5.8% from Latin America. According to Morningstar Research, EMC is a market leader in enterprise network storage market, commanding at least ~25% market share.
Growth - Top line has experienced decent historical growth at a 4-year CAGR of ~10.9% over the past 5 fiscal years. Street analysts expect revenues to continue the growth momentum by increasing at ~11.1% and ~11.3% in the current and next fiscal years. EPS has grown at a 4-year CAGR of ~9.3% over the past 5 fiscal years. It is expected to experience substantial growth of ~58.4% in the current fiscal year and a slower pace of ~14.7% in the next fiscal year. Both EMC's top-line and bottom-line growth prospects are in much better shape than its major competitor NetApp's (NTAP) estimates. Analysts expect NTAP's top line growth to be ~3.4% and ~8.2% in the current and next fiscal years, and EPS growth to be ~2.1% and ~2.46%.
Profitability - EMC has demonstrated solid profitability. Its 5-year average EBIT margin, net margin, and ROE are ~13.4%, ~10.6%, and ~11.6%, respectively. The performance is in line with NTAP's records - EBIT margin of ~10.3%, net margin of ~9.0%, and ROE of ~15.8%.
Liquidity Position - The firm has ~$1.7B debt and ~$6.3B cash, amounting to a net cash position of ~$4.6B, which is equivalent to ~$2.2 per share. It is a robust cash flow generator with an average FCF margin of ~19% over the past 5 fiscal years. EMC has no problem in servicing its debt with a LTM interest coverage ratio of ~25x.
Valuation - At its current market price of ~$23, EMC is trading at ~11.6x forward FY2013 EPS, slightly lower than NTAP's ~12.0x. However, I believe a valuation premium of at least 10% should be warranted given EMC's better growth prospect, in-line profitability performance, and market leadership in the enterprise network storage field. The stock would fetch a value of ~$26.4 on a 10% PE-multiple premium to NTAP. In addition, I checked that value against my DCF model with the following fairly conservative assumptions:
|Revenue Growth||Steadily decline from 10% to 3% over the next 10 fiscal years|
|EBIT Margin||An average of 15% over the next 10 fiscal years (lower than consensus estimate)|
|D&A Expense||7.1% of revenue (historical average)|
|Share-based Compensation||3.7% of revenue (historical average)|
|Provisions for Doubtful Account||0.1% of revenue (historical average)|
|CapEx||6.3% of revenue (historical average)|
|Change in NWC||5.0% of change in revenue|
The stock's fair value under the model is ~$27, very close to the result calculated under the PE-multiple method.
Potential Catalysts - Exploding data growth has been driving significant demand for data storage services from corporate customers. The popularity of cloud computing also helps fueling the robust demand. With the leading market share and ample financial flexibility, EMC is well positioned to ride on the wave. In addition, EMC's continued emphasize on storage software development will likely help improving margins.
Risks - Building their own storage systems by major cloud-computing players or EMC's inability to stay at the forefront of the technology curve will likely weigh on the firm's growth prospect.
Financial data is sourced from company 10-Q, 10-K, press release, Yahoo Finance, YCharts, Wall Street Journal, Thomson One and Morningstar.
Disclosure: I am long EMC.