S&P: "Should You Bow Out of Data Storage Stocks?"
businessweek.com
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>>>Richard Stice is a technology analyst for Standard & Poor's
SEPTEMBER 7, 2001
TECH KNOWLEDGE • From S&P
By Richard Stice
Should You Bow Out of Data Storage Stocks?
The IT spending slump is keeping these top data storage players under pressure.
But the longer-term picture is brighter.
The deck looks stacked against data storage stocks. The industry -- which makes hardware and software for computers and network systems to store information -- faces ongoing weakness. Corporate information technology spending is lagging, there's a lack of visibility regarding future customer orders, and many companies in the sector still have excessive valuations.
With all that, we at Standard & Poor's have recently taken a less favorable stance on the sector. Longer term, we still see impressive demand for the data storage group; sales of storage systems and software, which were $30 billion in 2000, are expected to double by 2004. But in the near term, we believe a more cautious view is warranted.
Our caution has prompted us to lower our investment rankings on three key industry players:
Brocade Communications (BRCD ); to 3 STARS (hold) from 5 STARS (buy)
EMC Corp. (EMC ); to 3 STARS from 4 STARS (accumulate)
and Emulex Corp. (EMLX ); to 3 STARS from 4 STARS
Let's look at the issues facing each stock right now.
BROCADE: NO CATALYST.
Brocade is the world's leading provider of storage area networking (SAN) infrastructure solutions. Its products allow companies to implement large, heterogeneous, block-data networks supporting business-critical storage applications. Brocade's SAN infrastructure can be used to move blocks of data over long distances at high performance, and to create a networking platform to simplify the administration, management and movement of data.
Its products are sold through original equipment manufacturers (OEMs), systems integrators and resellers. Brocade has OEM partnerships with the companies that supply the majority of the world's external storage. In the fiscal year ended October 2000, Compaq and EMC together accounted for 49% of total revenues, and were the only customers with over 10% of the total.
Brocade's shares are down sharply so far in 2001. However, despite the precipitous fall, the stock continues to possess a hefty valuation. At recent levels Brocade trades at 58 times the fiscal year ending October 2002 earnings estimate of $0.35, which is a significant premium to the S&P 500, as well as its projected long-term growth rate of 41%. Moreover, S&P's discounted cash flow analysis indicates that the shares are trading near their intrinsic value. Finally, despite the projected growth of data and Brocade's diversified customer base, we do not see a near-term catalyst to propel the shares to a level of outperformance.
EMC: STILL PRICEY.
EMC Corp. is the leader in the enterprise data storage industry. EMC sells hardware, software and services for the storage, management, protection and sharing of electronic information. The company's flagship product, Symmetrix, was the first intelligent disk storage system to integrate software with large amounts of cache memory and arrays of standard disk drives. In 2000, 70% of total revenues were from information storage systems.
EMC also offers highly innovative software that provides customers with superior information management, sharing and protection capabilities. These capabilities include enhanced backup, disaster recovery, business continuance, data migration and data movement. Software provided 16% of revenues in 2000. The company's global services organization offers consulting, installation, training, day-to-day support, parts delivery and system upgrades. The organization unites all of EMC's service functions, including customer service, professional services and technical training services. Revenue from storage services was 7% of the 2000 total.
The shares of EMC have fallen sharply in 2001 and are trading near a 52-week low, after being punished by negative industry fundamentals. S&P's downgrade reflects the belief that corporate IT spending is unlikely to improve meaningfully over the near term. From a valuation standpoint, EMC trades at roughly 36 times our 2002 earnings estimate of $0.40, which we believe is an excessive level given the ongoing economic malaise. The downgrade was further supported by S&P's discounted cash flow analysis, which suggests that EMC's stock is appropriately valued.
EMULEX: PROMISING, BUT ...
Emulex designs, develops, and supplies fibre channel host bus adapters (HBAs), hubs, application-specific computer chips (ASICs), and software products. In fact, according to International Data Corp., Emulex is the world's largest provider of HBAs. These products provide connectivity solutions for SANs, networked attached storage (NAS), and redundant array of independent disks (RAID) storage technologies.
Emulex sells products worldwide to OEM's and end users, and through other distribution channels, including systems integrators, industrial distributors and resellers. In the fiscal year ended June 2000, fibre channel technology accounted for 85% of sales, while traditional networking products provided 15%. Its largest customers during the fiscal year were Compaq, IBM, EMC and Avnet. International revenues accounted for 30% of the overall total.
Emulex's year to date performance has been abysmal. The shares plunged following the company's announcement of order deferrals. However, S&P still believes Emulex is well positioned to take advantage of the expected growth in the HBA market. This market is expected to grow 60% annually over the next several years, once the economy begins to stabilize. On the other hand, in spite of its favorable prospects, we have some concerns. In the near term, industry growth rates will be weak due to delayed IT spending in the storage sector. In addition, the stock still trades at a pricey 34 times our fiscal year ending June 2002 estimate of $0.42, which is above its estimated long-term growth rate of 32%. Consequently, we believe the shares are likely to perform in line with the broader market over the next six to 12 months. <<< |
