Should You Be Storing EMC in Your Portfolio?
Business Week Online
How long can EMC Corp.'s (EMC) stock keep up its torrid pace? In the past year, its shares have risen 150%, with most of that gain coming in the last six months. Dell Computer Corp. (DELL) is the only stock that has performed better over the past decade -- and EMC plans its fifth stock split since 1992 this May. Its shares closed on Mar. 4 at $101 1/8, adding 3 1/4 points in a stellar day for tech stocks. It's hardly a surprise that Wall Street loves EMC. The company's earnings and revenues are expected to grow at better than a 30% clip for the next three years. Its 1999 profits should top $1 billion, with revenues reaching $5.3 billion.
Even without increasing its 35% market share (IBM is No. 2 with a 22% share), EMC can do $10 billion in sales by 2001, believes Merrill Lynch analyst Steven Milunovich. He set a 12-month price target of $125 after EMC reported record fourth-quarter earnings and revenues on Jan. 26. Net income was $256 million, up 54% from the prior year, on
revenues of $1.19 billion, 36% higher than in the fourth quarter of 1997. Sales of enterprise storage software -- a hot, high-margin segment of its business -- grew to $164 million, up 175% from the year before.
"POWERFUL DRIVER." The overall market for EMC's type of systems is expected to grow from $10 billion currently to $35 billion in 2001 and possibly $50 billion by 2002. And there's room for even faster growth. With its new line of Storage Area Network (SAN) systems announced Mar. 1, EMC's target market could reach $50 billion by 2001, Milunovich believes. Growth of the Internet is key to EMC's story. "If you believe that use of the Internet is now doubling every 95 to 100 days, that is an extremely powerful driver for demand for systems data storage," says James Gribbell, a portfolio manager at investment advisory firm David L. Babson & Co. "Long term, it's very difficult to make a bearish case for EMC -- except for the valuation."
EMC, like all technology leaders, is expensive. It is trading at about 50 times 1999 projected earnings, which is more than twice the multiple of the S&P 500. "The stock finally reflects the fact that it is a market leader," says Brian Goodstadt, an analyst with Standard & Poor's equity research group, who still rates it a strong buy. "A year ago, I could say it was undervalued, but not anymore."
The case for a higher stock price is starting to sound like a bit of a stretch, though. Essentially, analysts argue that EMC shares can go higher because the company is growing faster than other high-tech leaders that share the same sky-high multiples. "EMC's multiple is a bit below fellow franchise players, while the p-e to growth ratio is well below," Milunovich wrote in a Jan. 26 research note.
According to figures from Salomon Smith Barney, EMC is trading at a forward p-e that is about 1.8 times its growth rate, while Microsoft (MSFT) is trading at 2.5 times its growth rate, Cisco Systems (CSCO) at 2.3 times, and Intel at 1.5 times. That gives EMC some more room to rise, although it shouldn't trade at the same level as Microsoft, says Chuck Jones, an analyst with Salomon Smith Barney. He rates EMC a buy with a $110 price target.
HAMMERED ON WEAKNESS? Investors have grown increasingly wary of technology stock values in recent weeks, however, and the sector has fallen about 10% from its high. Even EMC has cooled in recent weeks. It hit a 52-week high of $109 7/8 on Feb. 1 and has since traded in a range between there and the high 90s.
As with any company that has had Wall Street's high expectations already factored into its stock price, the concern is that EMC might get hammered on any small sign of weakness. Milunovich believes it faces very few threats over the next two to three years, but other analysts have spotted areas of concern. "In this kind of market, it doesn't take a whole lot to trip up a stock with valuations like EMC's," says Gribbell, who doesn't own the shares.
Near-term, Gribbell says, conversations with EMC customers have led him to believe that the company could face a slowdown in demand for storage as 2000 approaches. EMC has benefited from the Y2K computer glitch, since companies needed separate systems with stored data to do their testing on. But once the testing is done, that excess storage will be free, which could lead to a temporary slowdown in new purchases toward yearend and for 2000's first half, Gribbell says.
Another Y2K-related concern is that companies will "lock down" their main computer systems, delaying any upgrades or additions to make sure they're ready for the long-anticipated date change. Even after the New Year, companies may delay purchases for as long as three months to fix any glitches that occurred. "Insufficient attention is being paid to a
potential 1999 lock-down," wrote Gartner Group analyst Michael Chuba in a Nov. 2, 1998, research note.
"LESS WORRIED." Most analysts are confident that EMC management has factored Y2K into its planning and is well prepared for any issues that arise. "There is enough demand for storage and an explosion of data that they can manage through any Y2K slowdown," says Jones. Fears of a slowdown as Y2K approached have been in the air for months
now. "It hasn't happened yet," says Goodstadt. "The closer we get, the less worried I'm becoming."
Longer term, EMC is exposed to some risk if its bet on centralized data storage systems doesn't pan out, says Jones. For instance, customers could decide to attach storage to each network server rather than centralizing it with one of EMC's massive new systems. "That is probably one of the biggest potential stumbling blocks," says Jones.
EMC will clearly have to fight to maintain its lead. But it is such a well-managed company in such a fast-growing business that even if it suffers a setback, that might just provide an opportunity for long-term investors to buy in at a better price.
By Amey Stone in New York |
