Is Red Hat A Good Buy Going Into Earnings?

Red Hat’s (RHT, Financial) growth story has been phenomenal. Over the last five years, the open source software company witnessed over 118% growth in revenue and over 119% growth in earnings. This is an astounding achievement, given the fact that Red Hat competes with many proprietary environment software companies like Microsoft (MSFT, Financial), Oracle (ORCL, Financial) and others, whereas one can download the basic product of Red Hat free.

Shareholders who bought the stock five years back are now sitting on gains of close to 150%. In fact, this year on May 22nd the stock has touched an all-time high of $79.35 a piece, since February 2000. The company is set to report its Q1 earnings after the market close on June 18. So, is the stock a good buy going into the earnings? Let’s take a look at the last reported quarter and the growth drivers.

Fourth-quarter fiscal 2015 in focus

Red Hat’s fourth-quarter fiscal 2015 results were better than Street’s expectations both on top- and bottom-line. Total sales increased close to 22% year-over-year to $487.9 million, exceeding the consensus estimate of $457 million. This was backed by robust revenue growth in all segments of the company.

On the back of healthy sales growth, adjusted earnings came in at $0.30 per share, ahead of the consensus estimate by $0.03. During the quarter, the company repurchased shares worth $220 million.

Red Hat exited the quarter with cash and cash equivalents were over $1 billion, generating $217.4 million from operations.

Growth drivers

1. Management authorized a new $500 million share repurchase program to replace the expiring authorization. Share buybacks will add to bottom line growth.
2. Red Hat continues to gain market share in the enterprise server market, with Linux gaining from Microsoft’s Windows server.
3. The company’s partnership with companies like IBM (IBM, Financial), Dell (DELL, Financial), Intel (INTC, Financial) will keep driving growth.
4. Also to core open-source Linux operating system, the other products like storage software, virtualization software and the cloud will also drive growth.
5. Outside of core open-source Linux, customers are interested in OpenStack, followed by Red Hat Enterprise Virtualization and OpenShift from Red Hat. Openshift has been performing very well, and the momentum is growing. According the partners, 31% of customers have 31% of customers have made a purchase outside of RHEL, and this number is expected to increase to 46% by the end of fiscal 2016.
6. Red Hat’s recent partnership with NEC will also be a good growth driver. This is a collaborative effort to develop NFV features in OpenStack for delivering carrier-grade NFV solutions based on Red Hat’s OpenStack Platform.
7. A Larger number of $ 1million-plus deals in the U.S. banking and manufacturing verticals will push growth. In fact, during the fourth quarter fiscal 2015, all top 30 deals were over $2 million, with one being over $10 million and 12 being over $5 million.
8. Red Hat’s partnership with Dockers for launching one of the first certified, end­-to-­end ecosystem programs for Linux containers based on Docker. RHELDoc, a software stack made up of Red Hat Enterprise Linux (RHEL) and Docker containers. Experts feel that RHELDoc can do for the cloud and data center what RHEL did for servers.

Analysts are optimistic

For the first-quarter fiscal 2016, analysts polled by Thomson Reuters expect Red Hat to report adjusted earnings per share of $0.41, up 20.5% from the year-earlier period. Revenue growth of 11.5% to $472.5 million is also projected.

Other analysts expect Red Hat's EPS to rise 9.7% to $0.45 and revenue to grow 10.6% to $493.2 million.

Wrapping up

Red Hat is almost synonymous with LINUX. The company’s growth has been stellar, and the momentum isn’t going to fizzle out anytime soon. Also, the company has a strong balance sheet with $1.26 billion in cash versus debt of $714.5 million.

There are growth significant catalysts, and I think that the company will be able to beat Street’s expectations in the first quarter fiscal 2016 results, despite currency headwinds.

Hence, it is an excellent opportunity to buy Red Hat going into the earnings.