Red Hat (RHT) is set to report first quarter fiscal 2019 earnings results after the closing bell Thursday.
While the Linux and Cloud software provider — thanks to breakthrough success with its application development offerings including OpenStack and OpenShift — has impressed Wall Street with exceptional growth of more than 20% annually, there are now signs that growth has begun to slow. The questions investors must reconcile include, as the company transitions from growth cloud stock to a maturing software vendor in the realm of, say, Oracle (ORCL), does Red Hat’s current valuation make sense?
Michael Turits, analyst at Raymond James, has grown cautious. Turits on Tuesday downgraded Red Hat stock from Outperform to Market-Perform. "Red Hat faces risk to margins and top line with a shift in focus to mid-market this year and risk to billings and cash flow from ongoing duration and linearity issues,” Turits said in a research note to clients.
RHT shares closed Wednesday at $169.22 and have been red hot so far in 2018, rising 41% year to date, compared with a more than 3.5% rise for the S&P 500 index. And if you’ve owned RHT shares over the twelve months, you’re up a whopping 88%, while the S&P has risen just 13% during that span. Red Hat shares are currently priced at a forward of 49, compared to a P/E of 19 for the S&P 500 Index and a P/E of 30 for the Invesco Dynamic Software ETF (PSJ).
As such, it’s critical for Red Hat to demonstrate on Thursday that it still has multiple growth levers it can pull. Just as important, the management must assuage investors who fear that its growth is coming at the expense of other aspects of the business and stiff competition it faces from the likes of Citrix (CTXS) and VMware (VMW).
For the quarter that ended May, Wall Street expects the Raleigh, NC-based company to deliver earnings of 69 cents per share on revenue of $807.45 million. This compares to the year-ago quarter when earnings were 56 cents per share on revenue of $676.8 million. For the full year, ending February, earnings are projected to rise 14.7% year over year to $3.42 per share, while full-year revenue of $3.45 billion would rise 18.2% year over year.
Beyond the core headline numbers, the company must also guide confidently and highlight strong demand for RHEL (Red Hat Enterprise Linux) — its software-as-a-service suite for managing application servers and data storage, which is sold by its cloud partners, including Fortune 500 titans such as IBM (IBM), Amazon (AMZN), Google (GOOG , GOOGL) and Microsoft (MSFT), among others.
All that said, there are no clear signs that the fundamentals of the business is eroding. Red Hat earnings are still predicted to grow at more than 16% annually in the next two years, while revenue is projected to grow at an average rate of 18% over the next five years. So, while the shares are no longer in the bargain bin, they should continue to deliver above-average returns, reaching $190 to $200 in the next 12 to 18 months.