$RHT Fiscal Q4 Earnings Preview

by Dan March 22, 2016 2:56 pm • Commentary• Trade Ideas

Event: Infrastructure Software vendor RedHat (RHT) reports their fiscal Q4 results after the close. The options market is implying about an 8% one day move which is very rich to the 4 qtr average of about 3.5%, but basically in line with its 10 year average.

Price Action / Technicals: RHT traded from a 52 week high on December 30th 2015 at $84.40 down to a 52 week low on February 8th to $59.59, down nearly 30%.  The stock has since rebounded 27%, but is still down about 8.5% on the year, and down about 10% from its 52 week highs.

The 8 year chart from its 2008 lows shows the stock holding its uptrend like a boss, with the most recent test stopping right at $60 support level, which was also a prior breakout level:

[caption id="attachment_62392" align="aligncenter" width="600"]RHT 8yr chart from Bloomberg RHT 8yr chart from Bloomberg[/caption]

Valuation: RHT has been a bit of an nominally as it comes to sales growth in the software space. There are few companies that can boast double digit sales growth over the last 10 years without a year over year decline. While RHT’s march to $2 billion in sales has been impressive, the company is set to report is slowest year over year sales growth in the last 10 years at 14% in fiscal 2016 and expected 15% in f2017.  RHT’s valuation reflects this steady sales growth, trading 63x trailing earnings and 41x expected f2017.  But that’s adjusted, the $2.19 adjusted estimate drops to $1.31 on a GAAP basis, placing the shares forward P/E at 58x.

RHT has a very solid balance sheet with 13% of their $13.8 billion market cap in cash, 8% net of $730 million in debt.  RHT is clearly a growth stock, priced for future growth that likely exceeds its current multiple.

Given the results and stock reactions of software vendors in the latest earnings cycle (WDAY up 18% MSFT up 5.8%, ADBE & ORCL up 3.8%, CRM up 11%) it might not be prudent to fade a move higher, but it might make sense to fade the implied move of about 8%.

My View:  If revenue growth were to decline to high single digits this year, the stock would likely see a massive re-rating lower. If growth were to be in line to slightly higher I am not sure there is too much upside beyond the prior 52 week highs at $84.40.

Options are tough with no weekly expirations and just $2.5 strikes.

This is not a stock I would or could buy. Yeah, they could beat and guide higher, and the stock could squeeze higher.  But it’s just not my game to chase a stock after a 27% bounce.  I would add the most active strikes today at 2,000 April 85 calls, but they look to be sold to close in small lots, and then 1600 of the April 80 calls, and 1400 of the April 75 calls.

If I were inclined to make a bearish leaning bet with defined risk, I might consider the April / May 67.50 put calendar, selling one of April 67.50 puts to open at 85 cents and buying to open one of the May 67.50 puts for 1.50, with the spread costing me 65 cents.

I lack directional conviction, and this could be a great set up to wait and see what guidance is, confirming the recent rally, or revealing it to be nothing other than a dead cat bounce.


Estimates and Forecasts from Bloomberg:
-4Q adj. EPS est. 47c (range 47c-51c); co. forecast 47c on Dec. 17
-4Q rev. est. $537.5m (range $525m-$540m), co. forecast $535m-$539m (Dec. 17)
-1Q adj. EPS est. 50c
-1Q rev. est. $554.5m
-FY2017 adj. EPS est. $2.19
-FY2017 rev. est. $2.35b


  • Deutsche Bank (buy): Investors expecting mid-teens billings growth given cautious macro comments from large infrastructure IT vendors like HP Enterprise and Cisco
    • NOTE: RHT had billings growth of 14.9% q/q in 3Q
    • Says hasn’t seen any signs of weakness and encouraged by better-than-expected server industry data and Microsoft’s bigger embrace of Linux
  • MKM Partners (neutral): sees FY2017 margin forecast flat y/y, a slight disappointment but better than down y/y, which would have been case without recent pullback in hiring efforts