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3 Key Takeaways From Red Hat’s Quarter

By Jamal Carnette, CFA – Apr 2, 2018 at 9:06PM

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Here's what you need to know about Red Hat's strong earnings beat.

In a week in which investors watched tech stocks harshly sell off, Red Hat (RHT) gave reason to believe the sector's run isn't over just yet. Shares of the open-source IT specialist jumped in response to its strong fourth-quarter results last week.

Red Hat beat analyst estimates on both the top and bottom lines by growing sales 23% over the prior year to $772 million, its 64th consecutive quarter of growth, and reporting adjusted EPS of $0.91 per share versus expectations of $762 million and $0.81, respectively.

And the stock's strong run is continuing as well. Red Hat shares have jumped by about 80% over the past year, including the 6% gain in response to the stronger-than-expected quarter. Because of the rally, shares continue to be richly valued. Can Red Hat continue to grow fast enough to please Wall Street? Here are three takeaways from Red Hat's last quarter.

Cloud computing concept

Image Source: Getty Images

Free is a strong business model

Red Hat is often thought of as a software firm, but the reality is more complicated. Red Hat operates a semi-fremium business model. The underlying software is open-source, generally Linux-based, and the company makes money by providing services, support, and customization to optimize the underlying technology, tailored to the individual customer.

Of course, free tends to have strong lock-in effects -- Linux is one of the fastest-growing server operating systems -- and the company's experience in support, cloud management and deployment will provide a long runway for growth. Red Hat's business model is paying off: in the fourth quarter the company closed 169 deals over $1 million, 50% higher than in the prior-year quarter.

The business shift to cloud is paying off for Red Hat

It's not just big infrastructure-as-a-service providers like Amazon and Microsoft that are benefiting from the tremendous growth in the cloud. Middleware and cloud enabling technology firms are also making money on the shift away from on-premise storage and compute functions. Red Hat has acutely taken advantage of the growth of cloud storage.

Last year Red Hat reported total spend for customers buying cloud technologies increased at a 25% annualized growth rate, while spend among those that did not increased at only a 5% growth rate. Look for more to join the former group as the shift to cloud-based computing continues.

Red Hat expects strong growth to continue

Red Hat's forecast is for continued growth. Management is guiding for full-year 2018 revenue to come to $3.44 billion at the mid-point, an increase of 19% from the prior year. On the bottom-line, the company expects full-year GAAP EPS to be $2.27 at the midpoint, up more than 62% from fiscal 2018. It's possible this EPS figure will be higher, as the company has approximately $400 million in its share repurchase authorization to lower outstanding shares.

The company will need to continue its strong growth to match aggressive valuations. Shares currently trade at 45 times forward PE, using analyst estimates from Thomson Reuters, versus the greater S&P 500's valuation of 17 times. Shares are priced richly, but Red Hat should continue to report stellar financial results.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Jamal Carnette, CFA owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.

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