Can VMware, Inc. (VMW) Stock Maintain Its Long-Term Strength?
VMware, Inc. (NASDAQ:VMW) has a high bar to cross. The stock is already pre-announced preliminary second-quarter results and raised its full-year guidance. Needless to say, VMW stock is trading yearly highs.
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It will take a “sell on the news” event on Aug. 24, after the market closes, for VMware stock to fall. If the chances of the stock dropping are low, what should investors expect in the company’s quarter?
VMW Stock: Preliminary Results
VMware expects revenue growth of as high as 12.6% year-over-year to $1.9 billion, above the $1.86 billion consensus. GAAP operating margin will be in the 30% range, while earnings-per-share will be between $1.15 to $1.19 per share. The EPS forecast is above the $1.13-a-share forecast.
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For the fiscal year 2018, VMware expects revenue growth of 10% YOY and an EPS of $5.08 a share. The update is a remarkable reversal from the outlook given during its Q1 announcement.
VMware had forecast earnings of $4.91 a share for the year. Despite experiencing strong momentum across all of its businesses into Q2, VMW stock actually fell from around $98 to as low as $85 after the report. Investors likely sold the stock because they were disappointed in the company’s outlook. They failed to realize that customer demand improved through the quarter. By providing higher value in its products, including SDDC, EUC and hybrid cloud offerings, sales would accelerate.
As early as Q1, VMware already said it had a healthy mix of backlog for both its licensed SaaS and software/services. It probably signed many bigger-than-expected agreements with customers before the second quarter ended.
Strong Demand for VMware Products
Take vSAN as an example of a good product growing rapidly. In Q1, VMware integrated NSX, which led to 85% customer growth for the product. vSAN enjoyed a 150% customer growth rate, with VMware counting over 8,000 customers using the product. Product adoption happens without much effort, thanks to the company having hundreds of partners.
In the cloud networking space, VMware counts on International Business Machines Corp. (NYSE:IBM) as one of its partners. Despite IBM stock trading at yearly lows, IBM is viewed as a mega cloud player. On its conference call, the company did not break out the revenue generation for vCloud Air coming from the partnership. It also pointed out its strong history with IBM. Previously, IBM Global Technology Services was a systems integrator that helped promote VMware’s solutions.
Solid Licensing Revenue
VMware owes its stronger revenue forecast and steady profit margin to the growth in licensing. This type of revenue is good for software companies in general. It is more profitable and customers typically renew the licenses year after year. Last year in 2016, VMware benefited from unusually strong second-half licenses. Typically, seasonality would imply a drop in such revenue. That momentum carried into the first half of this year and once again, it will add meaningfully to this year’s results.
Don’t forget that adding multiple products is central to VMware’s cloud strategy. As mentioned already, vSAN and vCAN have strong customer demand and are giving management the confidence to lift its full-year outlook.
Bottom Line on VMW
VMware is in the sweet spot of the computing market. Demand for cloud computing, secure server, network and storage virtualization is growing enough that management forecasts a bright outlook for the rest of this year. Chances are good the stock will go up after the earnings report. VMW stock trades at a price-to-earnings ratio of 33.5X, but its forward P/E is 18.3X. That is a fairly inexpensive multiple given the growth that lies ahead.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.
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