Why VMWare, Inc. (VMW) Stock Deserves Far More Attention Now
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VMware, Inc. (NYSE:VMW) stock is higher today amid reports that Amazon.com, Inc. (NASDAQ:AMZN) wants to expand its partnership with the virtualization company. It is welcome news for VMW stock investors, who have suffered from an unusual sell-off in the growth name. VMware topped Q1 estimates in early June, posted robust growth in all critical areas, yet it has sold off sharply since then.
Since the Q1 report, VMW stock is down about 7%.
What’s causing the sell-off? Well, not much really, and that is exactly why VMW stock looks like a good buy here.
VMware Is a Secular Growth Story
For the most part, VMware’s growth story parallels the rapid transition companies are making to the cloud.
VMW makes the type of the stuff that makes it easier and cheaper for companies to adopt and fully reap the rewards of cloud technology. This transition has shown no signs of slowing. Rather, the trend is that cloud adoption is actually accelerating. As this trend accelerates, so too will VMW’s total revenue growth.
Hybrid cloud and SaaS revenues, which grew over 30% year-over-year in Q1, now represent more than 9% of VMware’s total revenues. As these hyper-growth segments continue to comprise a larger and larger piece of the revenue pie for VMware, the company should see its total revenue growth rate inch higher as well.
Perhaps most impressively, VMW is already partners with the cloud giants that dominate the space. Beyond Amazon, VMW is also helping power Microsoft Corporation’s (NASDAQ:MSFT) Azure cloud. These strategic partnerships not only ensure that the company wins if the big players in cloud win, but also underscore that it offers top-of-the-line solutions. Together, this combination implies that VMware’s runway for growth in the cloud space is very long and promising.
Moreover, VMware is making inroads in the rapidly growing Internet-of-Things space. The company’s new product, VMware Pulse IoT center, is the company’s first IoT offering. It is a secure enterprise grade IoT infrastructure management solution that is geared towards helping customers more efficiently manage their IoT projects. This is a brand new product in a hyper-growth space, so VMW’s topline could get a nice multi-year boost from its IoT offering.
VMW Is Significantly Undervalued
VMware has about $8.6 billion in cash on the balance sheet against $1.5 billion in debt. That gives the company a net cash position of $7.1 billion, or about $17 per share. VMW stock, meanwhile, trades around $90. That means that nearly one-fifth of VMWare’s market capitalization is covered in net cash.
That is a huge cushion for investors to fall back on, especially considering that the net cash balance is up year-over-year.
Essentially, then, the market is valuing VMW’s operating business at around $73 per share (the valuation after backing out the net cash). That is merely 14-times next year’s consensus earnings-per-share estimate. Meanwhile, earnings growth over the next several years is pegged at around 11% per year. A 14-times multiple for 11% growth in a secular growth business is a good set-up for VMW stock to head a lot higher.
Bottom Line on VMW Stock
The bull thesis is also supported by very healthy cash flows for VMware. VMW is a high cash earnings business with a low capex rate, meaning there is lots of free cash flow left over at the end of the day. VMW generated $726 million in free cash flow last quarter, up 7% year-over-year so roughly in-line with the topline growth rate. Trailing twelve month free cash flow is around $5.50 per share. That gives VMware an attractive 6% trailing free cash flow yield.
Overall, there are many reasons to like VMW stock from a valuation standpoint.
VMware stock is a growth story being noticeably under-appreciated by the market in a time when other growth stocks are being fully appreciated. That makes VMW stock a compelling buy here.
As of this writing, Luke Lango was long VMW and AMZN.
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