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EMC: Stick with Storage

11/19/2004 12:00 am EST


Stephen Biggar

Director, Product Strategy, Argus Research Corporation

EMC, whose name was taken from Einstein's equation, has caught the attention of two of the market's leading stock pickers. Elliott Gue sees the stock as a way to play a fourth-quarter tech rebound, while Stephen Biggar awards the stock S&P's highest five-star rating.

"Seasonally, the fourth quarter is almost always a good one for the market, and so it’s time for us to get a little more aggressive," says Elliott Gue, editor of Wall Street Winners and co-editor of Personal Finance . "We always like to keep our eyes on what the big money is doing. Right now, fund managers are looking to generate some positive returns and are looking for where best to allocate their funds. They are looking for the stocks that are going to run up the most when there’s a rally, which means buying tech. This is precisely why the NASDAQ has been such a notable outperformer since the August lows.

"Our pick to play this move is storage-maker EMC (EMC NASDAQ). EMC is the largest player in storage space with its market share globally topping 20%. The explosion of electronic data in the 1990s meant corporations had to buy a great deal of storage hardware to manage all that information. Not surprising, EMC was among the NASDAQ's best-performing stocks during those years. Of course, the tech bust post-2000 wasn’t kind to EMC. Corporations overspent on storage equipment in the late ‘90s and simply stopped buying. Almost simultaneously, companies like IBM and Hewlett-Packard began aggressively picking at EMC’s core market. In fact, prices for storage equipment fell by approximately 90% between 1999 and 2002.

"However, we like some of the company’s more recent tactical moves. Instead of simply circling the wagons around storage hardware, EMC has decided to diversify into software and consulting services. During the last two years, the company spent $3 billion on targeted acquisitions in this space. Even better, these new businesses carry much higher profit margins. This positive shift in business mix was apparent from EMC’s recent quarterly report. Profit margins are back to nearly the same level as during the company’s heyday in 1999. And EMC has actually been gaining market share. We’re looking for a rally above 15, and if we’re right about the broader averages, EMC could move a lot higher than that. Buy under 13.50, with a stop at 11.23."

Stephen Biggar, equity research director for Standard & Poor’s The Outlook , adds, "EMC has made a series of acquisitions in the past few years that we think has broadened its product line and should add to long-term earnings growth. In addition, we expect EMC’s financial performance to improve as businesses continue to increase their spending on data storage. In our view, the company’s gross margin should expand as overall data storage unit sales increase and the sales mix shifts to higher-margin products.

"We forecast that operating expenses as a percentage of sales will decline this year and next, now that the acquisitions have largely been integrated. Storage systems accounted for 53% of the company’s $6.2 billion sales in 2003, and software contributed 22%. The remaining 25% came from services and consulting. We project that operating earnings will be $0.48 per share in 2005 vs. our forecast of $0.35 for 2004. The company earned $0.22 a share in 2003. Our Standard & Poor’s Core Earnings estimate of $0.31 per share for 2005 reflects projected stock option expense. The stock has our highest five-star rating which is given to those stocks that we believe will outpace the S&P 500 in per-share earnings growth and produce market-beating total returns over the next 12 months. We have a 12-month target of $17 and believe the shares are a strong buy."

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