Markets & Finance

Equation for Growth


By Jim Corridore This week's S&P Focus Stock of the Week is EMC Corp. (EMC). As the global leader in the enterprise and the mid-range areas of the storage industry, we expect EMC to benefit more than any other company from the exploding demand for storage capacity. EMC carries S&P's highest investment ranking of 5

STARS (buy).

Though past performance is no indication of future potential, EMC was the best performing stock of the 1990's, rising an estimated 80,575%. Over the past ten years the stock has averaged a 95% annual return, which accelerated to an average 130% return over the past three years. It is the only NYSE-listed company to be an S&P 500 top performer for the past three, five and ten years.

The strong demand the storage industry is currently seeing is being created since virtually every major technology trend creates information that needs to be stored, from the Internet, to E-mail, to the digitization of information, to the convergence of voice, data and video. This is creating an exponential rise in information and correspondingly, the need for more storage.

In fact, the company cites a study by the University of California, which predicted that the amount of new information created in the next two and a half years, will be more than created in the past 300,000 years combined. Of the 12 Exabytes of data created in the next 2 and a half years, 93% will be created and stored digitally. The number of bytes in an Exabyte is a one followed by 18 zeros, or a billion gigabytes.

ROOM TO GROW. EMC estimated the size of its addressable market in the storage industry at $44 billion in 2000, of which the company currently has only a 20% share, although it is by far the market share leader. This industry is projected to grow to over $100 billion by 2005. In light of this rapid expansion, EMC would enjoy strong growth even while only maintaining its market share.

However, we see the company steadily increasing its share in 2001 and beyond in each segment it competes in. This is being aided by EMC's leading technology and expertise, its dominant position, and its excellent customer retention and satisfaction ratings. We think the company could easily capture 25% of the storage market over the next few years, implying accelerating revenue growth ahead.

The company has been able to expand its addressable market by recognizing where the industry is going and putting itself in position to be the leader. In 1990, EMC came out with Symmetrix, which was the first enterprise storage product to use RAID (redundant array of independent disks) technology, which is now the de facto standard in the industry. In 1999, recognizing that it lacked a presence in midrange storage, EMC bought Data General Corp., which expanded the company's addressable market by 40%.

The company has devoted recent efforts towards networked storage, both NAS (network attached storage) and SAN (storage area networks). These technologies allow storage to be taken off the main server, accessed over the network, and saved on either a separate device (NAS), or shared on numerous devices (SAN). While NAS and SAN are in early stages, they are expected to see exponential growth in the next few years. EMC forecasts the networked storage market to hit $34 billion by '03 with a 92% compound annual growth rate from 2000-03.

POSITIVE OUTLOOK. Drivers of growth for 2001 and beyond include the rise of networked storage, increasing complexity of storage which is driving software growth, international expansion (as EMC gets an increased percentage of its sales from overseas), the need for increased services due to a shortage of IT professionals at customers, and the expected rise of information plants, which are large providers of storage similar to how the electric company today provides you with energy for your home.

Standard & Poor's outlook in 2001 for EMC is very positive. On the heels of last year's 32% rise in revenues, this year's growth is expected to be even more impressive. S&P expects revenues in 2001 to grow about 40% and surpass the $12 billion mark (an often cited target by the company), representing a strong acceleration over the growth rate seen in 2000. International revenues should grow even faster than the overall average, as the company increases its penetration of overseas markets.

Gross margins should remain strong. In 2001, S&P targets 57%-59% gross margins, vs. last year's 58% gross margin level. With selling, general and administrative and R&D expenses staying in the range of 2000, we target EPS to grow about 39% to our street high EPS estimate of $1.10 (the street consensus EPS estimate is $1.03).

Trading at about 70 times that estimate and 55 times our '02 EPS estimate of $1.40, the stock trades at a premium to the overall market. However, looking at the p-e to growth or PEG ratio and using a conservative long term EPS growth rate of 30% gives the company a PEG of 2.3 times for '01, vs. a market PEG multiple of about 2.2. Using that valuation metric, we would argue that the shares are not getting a substantial premium over the market.

WORTH THE PRICE. However, we think the stock warrants a large premium to the market due to its dominant market share, leading position in a rapidly growing industry, extremely high margins, and a visionary management team that has shown time and time again an ability to stay ahead of the technology curve.

Despite worries about an economic slowdown and a corresponding slowdown in information technology purchases, EMC is currently not seeing any slowdown in demand for its products to start the year. We don't expect a storage slowdown to materialize, reflecting our opinion that storage is not a want but a need due to the rapid growth of information. Thus, IT managers cannot afford to delay purchases of storage devices to hold the information their employees are constantly creating.

In summary, EMC is the best positioned company is the rapidly growing storage arena, will continue to post strong revenue and earnings growth, paced by rising market share in the rapidly growing storage industry. To us, it all adds up to another good year for the company and the stock in 2001. S&P's 12 month price target for EMC is $98, derived by giving EMC a p-e multiple of 70 times our 2002 EPS estimate of $1.40. This is still in the middle of the company's historical p-e range and on a p-e/growth basis, still represents only a modest premium to the overall market. Our price target implies the potential for a 27% appreciation in the stock from its recent level. Corridore is an equity analyst for Standard & Poor's covering the data storage industry


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