RHT Stock: Here’s Why the Bears Are Wrong on Red Hat Inc

RHT StockRemember Mr. Market—an emotional character created by Warren Buffett’s mentor Benjamin Graham? Right now, Mr. Market is not in a good mood about software company Red Hat Inc’s (NYSE:RHT) stock.

Despite posting a solid earnings report, Red Hat stock did not get applause from the market. On Wednesday by around noon, RHT stock had slipped nearly five percent. Is Mr. Market right about the stock or is he just being irrational? Let’s take a look.

RHT Stock: Is Red Hat Inc a $91.00 Stock?

For those not familiar with the company, Red Hat is a leading provider of open source software solutions to enterprises. Its main offerings include operating system platforms, middleware, storage, applications, management products, as well as support, training, and consulting services.

The company posted great financial results for its most recent fiscal quarter. In the three months leading up to February 29, Red Hat increased its revenue by 17% year-over-year to $544 million. On a constant currency basis, revenue growth would have been an even better 21%. (Source: “Red Hat Reports Fourth Quarter and Fiscal Year 2016 Results,” Red Hat Inc, March 22, 2016.)

Top-line growth trickled down to the bottom line. For the quarter, Red Hat generated adjusted net income of $97.0 million, translating to adjusted earnings of $0.52 per share. Compared to the $0.43 earned in the year-ago period, that’s a 20.9% growth in earnings per share (EPS)! Note that these numbers also beat Wall Street’s expectations. Analysts were expecting revenue of $537 million and $0.48 in adjusted EPS.

If you look a little closer, you’ll see that almost everything looks great. Subscription-based services represent Red Hat’s largest revenue source. In the quarter, subscription revenue surged 18% year-over-year and would have increased 22% on a constant currency basis.

Cash flow also turned out to be good. Red Hat generated a record cash flow of $716 million in the fiscal year, an increase of 15% compared to the previous year.

Forward guidance was better than expected as well. For the current quarter, the company expects revenue to be in the range of $558 million to $566 million, while analysts are projecting revenue of $555 million. So even the low end of the guidance was more optimistic than analysts’ expectations.

Of course, not everything is perfect. Red Hat’s billings grew 11% to $763.9 million for the reported quarter, slightly less than Wall Street’s expectation of $771.6 million.

Although the stock is currently down, quite a few analysts are upbeat about the company. Citigroup Inc (NYSE:C) reiterated its “Buy” rating on RHT stock and raised the price target to $90.00, which would imply a larger than 25% upside in Red Hat stock. (Source: “Red Hat Shares Lower Following Q4 Results; Analysts Weigh in,” Benzinga, March 23, 2016.)

JPMorgan Chase & Co. (NYSE:JPM) has an “Overweight” rating on RHT stock and a bullish price target of $91.00. The bank said, “we affirm our thesis that Red Hat is capable of disruption large swaths of the traditional infrastructure software market as global trust for open source software grows.” (Source: Ibid.)

The Bottom Line on RHT Stock

Let’s not forget how much momentum Ret Hat has in its business. Despite all the business cycles and market downturns, the company has been growing its revenue for 56 consecutive quarters.

Going forward, the company will likely benefit from a bigger market. By 2018, the total value of Red Hat’s addressable market is expected to reach $67.0 billion. (Source: “Investor Presentation,” Red Hat Inc, January 12, 2016.)

Don’t worry about the pullback, RHT stock could see a nice rally ahead.