The $15 billion company, which offers open-source software products to businesses, released robust fourth-quarter results just a few days ago. It beat revenue growth expectations and consequently announced fiscal year 2018 guidance that surpassed previous expectations.
The buoyant Q4 earnings report and current period outlook signify a comeback from Red Hat's Q3 miss in December. But how did Red Hat grow Q4 revenues by 15.7% and beat estimates?
In Q3, the growth rate was stronger, but expectations were higher. In the fourth quarter, Red Hat registered subscription revenue of $560 million, up 17% year-over-year. Subscriptions now account for almost 90% of sales.
Moreover, application development-related and other emerging technology subscription revenue in the fourth quarter reached $125 million, up 40% year-over-year.
The numbers mean that Red Hat, which trades at an expensive 28 times forward earnings, was able to deliver its 60th successive quarter of revenue growth. That's an incredible feat considering that tech giants like IBM (IBM) - Get International Business Machines (IBM) Report are struggling to maintain revenue growth for 19 straight quarters.
Subscriptions are driving Red Hat. The company earned $2 billion in subscription and deferred revenue in the fiscal year.
Hybrid solutions are a big area of growth today. As businesses swing workloads to the public cloud led by Red Hat's partner Amazon (AMZN) - Get Amazon.com, Inc. Report Web Services, traditional tech leaders have been caught off guard.
The likes of Cisco Systems (CSCO) - Get Cisco Systems, Inc. Report and Hewlett-Packard Enterprise (HPE) - Get Hewlett Packard Enterprise Co. (HPE) Report are no longer chasing their own cloud platforms, but seeking to offer hybrid solutions. This is where Red Hat has scored as the leading provider of open-source Linux software for corporate data centers.
Red Hat's repertoire of high-performing cloud, middleware, storage, and virtualization technologies are helping the company gain revenue share. With a total backlog for the fiscal year 2017 in excess of $2.7 billion, up 28% year-over-year, Red Hat clearly provides a strong outlook for revenue growth in coming years.
Red Hat is now projecting fiscal year 2018 revenue of $2.72 billion to $2.76 billion, earnings per share of $2.60 to $2.64, operating margin of 15.2%, and operating cash flows of $850 million to $870 million.
The operating margin guidance shows Red Hat isn't merely earning more revenue by sacrificing profits. Now, analysts think Red Hat can deliver upwards of 16.4% annual earnings growth for the next five years. This projected rate of earnings growth is much faster than VMware (VMW) - Get VMware, Inc. Class A Report and other peers.
Wall Street's confidence in Red Hat has improved since Q3 when the company fell short and announced the departure of its CFO. While there is some concern about certain products (OpenStack, OpenShift), hyper-scale cloud solutions from its partner Amazon will hold Red Hat in good stead.
Given that the stock has already gained 24% year-to-date, and trades at premium valuations that are perhaps justified by recent earnings, the Red Hat stock doesn't offer a lot of upside at these price levels. Investors should wait for a 10% pullback before buying the stock.
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The author is an independent contributor who at the time of publication owned none of the stocks mentioned.