Buy Red Hat Stock Ahead of Earnings Before It Gets Red-Hot

NEW YORK (TheStreet) -- Better days are coming for Red Hat (RHT) once the company reports earnings Wednesday.

Right now the company is a victim of lower expectations -- the market's, thanks to overreaction to weak guidance from the company.

Since reaching its 2014 high of $60.52 back in March, shares of the enterprise software giant have been in the red -- down nearly 10% in the last three months and 7% for the year to date, based on the closing price of $52.14 Monday.

But with so many new companies embracing Rad Hat's OpenStack standard, astute investors should buy the stock now. Red Hat should easily beat expectations when it reports fiscal 2015 first-quarter earnings results Wednesday. 

I won't deny that Red Hat has seen better days. But the growth rate in the company's enterprise Linux solution is not as bad as initially perceived.

When you combine this with Red Hat's confidence in next year's adoption rate for OpenStack and its Cloud platforms, these shares should reach $60 in 12 months, if not sooner. Of the 30 analysts that cover the company, there is a median price target of $64.50. The highest price target is $74.

OpenStack is Red Hat's open-source software cloud computing platform, which is free and deployed as an infrastructure-as-a-service (IaaS) solution.

Management is also working to grow Red Hat's capabilities in software-defined storage, the Cloud and middleware, which is the software that lies between an operating system and specific software applications. So investors who still regard Red Hat as just niche Linux operator need a wakeup call.

Prior to Red Hat entering these new vertical markets, there were concerns that the company's Linux operation was on its last legs. Investors feared that Linux wouldn't sustain the rate of growth necessary to bridge the company's entry into higher margin businesses. These fears continue to be misguided.

Consider, close to 90% of Red Hat's subscription revenue in fiscal 2014 came from its infrastructure segment, which includes Linux. That segment is still growing at a14% annual rate, or 4% better than the 10% rate, which the bears cite as reason to avoid the stock.

Equally and perhaps more impressive, middleware accounted for 16% of fiscal 2014's subscription growth. This has turned Red Hat into a fierce rival to companies Oracle  (ORCL) and Microsoft  (MSFT). But Red Hat has only just begun.

From my vantage point, these shares are worth a gamble ahead of earnings. With OpenStack gaining strong adoption, both revenue and earnings should begin to trend higher in a manner of time.

Wednesday the Wall Street will be looking for 33 cents in earnings per share on revenue of $414 million. This represents a year-over-year earnings and revenue increase of 3% and 14%, respectively.

Red Hat is coming off a strong March quarter that delivered a beat on both revenue and profits. Profits were up more than 8% year over year, beating consensus estimates by 2 cents. But this is not a one- or two-quarter story. It's about the long term.

Management has promised to deliver revenue growth in the mid-teens range for several more years. And assuming that Linux can continue to grow at that same rate, investors should expect $70 per share at some point in 2016, representing a 35% premium from Friday's close.

Management is quickly differentiating Red Hat's products versus that of both Oracle and Microsoft. Plus, by having landed prominent customers like IBM  (IBM), which has shown a strong commitment to OpenStack, Red Hat is building enough firepower to turn red-hot in the coming years.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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