BofA Stays Bearish On Red Hat After Q2 Print: 6 Reasons Why

Red Hat Inc RHT shares are trending lower in reaction to its fiscal 2019 second-quarter results reported after the close Wednesday that showed 14-percent year-over-year revenue growth and non-GAAP EPS of 85 cents per share against an 82-cents-per share consensus estimate.

The Analyst

Bank of America Merrill Lynch analyst Kash Rangan reiterated an Underperform rating on Red Hat and lowered the price target from $130 to $125.

The Thesis

Red Hat's Q2 billings came in below expectations, while 2019 revenue and cash flow guidance was maintained for the second quarter running as opposed to the historical norm of beat-and-raise quarters, Rangan said in a Thursday note.

The analyst attributed the softness to a deceleration in constant currency subscription revenues that began in the fourth quarter of 2018. 

Cash flow from operations is now increasingly driven by long-term deferred revenues, or longer contracts, rather than fundamental factors, Rangan said. Among its businesses, growth in Red Hat Enterprise Linux and emerging business decelerated from the previous quarter, he said. 

Rangan named six reasons for BofA's bearish stance on the software company: 

• Strong year-to-date stock gains.
• EV/next 12-month free cash flow to total billings growth has been at an average of 1x over the last seven years.
• Muted near- and mid-term margin leverage.
• FCF growth trending below billings growth.
• An increase in long-term deferred as percentage of cash flow from operations from fiscal 2014-2018, showing a rising trend.
• Middleware growth slowing from 20 percent in fiscal 2018 to an estimated 10 percent in 2019, suggesting a slowdown in emerging tech from 100 percent to 68 percent.

The Price Action

Red Hat shares have gained about 19 percent year-to-date.

The stock was down 5.87 percent at $134.76 at the time of publication Thursday.

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