Research in Motion (RIMM): Trading at a discount to its growth rate (even at a whopping 50 p/e) ~ market folly

Saturday, April 19, 2008

Research in Motion (RIMM): Trading at a discount to its growth rate (even at a whopping 50 p/e)

Buy: RIMM, Target Price: $140, Time Frame: 6 months.

Apart from RIMM being a strong tech player and mobile e-mail dominator, it has a few things working for it this time of year. Even amongst the credit crunch and sub-prime mortgage mess this summer, Tech has slowly but surely led people out of the trenches in the early stages and then got some help with aid from the fed. There was a massive influx of cash into tech names (institutional money/hedge funds, etc) as they realized the beaten down names represented good value.

Reasons for RIMM to head higher: Firstly, earnings guidance is a major one. Next year's earnings per share (EPS) estimates have been raised from from $6.15 to $7.68. This obviously signals a general consensus that RIMM and its armada of Blackberries will continue to perform. And, rightly so. Practically every businessman/woman walking around has a Blackberry, it really is amazing. Most of these people receive them through their companies, which is where RIMM derives its major consumer base. Corporations and even small businesses outfit their employees with Blackberries in order to stay in touch with their business and e-mail 24 hours a day. And it is not like they just buy one set of Blackberries and call it good. Nope, they upgrade every time a new Blackberry comes out, constantly fueling sales for the company. In fact, even though the company is supplying the employee with the device, the employees seemingly fall in love with the device and can't live without it, which explains why the device has been nicknamed a Crackberry, due to it's addictive nature. Now, with a loyal consumer base and constant sales due to corporate orders, RIMM seemingly has it made. But what about it's competitors. Exactly, what about them? Where are they? Palm has seemingly fallen off the planet. Their stock has been doing nothing compared to RIMM and continues to decline. Apple iPhone? Sure, it's a great device, but it targets a totally different consumer. There is no way iPhones will invade the corporate workplace for numerous reasons, among them: possible security and compatibility issues, no physical keyboard, etc. Basically, it is a multimedia/communication device, while Blackberries focus mainly on what they do the best, e-mail. With a loyal consumer base, RIMM will always be able to sell future products. Sure, they can sustain market share, but can they continue to grow it? I believe so. As mentioned earlier, corporate sales are a major driver for RIMM. However, you are starting to see small businesses and even people who don't receive a Blackberry for work are purchasing them, diversifying their consumer base a little bit more. Smartphones are penetrating the personal cell phone market by becoming people's personal phones as well, rather than just a business phone. Not to mention, corporations always go through upgrade cycles to upgrade their employees hardware and thus RIMM sees big bulk orders. Now, RIMM trades with a trailing PE ratio of 52 which is obviously high due to its anticipated growth. It has a PEG ratio (price to earnings growth) of 0.94, signaling that the stock is still slightly under-priced and has room to grow. (PEG ratio of 2 indicates that the stock is valued fairly based on growth estimates). So, RIMM still has room to grow based on estimates. Thus, I am recommending a shorter term trade/investment for 6 months, to extract the full value determined in the PEG ratio. And, as pointed out earlier, estimates have already been raised for the next fiscal year. It has a return on equity (ROE) of nearly 40% (and this number has accelerated over the past few quarters), which is definitely a solid number as well. Additionally, they have strong margins of 28% and quarterly revenue growth of 102% and quarterly earnings growth of 123%. These numbers are massive and are not sustainable in the long term. But, this is after all a growth name and you have to play it for its growth while it lasts. The second they start showing signs of growth get out of this name because it will plummet and will need a lower multiple. In the mean time though, RIMM is easily trading at a big discount to its growth rate (thank you big tech sell off earlier this year). With quarterly earnings growth of 123% and a PE of (only) 52, RIMM is trading at a very substantial discount to its growth rate. You are basically getting RIMM here at half price to its growth rate, amazing. This is one of the main reasons to buy this name.

Last, but not least, Blackberry has been pumping out international ready versions of it's smart phones in order to serve the truly international businessman/woman. Now, in addition to this being a positive for American users of the device who go on business trips abroad, it opens the door for further international exposure, possibly growing the brand even more by selling them in additional international markets. After all, Blackberry is already growing this fast with the majority of its business coming from America. Once it taps into more markets, its growth could even accelerate, or at the very least remain consistent.

RIMM is a growth name and thus needs to be evaluated as one. Its PE seems high at first glance, but it is trading at a discount to its growth rate and needs to be bought for this reason. Simply put, RIMM has a quality product with both a sustainable and growing consumer base, and constantly has new Blackberries in the product pipeline. They are growing fast and their PE reflects that. It will be hard to sustain this growth further down the road, but in the nearer term (6 mos- 1 year) I see RIMM continuing to grow and lead the tech sector. That is why I have selected a time frame of 6 months. Keep an eye on earnings if you wish to hold longer term simply because this is a growth name trading at a high multiple because it is experiencing high growth. Once this growth slows or contracts, RIMM will sell off because it will need to trade a lower multiple that reflects its slowing growth. Until then, ride the wave.

Buy: RIMM, Target Price: $140, Time Frame: 6 months.