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Introduction

Sun Microsystems (JAVA) is a $13.67 billion company in the computer hardware industry. Market capitalization competitors in this industry include Ingram Micro, Tech Data Corporation, and Palm. The computer hardware industry is up 8.14% over the past year compared to the S&P 500 which is down 7.90% during the same period. Over the past month, the industry has been down 17.42%, while the S&P 500 has been up 1.31%. After a strong sell-off earlier in the past month, there is a strong potential for computer hardware companies to grow. Evidence comes from an increase in potential demand for future capital restructuring and a weak dollar which improves technology corporation margins. Sun’s growth and valuation illustrate the potential for a strong earnings report next quarter.

Business

This section describes what Sun Microsystems produces. According to Reuters, Sun “provides network computing infrastructure product and service solutions.” The company offers both product (computer systems and storage products) and services (IT, consulting aid, and networking computing environments) to a multitude of different industries including business, engineering, financial services, and healthcare companies. About 47% of all revenues come from computer sales.

More specific to the different types of business segments, systems hold the most prominence. Systems include server stations that are differentiated by size, target environment, and processor architecture. The company also holds data and enterprise centers. Most of these centers are used to provide solutions for a range of business and technical activities. There is also the product, Sun Ray-Ultra Thin Client, which replaces a desktop computer for more efficient networking on a computer.

Other business areas include software and storage. Some of the software includes the Solaris operating system and Java technology. The company also offers middleware software used for identity management and mission-critical clustering, among other areas. Storage is also important to Sun’s business. Differentiated storage is used to help store data for mainframe and open system environments.

Growth

Sun has illustrated solid growth prospects over the past year. According to Reuters, Sun reported a $13.67 billion revenue product last year. This number is over 1.40% higher than it was the previous year. Compared to the industry’s average of 18.56%, some investors may question the large discrepancy between the two averages. However, Sun is one of the top leaders, both market-cap and revenue wise, for the food processing industry. Comparing the revenue growth figure to market-cap competitors and investors can have a more relevant range. Palm didn’t grow but fell 1.18% during the same period year over year. And Palm has lower revenue figures. In terms of EPS growth, Sun saw growth of over 265%. However, market-cap competitor Ingram only reported a 0.15% increase in earnings, while Palm saw a decrease in earnings at 80.49%. Therefore, there is evidence that Sun is growing not only in absolute terms, but in relative terms against its competitors as well.

Another way to evaluate Sun’s growth and cost structures can come through margins. Over the past year, Sun has seen gross, operating, and net income margins of 47.21%, 4.72%, and 5.34%. Comparing these numbers to the industry averages of 31.13%, 13.97%, and 11.16% respectively, some investors may wonder about the differences between the sets of margins. However, this point can be cleared from the company’s five year average reports. Sun’s five year average margins come out to be 42.79%, -5.10%, and -7.04%. Therefore, Sun is improving year-over-year with its margins. If this trend continues, Sun will be able to compete with some of the bigger players in the industry and see higher share price appreciation in return. However, despite the small numbers, Sun still beats out competitor margins such as Ingram (5.45%, 1.27%, 0.79%). So there is still a current relative positive value on this company.

Combining these bits of information together and ROE emerges. ROE is how much net income is produced for every dollar of shareholder equity. According to Reuters, Sun saw an ROE of 11.79% over the past fiscal year. While this number is below the industry average of 34.06%, the number is significantly higher than the five year average of -12.38% and the competitors’ averages of 8.69% (Ingram Micro), 5.28% (Tech Data) and 2.73% (Palm). While investors may be cautious that ROE was negative, investors need to realize that the past couple of years have been tough for Sun, but a recent turnaround will be very beneficial to this company. The same logic also applies for Sun’s 5.18% ROA and 8.12% ROI.

Valuation

With fairly high growth estimates and historical data, there should be evidence of an overvalued company. However, this is not the case. Currently the industry supports a P/E ratio average of 23.27 and a price to sales average of 2.95. Sun sees a forward P/E ratio of 14.97 and a forward price to sales ratio of 1.00. While much can be said about the stock market’s recent bear run, there is plenty of evidence regarding growth that Sun’s share price has been hit too hard. While some investors may claim the same is true for all companies in this industry, a few ideas emerge. Palm’s valuation is high at 40.67, despite weaker growth expectations. The trend is an excellent resource, and given Sun’s previous financial success, the company is too undervalued given its growth prospects. Further evidence comes from Sun’s low PEG ratio of 1.84, which is lower than competitors’ figures such as Palm’s infinite number.

Efficiency

Sun is efficient. Inventory turnover at 11.92 is respectable compared to other industry market-cap rivals. Moreover, asset turnover is also strong at 0.97 compared to competitor figures. Receivables turnover also illustrates a number of 5.45, illustrating cash received every 67 days. In terms of liquidation, Sun’s current ratio is 1.50. Some investors may wonder about such a highly risky figure, but because interest rates are low and Sun is a reputable company, incurring extra cash from loans may not be such a bad idea. The company’s capital expenditures have increased, which means further increases in capacity and economies of scale may be present in the future, because of this financing. Moreover, institutions own 67.92% of all Sun shares. Since the institutional investors have a larger gross amount of capital to lose compared to the retail investor, a high institutional percentage illustrates confidence in the stock's ability.

Technical Analysis

Sun is down 31.37% in the past year. The company’s share price has decreased 4.91% year-to-year. This type of fall is above normal, especially considering some other technology company’s hard-hit. There seems to be some support at the 16 dollar share price range dating back to earlier January 2008. The last time Sun reached this amount the company rebounded and appreciated 71%. There is a possibility a similar situation could occur in the future.

More specific to the current month, Sun illustrates strong technical signals. Parabolic SAR is below and upward trending the current share price. This event usually signals an upturn in share price. The company is a little undervalued compared to the RSI index at 47.39, but it is better to be an advocate of fundamental valuations before technical valuations. Therefore, while now isn't the most ideal time to purchase shares of Sun according to technical analysis, purchasing shares will still produce strong long terms gains.

Conclusion

Sun is a great acquisition for any portfolio. The company's business model and fundamental analysis are both strong. It is very rare to find a company that has both strong valuation and growth, so it is wise to take advantage of these situations as they arise.

-Dennis Biray
February 22nd, 2008