Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Storm Clouds for Rackspace Hosting, Inc. (RAX)?

Page 1 of 2

In researching stocks for the Fool, I’ve incorporated a Motley Fool Earnings Quality (EQ) Score that taps into a database that ranks individual stocks. The database designates an “A” through “F” weekly ranking, based on price, cash flow, revenue, and relative strength, among other things. Stocks with poor earnings quality tend to underperform, so we look for trends that might predict future outcomes.

Rackspace Hosting, Inc. (NYSE:RAX)Today’s stock, Rackspace Hosting, Inc. (NYSE:RAX), earns a failing “F.” Let’s see how it measures up against some of the competition.

Company Price/Earnings Ratio, TTM Earnings Quality Score
Rackspace(NYSE:RAX) 76.4 F (NASDAQ:AMZN) NA B
Google (NASDAQ:GOOG) 24.9 F

Source: Yahoo! Finance.

San Antonio-based Rackspace is an open-source cloud computing company that manages Web-based IT systems for everything from small businesses to large worldwide enterprises. Founded in 1998, the company has historically treated investors well. The stock set a high of $79.24 on Jan. 24, a 92.24% increase from a low of $41.22 on July 24 of last year. It hasn’t even seemed to matter that Rackspace competes cloud-computing against titans such as Amazon and Google — at least not until recently.

Rackspace’s stock price had increased almost 20-fold until its recent revenue shortfall. On Feb. 12, the company reported quarterly revenue of $352.9 million and GAAP earnings per share of $0.21, against analysts’ consensus estimates of $355.4 million revenue, and $0.21 EPS. That revenue miss sent the stock plummeting more than 17% the next day.

Even with the current price hovering around $57.50, Rackspace’s P/E ratio of 76.6 shows just how much momentum investors can put into a stock despite fundamentals that don’t back up the price. Its revenue and earnings trends, at 25% and 17%, respectively, certainly don’t justify its lofty P/E. But since the revenue miss is what appears to have spooked investors, let’s look at Rackspace’s income-statement metrics.

Metric 12/31/12 12/31/11 12/31/10
Revenue (millions) $352.91 $283.26 $214.73
% change YOY 25% 32% 27%
Operating income (millions) $48.88 $38.24 $21.57
% change YOY 28% 77% 58%
Net income (millions) $29.91 $25.05 $13.54
% change YOY 19% 85% 50%
Earnings per share $0.21 $0.18 $0.10
% change YOY 17% 80% 43%

Source: S&P Capital IQ.

While Rackspace’s income statement exhibits positive growth trends, revenue, operating income, net income, and earnings per share are all slowing down. In addition, while the EBITDA margin for the past 12 months shows slight growth from 28% to 32% over the past two years, the operating cash flow margin over the past 12 months has declined slightly, causing the spread between the two metrics to widen. That means earnings aren’t translating into cash flow.

Metric 12/31/12 12/31/11 12/31/10
Operating cash flow (millions) $120.79 $104.92 $74.27
Free cash flow $20.82 $27.24 $23.63
Days payable outstanding 167 56 42
Payables $175.13 $51.10 $30.60

Source: S&P Capital IQ.

Operating cash flow continues to grow, but free cash flow — operating cash flow minus capital expenditures — is anemic. Also notice that days payable outstanding — a measure of how long it takes to pay monies due — jumped markedly last quarter and year over year. Total outstanding payables of $175.13 million are more than triple the amount in previous quarters.

Payables are higher than operating cash flow, and the $123.25 million increase makes the payables figure bigger than operating cash flow. Without that sizable jump, operating cash flow would have been negative. At least Rackspace’s debt level is low, but total shares outstanding have increased by almost 8 million shares in two years. Frankly, there’s not much reason to hold this stock. Get off of this cloud until it comes down to earth.

Page 1 of 2

Biotech Stock Alert - 20% Guaranteed Return in One Year

Hedge Funds and Insiders Are Piling Into

One of 2015's best hedge funds and two insiders snapped up shares of this medical device stock recently. We believe its transformative and disruptive device will storm the $3+ billion market and help it achieve 500%-1000% gains in 3 years.

Get your FREE REPORT and the details of our 20% return guarantee today.

Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.
Loading Comments...

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 102% in 3 years!! Wondering How?

Download a complete edition of our newsletter for free!