NetApp, Inc. (NTAP) competes with EMC (EMC) in the enterprise electronic data storage market. EMC is just over three times larger than NetApp in terms of annual revenues. Of the two companies, NetApp has the higher growth rate.
Near term, NetApp faces growth headwinds in the form of pricing pressure and cloud computing, but the software, maintenance and services offerings could offset small declines in the demand for data storage products.
Getting into finance, the company plans to repurchase shares during fiscal 2014, which I estimate could boost EPS by 5%. Also, management plans on increasing the operating margin. Both of these could act as a catalyst to drive the share price of NetApp higher.
From examining the company's financial statements and some of its strategic product offerings, I am bullish on the common equity shares of NetApp. More details are provided in the sections that follow.
Top line growth is coming from the Americas and Asia Pacific regions, but revenues from Europe could increase during the coming fiscal years. There was near term weakness in the Products segment during fiscal 2013 with software, maintenance and services offsetting that weakness. I think of Products as being soft in fiscal 2014, which could pressure the gross margin.
I am attributing the historic gross margin decline to pricing pressures which are adversely impacting GAAP profitability. But profitability could improve as software, maintenance and services become a larger portion of total consolidated revenues. Additionally, management discussed increasing the operating profit margin to the 17% to 19% range; I'm not sure if they are talking about on a GAAP or non-GAAP basis, but I need to see 500 to 1,000 basis point coming out of operating expenses, which could get the company in the 17% to 19% range.
For fiscal 2014, I am predicting GAAP basic EPS of $1.61, which would represent a 15% increase relative to fiscal 2013. I am modeling 5% of the increase in EPS coming from the share repurchase program. Another portion of the increase is attributable to revenue growth, operating margin expansion, and a reduction in the interest expense.
That is the forecast. Historically, NetApp has been building productive capacity as deferred revenues increased. Also, cash flow from operations has shown a steady increase, which could be due to accounting choices. I like what the company is doing with OpenStack, software-defined storage, the Clustered ONTAP, and the EF540. Also, I think the partnership with Amazon's AWS in IAAS could be materially beneficial over the medium term. Consequently, I am bullish on the fundamentals of NetApp.
To be fair and balanced, Products revenue may be soft on pricing pressures, and the company does face competition from larger, better capitalized firms. Also, cloud computing is consolidating storage.
Valuations & Portfolio Management
From examining the multiplier model valuations, I think it is almost safe to think of NetApp as not being overvalued. So, from a valuation and portfolio management perspective, I am bullish on NetApp. I use comparables to assess the relative value of NetApp.
On an absolute basis, the twelve trailing months P/E ratio is high; paying $28 for $1 of earnings is expensive, in my opinion. But on a forward looking basis, if the top line continues to grow and management delivers on margin expansion, NetApp becomes significantly cheaper with more upside potential. This leads me to my next point, the P/S ratio on an absolute basis is not too high; I think 2.3 times sales is on the lower end of the intrinsic value, given the 10-year average revenue growth rate of 21.7%.
Relative to EMC, NetApp is overvalued, but that could be because NetApp has a higher long term growth rate.
Next, relative to the market and the industry, NetApp is expensive. But, relative to the 5-year average valuations, NetApp is cheap. Lastly, on a time-series basis, NetApp is fairly valued. Overall, NetApp is not overvalued.
From a technical perspective, the share price of NetApp is in an intermediate term bear market as part of a primary degree bull market. This is probably a good area to start accumulating shares based on the technicals.
In terms of the return distribution, since March 2009, NetApp has returned 1.8% per month. The distribution is negatively skewed and is not leptokurtic. A linear forecast estimates a 52-week price target of $43.63, which is above the current share price