The Fairly Valued NetApp May Bounce 10-15%

Apr.10.14 | About: NetApp, Inc. (NTAP)

Summary

The electronic data storage industry is the consumer staples of technology.

NetApp should continue to generate a substantial amount of free cash flow.

The share price is expected to bounce.

NetApp, Inc. (NASDAQ:NTAP) is a provider of storage systems and data management solutions that form the foundation for efficient and flexible IT infrastructures. NTAP is one of the smaller players in the electronic storage industry, relative to EMC (EMC) and HP (NYSE:HPQ).

The company's revenues have been flat lately, which is at least part of the reason that the share price is stalling. Overall, while I don't expect NTAP to be a double-digit growth story, I think the firm will grow roughly in line with U.S. GDP growth, as there are secular tailwinds for the storage industry. I'm looking for 3% revenues growth in 2014 and 2015.

Right now, NTAP is about fairly valued, but more nimble traders may be able to ride NTAP higher for a 10-15% return on investment.

Recent Developments

  1. As Dan Warmenhoven rides into the sunset, Tom Georgens, CEO of NetApp, will assume the role of chairman of the board. I would rather there be a chairman who is not an executive at the company.
  2. Robert Salmon has been promoted to president and head of Go-to-Market Operations. He previously served as executive vice president of worldwide Field Operations for NetApp.
  3. Morgan Stanley cut NetApp to Underweight after the company announced it is cutting 600 jobs and is seeing weakness in the IT spending environment.

Analyst's Note

NetApp creates innovative storage and data management solutions that deliver outstanding cost efficiency and accelerate business breakthroughs. The company generates total revenue from sales of its branded products and sales of its products by other companies, such as IBM (NYSE:IBM) and Fujitsu. The majority of total revenue is derived from the Americas.

Qualitatively, digital data storage is a growth industry. Growth in the industry is being driven by the adoption of cloud storage solutions as well as data analytics. Additionally, media, including but not limited to audio and video, is being stored digitally. As the quality improves, the capacity utilization increases. Consequently, data storage could be a secular growth story. But, the rate of sales growth may be roughly in line to slightly above global GDP growth.

FAS8060

VNX8000

Max raw capacity

4,800 TB

6,000 TB

Maximum drives

1,200

1,500

Memory

128 GB

256 GB

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NetApp's FAS8000 Series storage systems combine unified scale-out architecture with data-management capabilities. EMC's VNX8000 unified storage system is the largest VNX system. Comparing the two unified storage systems, EMC's VNX8000 has the higher raw capacity, maximum drives, and memory per array.

In addition to having a technological advantage in unified storage systems, EMC offers a wider array of services and products than NetApp. But NetApp is the purer storage play. Additionally, EMC's annual revenues are four times larger than NetApp and provide EMC with a significant scale advantage.

For the year ending (in millions of dollars except per share data):

2012-04

2013-04

2014-04E

2015-04E

2016-04E

Revenue

6,233

6,332

6,346

6,536

6,732

Gross profit

3,713

3,761

3,871

3,922

4,039

Operating income

747

608

698

719

741

Net income

605

505

616

634

653

Diluted EPS

1.58

1.37

1.75

1.84

1.94

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Fiscal-2014 revenue is anticipated to come in at $6.35 billion with fiscal-2015 revenue increasing 3% on demand for cloud, big data, and analytics solutions. Fiscal-2016 revenue is forecasted to increase by 3%. Diluted EPS is forecasted to increase faster than revenue on the impact of share repurchases.

2012-04

2013-04

2014-04E

2015-04E

2016-04E

Asset turnover

0.65

0.56

0.70

0.73

0.75

Financial leverage

2.22

2.38

2.42

2.44

2.46

Debt-to-capital

0.23

0.32

0.21

0.21

0.21

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The share repurchases have had the impact of improving the asset turnover ratio. They have also increased the financial leverage ratio. The debt-to-capital level appears to be roughly optimal. Lastly, there appears to be ample liquidity, and the solvency position seems solid.

2012-04

2013-04

2014-04E

2015-04E

2016-04E

Cash flow from operations

1,463

1,386

1,450

1,503

1,548

Capex

407

303

275

300

300

FCFF

1,120

1,161

1,218

1,246

1,291

FCFE

1,056

2,070

-90

1,203

1,248

Share repurchases

600

590

1,700

900

900

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Cash flow from operations growth should be driven by revenues growth, as capital expenditure requirements remain moderate. This leaves significant free cash flow to equity, which will likely be deployed in share repurchases, dividends, and acquisitions. The expectation is that almost all of free cash flow to equity is returned to shareholders in the form of share repurchases and dividends.

The expectation is that NTAP grows in line with U.S. GDP growth, 3%. The firm should continue to earn more than its cost of capital. The business is solid, but the question remains, "How does NetApp get to the next level?" I'm thinking well-selected horizontal integration, which could require more capital building and less capital distributions.

General Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in NTAP in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for NTAP's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in NTAP.

Portfolio & Valuation

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While NTAP is in a bear market of intermediate and primary degree, the current level appears to be a strong support level. Consequently, I expect a bounce to at least the $40 per share level.

Expected Monthly Return

Expected quarterly return

Quarterly standard deviation of returns

1.5%

4.5%

17.47%

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Estimated intrinsic value

Forward multiplier model valuations based on base case

Optimistic

$42.67

P/E: 13.50

Base case

$24.90

P/S: 1.31

Pessimistic

$12.45

P/BV: 2.33

P/CFO: 5.70

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So, the market is paying a premium relative to my intrinsic value estimate for shares of NTAP. Honestly, I think the intrinsic value is somewhere between $24.90 per share and $42.67 per share. Looking forward, I think management will be able to increase the intrinsic value of the shares through sound capital allocation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.