NetApp - Fair Valuation And Strong Balance Sheet, Yet Revenue Stagnation Remains A Worry

May.23.14 | About: NetApp, Inc. (NTAP)

Summary

NetApp delivers strong fourth-quarter earnings on soft revenues.

Full-year outlook is conservative and little inspiring.

Fair valuation and rock-solid balance sheet, yet limited appeal given continued stagnation.

NetApp (NASDAQ:NTAP) surprised the market after the provider of storage systems and data management solutions reported a strong set of earnings for its fourth quarter.

The market is relieved, despite the fact that the company issued a soft, yet conservative outlook. Despite the strong balance sheet, I remain on the sidelines amidst a fair valuation and pressure on top line revenues.

Fourth-Quarter Highlights

NetApp reported fourth-quarter revenues of $1.65 billion, down 3.9% on the year before.

Despite the decline in top line revenues, NetApp reported a 13.3% gain in its net earnings, which came in at $197.0 million. Thanks to rather sizable share repurchases, earnings per share were up by 25.5% to $0.59 per share.

Looking Into The Operational Performance

The decline in reported revenues was entirely due to lower product sales, which fell by 8.3% to $1.04 billion. Software entitlements and maintenance revenues were flat at $227.5 million as service revenues rose by 7.7% to nearly $379 million.

Despite the decline in revenues, gross profits were actually up slightly, providing a big boost to gross margins. Gross margins improved by more than 3 percent points to 63.2% of sales.

Despite recording $38.8 million in restructuring charges, the company boosted the bottom line, as the company aggressively cut back its sales and marketing, as well as research & development efforts.

As such, the profit being reported by the firm was really strong given the lower revenues, the inclusion of nearly $39 million in restructuring costs and a much higher effective tax rate compared to last year.

First-Quarter Outlook

For the current first quarter, NetApp anticipates revenues to come in between $1.42 and $1.52 billion.

This should translate into GAAP earnings of $0.32 to $0.37 per share, while non-GAAP earnings are seen twenty-one cents higher. At this point in time, no full-year outlook has been given in the press release.

In the conference call, management anticipates a mid-single digit percentage increase in revenue growth from branded products, offset by declines of upto 40% in OEM revenues. Gross margins are seen between 63% and 64%, resulting in operating margins of about 18%

Given that the current repurchase program will be accelerated and completed within twelve months, earnings per share are expected to rise little less than 10%.

Valuation

NetApp ended its fiscal year with $5.00 billion in cash and equivalents. The company operates with roughly $2.65 billion in total debt, resulting in a rather sizable net cash position of around $2.35 billion.

NetApp generated annual revenues of $6.33 billion for the year, an amount roughly similar to the year before. Net earnings for the year came in at $637.5 million.

At $36 per share, NetApp commences an equity valuation of $11.9 billion, which values operating assets at roughly $9.6 billion. This values operating assets of the storage system provider at 1.5 times annual revenues and roughly 15 times GAAP earnings.

Transformation Continues

Given the company's outlook, branded revenues could increase by some 5% to roughly $6.0 billion this year, while OEM revenues, if they were to fall by 40%, would come in around $350 million. This should result in flattish revenue growth overall.

CEO Georgens is happy with the performance over the past quarter, although revenues fell short compared to consensus estimates, while earnings beat. Still the quarter was "solid", as the company gained market share. The company's clustered Data ONTAP, the flash portfolio and differentiated approach to the cloud lays NetApp's path to the future, according to Georgens.

Implications For Investors

Revenues have been soft, while earnings have been surprisingly strong. The market has forgiven the company after issuing a soft outlook for the current first quarter, although the company noted that the outlook was conservative.

The strong cost focus is impressive, especially for a firm showing high profit margins at the moment while operating with a very strong balance sheet. Often management does not feel the "urgency" to focus relentlessly on costs when firms have rock-solid balance sheets.

The company spent an incredible $2.1 billion to return to its shareholders over the past year through dividends and a 9% reduction in the share count. The company furthermore announced a 10% dividend hike to $0.165 per quarter, for a yield of 1.9%.

I must say that I am in doubt about NetApp. Just like its competitors, shares have retraced meaningfully from a high of $60 at the start of 2011. The company continues to have a strong balance sheet, which it will use to return cash to investors. Even when excluding the cash, operating assets still trade at 15 times earnings, which is fair, although revenues are under significant pressure.

Not being confident in the company's long-term competitive position and the impact of potential technological changes, I remain cautious, as the valuation is not compelling enough if top line results remain under pressure.

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.