Shares of NetApp (NTAP) are undervalued at current levels.
We believe the sell-off following the Q3 2011 earnings report was quite overdone, and that investors underestimate the high quality of earnings presented in the company's financial statements.
Cash Flow: In particular, NTAP's operational cash-flow (as defined in our dual cash-flow model) has been improving in each period since Q4 2010. NTAP posted its highest dual cash ratio in the latest quarter.
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Evidence of this can be seen the widening spreads between operating and balance sheet cash trends since that time (below). In fact, Q4 marked the crossover point where operating cash surpassed balance sheet cash flows, a trend which has continued through Q3 of 2011.
Accruals and Non-cash Issues: After peaking at a reading of +7.30, NTAP's accrual trend has improved considerably, ending Q3 2011 at +1.48. While we would be thrilled to see the accrual trend return to negative territory (<-5 is preferred), our confidence is bolstered by the company's moderation of non-cash adjustments to build the earnings statement in recent periods.
Revenue Metrics and Capital Productivity: COGS and SGA expenses as a percentage of sales improved in Q3, offset by modest declines in R&D and accounts payable. On average, NTAP spends 13% of revenues on R&D, which we view as a genuine commitment to future sales growth.
Capital productivity (per dollar amount of sales) improved for inventory and PP&E, offset by declines in accounts receivable.
Regarding ARs, we also note a slight increase in days-sales-outstanding (DSO) in the recent period. Not a concern now, but keep an eye on collection cycles in future quarters.
NTAP's earnings yield in the latest period was 3.24% vs. 3.04 for the computer storage industry. (Note: Sales to Asia Pacific and Japan accounted for roughly 10% of NTAP total net revenues in the three and nine months ending 1-28-11.)
Based on the Merriam Report analysis we assign a B+ grade to earnings quality and a "Buy" rating on the shares at current levels.
Our estimated fair-value on the stock is $54.25 (which includes normalized adjustments to balance sheet attributes in our model and an extraordinary estimate for potential impact to earnings as a result of the earthquake in Japan; subject to revision). Using NTAP's closing price of $46.52 on March 15, shares are -14.25% below our FV estimate.
A full report on NTAP can be viewed here.
Disclosure: I am long NTAP.
