NetApp (NTAP) has the kind of problems most companies would love to have. In the last earnings conference call on 2/16/11, CEO Thomas Georgens reported the company missed analyst expectations because of a shortage of materials that go into their new mid-range networked attached storage systems. It seems that the demand was too great for NetApp to keep up with the orders. As Georgens explained:
...we've introduced products before, but this one actually had four times the take-up rate of any of our previous products. So clearly the ramp is pretty steep.
Shares traded down from its 52 week high of $61 at the time of the announcement to a near term low of $44.50 on April 8th. They have since bounced back to $54 in anticipation of the next earnings report on 5/25/11, but, as Georgens cautioned in the previous conference call about the materials shortage:
As we go into the next quarter, our guidance currently reflects the fact that we've not resolved these problems yet. We're working on them. We think we have approaches that resolve them, but it did cause us to take some consideration here with respect to whether or not we get all the parts...
If you're not familiar with NetApp, the name resonates with an elite set of products and services in network attached storage, which is an integral part of virtualization, which is an integral part of cloud computing infrastructure. It's worth repeating that the build-out of the cloud is going to be a secular phenomenon that will last till the end of the decade. CEO Georgens sets the table on this opportunity in a 12/30/10 interview by Brian Deagon in an Investor's Business Daily article Opportunities for Investors in IT Buying Cycle:
The prolonged economic slowdown has caused a slowdown in the IT refresh cycle. In a lot of cases IT infrastructure is getting old and companies are looking at what to do next...The technology infrastructure in place the last three to five years isn't the architecture of the future.
NetApp is the leader in network attached storage and their products are considered the crown jewels in the industry. In a 3/16/11 Credit Suisse analyst report compiled by Deepak Sitaraman, Kulbinder Garcha, Vlad Rom, Alban Gashi, Andrew Muench and Adam Khorshid, indicates that the move to the cloud and virtualization should be a boon for companies like NetApp:
One of the key consequences of virtualization and mobile virtual machines is that it provides an inherent advantage to network attached storage. Because virtual machines move from one server to another, the data needed by that virtual machine needs to be consistently accessible. Since networked storage is attached to multiple servers, it is able to be used in such a capacity.
I don't like to use sweeping generalizations or blanket statements, but these cloud computing infrastructure pure plays like a NetApp, Acme Packet (APKT) and VMware (VMW) have overwhelming stories and have been stellar performers ever since the market's run began in early March of 2009. The 4/8/11 ValueLine report by Theresa Brophy gives you an indication just how fast NetApp is growing as compared to last generation storage systems:
NetApp believes it can grow at two to three times the market and also expand its geographic presence.
CEO Tomas Georgens in the last conference call expounds on this growth story:
...we're still 15% or so market share. And so I still think there's plenty of opportunity. So in a $15 billion market...growing at 7% or 8% per year, that's a big opportunity. We're number one or number two in market share...".
Earlier in the conference call he enunciated:
...the gap between our growth rate and that of the storage business of our nearest of the four largest competitors is nearly 30%. The greatest separation we have seen since we have started doing this analysis.
One thing that caught my eye in not only the conference call transcript, but also in another Investor's Business Daily article by Brian Deagon titled NetApp Sinks as Q3 Sales, Q4 Profit Outlook Miss published on 2/16/11, was the exposure, or lack there of, to government entities. Deagon reports:
Analysts have been worried about NetApp's sales to the public sector in light of massive budget issues facing governments. NetApp said public sector sales rose only 8% in Q3, vs. 59% in fiscal Q2.
And the other big mover of the entry-level products is actually Public Sector. And while the Public Sector business shipments don't look that impressive, that business is actually quite healthy for us.
Cisco Systems (CSCO) recently reported that a reduction in government purchases of their products would really hurt business going forward, and the stock paid the price as investors lowered the boom. As mentioned earlier, NetApp was also punished after its conference call, but has since recuperated some of its losses and has a much brighter future in regards to share price appreciation than the much larger Cisco.
By no means am I throwing Cisco under the bus, but I believe that their days of leading the tech sector is a decade behind them because of the law of large numbers, much like EMC (EMC) and Microsoft (MSFT). This isn't the 90s anymore. In fact, EMC is NetApp's largest rival and as CEO Geogens said in the conference call:
...the real key component there is that NetApp has become the innovation yardstick by which EMC is measured, and I think at least that part we felt good about.
I am not suggesting that NetApp will have the same success in the teens that EMC had in the 90s, but I believe they will be amongst the tech leaders when all is said and done.
According to Yahoo Finance, 37 analysts cover Net App with a breakdown of: one is an underperform, twenty say to hold the stock, and the remaining sixteen say it's a buy or strong buy. I contend that's an endorsement, and if the hold ratings get upgraded, the stock could experience more momentum to the upside.
Consensus analyst earnings estimates give it $2.05/share for 2011 and $2.25/share for 2012. In distilling the numbers, that gives us a P/E ratio of 26 for this year and a P/E ratio of 23 going forward at its current price of $53. That's very reasonable when you take into consideration the earnings growth of 35% for this year. However, next year earnings are only slated to grow around 10% although the 5 year CAGR (compound annual growth rate) is expected to be 20%. I believe the easy money has been made in NetApp, at least in the near term when you consider the advent of supply shortages and the slowdown in government spending.
If you've been following my posts, you can ascertain that there is a dichotomy in my financial leanings. As stated earlier in this article, I think we're in the early innings of the buildout of the cloud and that the next ten years will provide investors with ample opportunities to increase their assets, just like the last two years if you were early in on some of the high fliers in the Internet 2.0 infrastructure plays. That said, I think the market has had an incredible run and is due for a breather because of headwinds like Middle East uprisings, the debt crisis in Europe and the United States, and, a nuclear melt-down in Japan. If I am right with my assessment, there will be better opportunities to buy quality companies like NetApp. If I am wrong, I'll be a day late and a dollar short.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am short the market with inverse ETFs.