NetApp: Cloud Software Driving Growth And Multiple Expansion
Summary
- The Street continues to underappreciate NetApp's software business and ascribe more importance to the hardware business despite accounting for 25% of revenue.
- Newer software offerings such as Astra (Kubernetes and container storage), SPOT compute optimization software, and cloud data services to drive growth.
- We view the new NetApp as a software company more than a hardware company, given software and services revenue drives growth and profits.
- NetApp continues to gain share in the All-Flash-Array market, and as businesses head back to offices, we expect on-prem storage sales to accelerate.
- Estimates are conservative; compelling valuation, solid cash flow, a decent dividend payout, and an impending multiple expansion make NetApp a buy.
NetApp (NASDAQ:NTAP) is a buy since the company has one of the best on-premises storage portfolios and one of the best cloud storage portfolios in the industry. On top of this, NetApp's valuation is compelling (trading at 15.3x C2022 P/E, or 2.5x EV/C2022 Sales), and the company has promised to return 70-75% of its Free Cash Flow to investors through share buybacks and dividends. With revenue from Cloud accelerating, we believe NetApp multiple is poised to expand. Since we first recommended the stock in October 2020, the stock is up 55%, and the investor sentiment is improving on NetApp's stock. We believe NetApp shares should cross the $100 levels by the end of the year if it continues to execute the plan it laid out at its analyst day last year.
NetApp is one of the most unheralded names in over coverage universe despite having one of the industry's best portfolios. NetApp and other storage OEMs such as Pure Storage (PSTG) continue to be neglected under the faulty assumption that the whole storage market is in decline due to the cloud's advent. While HDD/hybrid storage is declining, several storage market segments, such as all-flash arrays, scale-out files, and object storage, are all growing north of 7%. NetApp has some of the best all-flash array, scale-out file, object storage, and cloud data services solutions in the market.
NetApp is one of those companies in our coverage that is helping enterprises move their workloads to the cloud. Without NetApp's help, we believe many enterprises will never move their critical applications to the cloud. Recognizing this, all the three major public cloud vendors Amazon (AMZN), Google (GOOG) (GOOGL), and Microsoft (MSFT) consider NetApp, a strategic partner. Both Google and Microsoft salespeople are allowed to retire their quota for selling NetApp's cloud products and services. NetApp has one of the best data management software in the industry and remains the #1 storage operating system both on-premises and in the cloud.
Cloud Data Services (CDS) should help drive the stock
Many enterprises will not consider moving to the public cloud without improved storage offerings. The public cloud storage offerings do not have many robust storage features that enterprises expect. Some of these features include shared storage capabilities, snapshots, cloning, guaranteed recovery time objectives, deduplication, and cross replication between clouds. Also, public clouds are much more expensive than on-premises storage offerings, yet not reliable. NetApp CDS product portfolio makes public cloud storage offerings better. Hence, the public cloud vendors partner with NetApp to make their storage offerings enterprise-ready. The following chart illustrates the growth of NetApp's cloud data services.
Source: NetApp presentation
NetApp guided CDS revenue in the range of $260-290 million for F4Q21. NetApp projects FY22 CDS revenue in the range of $400-500 million and $1 billion by F2025. The growth of CDS will drive multiple expansion. The following chart illustrates the expectation for CDS in FY22 and beyond.
Source: NetApp analyst day presentation
Estimates are conservative
After analyzing consensus revenue estimates available on Refinitiv, we believe NetApp estimates are conservative. The Street forecasts revenue to grow only 5% in both C2021 and C2022. While we understand that hardware revenue is under duress due to the decline in traditional and hybrid storage arrays, we believe NetApp's estimates may be conservative for the following reasons.
The all-flash array market is growing around 9%, the object storage market is growing at 13%, and the hybrid cloud market is growing at 8%. In C2020, since many data centers were closed to remote work, we believe there is a pent-up demand for on-premises storage devices. We expect storage demand to recover in 2H of 2021, as many businesses reopen their data centers. On top of this, the industry's most significant player Dell (DELL), is undergoing a major product transition, allowing NetApp to pick up some market share. Given this, we believe NetApp estimates may be too conservative, and we expect the company to beat forecasts in C2021 and beyond. The following chart illustrates consensus estimates.
Source: Author based on Refinitiv data
What to do with the stock
We would be buying shares of NetApp today and on all dips. Despite NetApp stock is up 55% since we first recommended it in October 2020, the valuation remains compelling. The stock is trading at 2.5x EV/Sales or 15x C2022 EPS of $4.81. We believe a significant upside exists from the current levels. We believe the stock could rise to at least $90 and more likely around $100 during 2021, driven by solid execution on the business side, stock buybacks, and multiple expansion. The stock sentiment remains Neutral, and we expect this to improve as the current year progresses.
Source: Author based on Refinitiv data
Since we first recommended the shares, the stock sentiment improved significantly, with six analysts moving to Buy from Hold/Sell. We expect this trend to continue over C2021. The following chart illustrates the rating revision since we first recommend the stock.
Source: Refinitiv
As the company beats its guidance and guides in line to above, the stock's sentiment would improve, and we would expect more upgrades to follow. Since the guidance is conservative and the fiscal year-end deal flush, we expect the company to beat estimates when it reports results on June 2nd, 2021. If the stock sells off for any reason and dips below $50, we recommend investors to back up the truck and add to their positions. At $50, the stock is overly cheap and would be trading at a multiple of 1.7x on EV/C2022 sales. However, we do not expect the stock at $50 levels anytime soon.
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Analyst’s Disclosure: I am/we are long NTAP. 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.
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