2023-06-12 02:48:34 ET
Summary
- NetApp is rated Neutral /Hold as, in my opinion, it is overvalued.
- Its positives are positive free cash flow, revenue diversity & global penetration, EPS growth, and a modest dividend opportunity near a 3% yield.
- Forward-looking sentiment will be to watch its role in the AI-driven decisions made by IT executives in the next few years, a major trend to track.
Summary
Today I discuss a tech stock called NetApp ( NTAP ), which I am giving a rating of Hold/Neutral .
As someone who worked in the tech sector, and understanding the value of data but also the challenge of storing it securely and reliably, and relying on its quality and availability in order to drive data-driven management decisions, this company catches my attention as a major data player in the tech sector.
Its rating is based on its positives of having healthy cash flow, EPS growth, a modest dividend opportunity, and a diversified revenue base across multiple solutions and global regions, along with value-add to clients such as support services in addition to the products and solutions business.
This is offset by negatives such as being overvalued based on its P/B ratio and not having a current price opportunity for a value buyer.
Company Brief
From their website , NetApp has a portfolio of leading data, application, and storage solutions that help organizations manage applications and data everywhere across hybrid multicloud environments.
With roots in 1992 and based in Silicon Valley, it boasts a client list that includes Dow Jones, FICO ( FICO ), The US Department of Justice, and French banking giant Societe Generale, to name a few.
Rating Methodology
My methodology is straightforward: find a value opportunity in a tech stock with otherwise strong financial fundamentals. For this specific type of company, by ranking the following key factors I can come up with a holistic rating score for the stock:
- Price opportunity: 10 points
- Valuation: 10 points
- Dividend opportunity: 20 points
- Healthy cash flow: 20 points
- EPS Growth: 20 points
- Revenue Diversification across Segments & Regions: 20 points
By adding up each category, I come up with a total score and rating:
- Strong Sell: 0 points
- Sell: 10 to 20 points
- Hold/Neutral: 30 to 80 points
- Buy: 90 points
- Strong Buy: 100 points
The following sections each present evidence to support my rating.
Price Opportunity Not a Value Right Now
It's price at market close Friday June 9th was $69.71.
The price chart above goes from the period of February 2022 until June 9, 2023. It shows two trends overlaid on the price, the 50 day SMA (dark blue line) and the 200 day SMA (dark red line).
This charting strategy is to spot the appearance of a golden cross , a lagging indicator of a bullish price trend, or death cross , a lagging indicator of a bearish price trend.
A death cross (red circle) formed in March 2022, followed by a very long bearish trend, which looks like it could be reversing back to a golden cross formation soon as the 50 day is closely approaching the 200 day SMA again.
I like the stock somewhere in the $60 to $64 range, so now as the price is pushing well past its 200 day SMA I don't see a current price opportunity as a value buyer, until another significant dip occurs. I would wait on the next major dip before snatching this one up, similar to the dip in December 2023.
Hence, this category scores 0 points.
Signs of Overvaluation are Evident
Now, let's talk about valuation. For this part, I look at two metrics, the forward P/E Ratio and the forward P/B ratio, from data provided in Seeking Alpha.
For the P/E, I will refer to the S&P 500's median P/E ratio of 14.93 as of May 2023, according to Investopedia , as the standard I use.
When it comes to NetApp, its forward P/E is 16.35 , around 35% less than its sector median and 11% below its 5 year average. This is slightly above the S&P500 median of 14.93, however.
For the P/B ratio, I will use the Corporate Finance Institute standard:
: a low ratio (less than 1) could indicate that the stock is undervalued (i.e. a bad investment), and a higher ratio (greater than 1) could mean the stock is overvalued.
In the case of NetApp, its forward P/B ratio is a whopping 10.98 , over 173% higher than the sector median , earning a grade of "D" in Seeking Alpha's ranking for this category. This more than offsets the P/E ratio, in my opinion.
Therefore, on the category of valuation I give it 0 points .
A Modest Dividend Opportunity
As a dividend-income oriented analyst, I am looking for dividend paying stocks of course, to provide the regular quarterly income.
From data in Seeking Alpha, I am excited to see that this stock has a current dividend yield of 2.87% , with a payment of $0.50 per share and an upcoming ex-date of July 6th.
It has kept is rate the same since July 2021, so not a lot of recent dividend growth with this stock. But how competitive is its yield among its peer group?
In comparison to its listed peers , Seagate Technology ( STX ), another data storage provider, has a dividend yield of 4.60% , Western Digital ( WDC ) does not pay a dividend at all, and Pure Storage ( PSTG ) also does not offer a dividend.
So, although Seagate has a much better yield, I believe NetApp's dividend is still highly competitive at nearly 3%, along with a steady quarterly payout over the last several years, especially considering that many tech companies I have analyzed do not pay any dividends.
In this case, it scores 20 points in the dividend category.
Healthy cash flow a Positive Sign
When analyzing a tech company stock, one thing I think is important is the company's free cash flow, as one of its key financial fundamentals.
The following is from their recent quarterly presentation:
From the data, they achieved $196MM in free cash flow in the most recent quarter, 12.4% of net revenue. Since Q1 of 2022, this free cash flow has been positive, although fluctuating.
Keep in mind that cash flow can be affected by changes in working capital , so I often see fluctuations in cash flow from quarter to quarter like above, when analyzing these stocks, and it is not unusual to see huge variations between quarters.
My focusing importance on cash flow comes at a time when the financial media is talking about recession potential, and the following sentiment from a May analysis in Forbes supports my perspective:
Companies with strong free cash flows are the ones that are typically able to sustain and emerge from an economic contraction. Some even thrive, as the weaker players in their sector get eliminated. So, for companies looking to ride out unscathed, the strength of their free cash flows becomes important.
Therefore, when it comes to NetApp, for the category of cash flow I give them a score of 20 points.
EPS Growth in the Right Direction
Next, let's take a look at their earnings per share growth over the last several quarters. The following is from their most recent earnings presentation slides:
The positive takeaway is that they posted an 8% YoY gain in their EPS , but also their highest EPS of the last 8 quarters .
A positive guidance was also echoed by their CFO Mike Berry in his recent quarterly earnings remarks after their Q4 fiscal year 2023 earnings release on May 31:
We delivered record setting operating margin and EPS above our guidance range in both Q4 and FY23. We will continue to prudently manage the business to position ourselves for long-term success while driving further operating margin expansion and EPS growth in FY24.
So, in the category of EPS growth I give them a score of 20 points .
Revenue Base Diversified across Segments and Regions
As an analyst, I look for tech brands that are not dependent on one single product or solution, or just one regional market. This may be different than being a "user" of that company's products, because when thinking like an "investor" I want to see the company being able to scale out beyond just one great idea or current media trend.
In the case of NetApp, it is highly diversified across its solutions portfolio and has global penetration beyond the US, not to mention having lasted in business since the early 1990s which by itself is impressive in the tech sector.
Here are some examples of revenue diversity:
As you can see from their recent quarterly net revenue results by segment, revenue is well balanced across product , support , professional and other services.
For instance, product contributes to 52% and support contributes to 42% towards hybrid cloud segment net revenues, which seems balanced.
For some personal insight, as someone who worked in IT support divisions in large enterprise and managed solutions providers, I see value in the fact that this firm can turn the support services into a revenue generation machine, rather than just selling data storage itself. It also is a value-add to clients too, and I think more and more clients recognize the value of premium support when you need it, and are willing to pay for it, which goes beyond just another contact center that processes IT tickets. That is my personal opinion of course.
The firm's CEO George Kurian set the following tone in the recent quarterly earnings remarks, with a focus on the value-add positioning I mentioned:
By providing customers with the ability to leverage data across their entire estate with simplicity, security, and sustainability, we increase our relevance and value. And we continue to introduce new innovations to deliver greater customer value, further strengthening our position.
Further, looking at their industry case studies of successful client implementations, I see global penetration by NetApp in regions outside its US home base, particularly in the EMEA Region. For example, the Zurich (Switzerland) University of Applied Sciences used NetApp to implement a successful hybrid IT model that boosted service quality, performance, and scalability.
In the category of revenue & regional diversification, I give them a score of 20 points.
Risks to my Outlook
The risks to my neutral and lukewarm sentiment about this stock, from an investor and analyst perspective, is that the tech-sector rally continues to have fuel well into 2023 and pulls this stock up with it, making my rating overly cautious.
I think the rally is overheated and will cool down as more investors see the sector being overvalued.
This sentiment was shared even back in a March article for Business Insider , by a Barclay's executive:
"Flight to safety has benefited Tech thanks to lower yields and the sector's quality bias. We caution against chasing this trade however, considering elevated valuations and exigent inflation/rate risks," Venu Krishna, head of US equities strategy at Barclays, wrote to clients in a note published Monday.
Conclusion
In conclusion, I reiterate my rating of Hold/Neutral for this stock, based on the stock's total score of 80% in my rating methodology.
Its positives are having healthy cash flow, nice EPS growth, a modest dividend opportunity, and a diversified revenue base across multiple solutions and global regions with lots of value-add offerings for existing clients.
This is offset by lack of a value buying opportunity in the current price, and overvaluation based on key metrics.
The forecasted risks to my neutral outlook is that the tech stock rally continues to be bullish for longer, however as I mentioned some major bank analysts have already shown sentiment that the sector is overvalued.
In closing, a notable forward-looking point to highlight is how the role of AI is ever growing in the economy, along with tech companies racing to be at the forefront of this trend, as shown in a March 31st article in Forbes .
According to the article, "nearly half of technology executives surveyed in the United States report that 'half or more' of their cloud deployments will be supported by AI-driven applications over the coming year."
A company like NetApp will be one to keep an eye on going forward, particularly their role in companies pivoting towards a new AI reality, and how it is managed effectively.
At the end of the day.. everything is powered by data !
For further details see:
NetApp: A Leader In Data-Driven Innovation But Currently Overvalued