2023-08-23 01:50:36 ET
Summary
- NetApp is a mature technology company that has been able to survive, stabilize its revenues, and managed to stay relevant even after 30 years from its inception.
- They have demonstrated that even with a lack of growth, they are able to return value to shareholders through increasing profitability, dividends and stock buybacks.
- I am not a buyer at this point as the outlook points to declining growth and the insider sales do not inspire confidence in the company's future.
Investing in technology stocks has been the rage for the better part of two decades. I am always puzzled when certain stocks get really bid up based on just the promise of growth but are burning through copious amounts of capital at the same time. The same stocks then face a reality check wiping out many shareholders in the process.
I am not a chaser. I am continuously in search of technology names where there are opportunities after a carnage or technology names that have matured and are able to return value to shareholders. Accordingly, I have NetApp ( NTAP ) on my watchlist for the following reasons:
- Focus on profitability which makes their valuations attractive
- Returning Value to Shareholders through stock buybacks and dividends
- Their longevity, resilience, and continued relevance in the technology sector
Focus on Profitability
Even while the revenue growth has remained flat, the company has managed to grow its profitability. Over the past 5 years, revenue has grown only 6 - 7% with up and down years. But diluted EPS has seen a big shot in the arm in the last few years.
This focus on profitability has led to their valuations becoming quite cheap. The company trades at 13x earnings, quite low when compared to the Technology sector median of 24x. The stock price is flat in the last five years and has even seen a decline of 20% from the highs it made in early 2022. This means when compared to the growth in earnings, we start observing low PEG ratios. For LTM, we see a PEG ratio of 0.3. I do want to warn the reader that this low PEG ratio is hard to maintain and going forward this is highly likely to go away. But if the company is able to maintain this kind of profitability while growing at moderate rates I would consider it a win.
Returning Value to shareholders
The company has been adept here through stock buybacks and paying a regular dividend. First, let's talk about their buybacks. For FY23 they returned $850M to shareholders and reduced their share count by 4% versus the prior year. Stock dilution is usually a big concern for a technology company with SBC playing a big role in dilution (For FY23 they issued SBC of $312M). But they have been able to more than negate this through their stock buyback plans.
Second, when we bring their dividends into focus there are attractive characteristics that lead me to believe that their dividends are sustainable.
1. Dividends have been stable and growing over the past decade. The current yield is 2.6%
2. Dividend payments are well covered by cashflows with a cash payout ratio of less than 50%. This is also true when you compare the dividends to its net income (<35%)
So what is the combined effect of focusing on profitability and value return to shareholders? Shareholders' share of the pie has been increasing through the years.
Survivability
Even in the face of rapid technological changes the company has managed to adapt and survive which is impressive, to say the least. NetApp's business model is centered around providing data management solutions and services to help organizations store, manage, and protect their data effectively. They offer a range of hardware, software, and cloud-based solutions to address the complex challenges of data storage, organization, and utilization.
The company is 30 years old and how organizations manage data has changed significantly over the last 30 years. But throughout this time NetApp has focused on innovation, acquired companies strategic to its vision, and has managed to stay relevant. As a result, NetApp's business model has evolved from hardware-centric storage solutions to a comprehensive data management provider that offers software, cloud integration, analytics, and services.
Tracking its evolution
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Shift to Data Management Solutions: In its early years, NetApp primarily focused on network-attached storage (NAS) hardware solutions. However, over time, the company shifted its focus from hardware-centric offerings to comprehensive data management solutions that encompass both hardware and software. This shift allowed NetApp to provide end-to-end data management solutions that address diverse customer needs.
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Expansion into Software: NetApp expanded its portfolio beyond hardware to develop a range of software solutions for data management, including backup, recovery, data protection, analytics, and cloud integration. This transition from a hardware vendor to a provider of software-driven solutions allowed NetApp to offer more versatile and comprehensive offerings.
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Cloud Integration: Recognizing the growing importance of cloud computing, NetApp shifted its strategy to include cloud-based solutions and services. The company developed cloud storage solutions and services that enable customers to manage data seamlessly across on-premises and cloud environments.
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Hybrid and Multi-cloud Focus: NetApp adapted its business model to cater to organizations adopting hybrid and multi-cloud strategies. The company's solutions help customers manage their data across various cloud platforms, ensuring data mobility, security, and flexibility in a multi-cloud world.
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Data Analytics and AI: NetApp incorporated data analytics and artificial intelligence capabilities into its offerings. This allows customers to gain insights from their data, optimize storage resources, and make data-driven decisions.
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Subscription and Service Models: NetApp introduced subscription-based pricing models and services, offering customers greater flexibility and scalability. This shift aligned with industry trends and customer preferences for pay-as-you-go models.
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Industry Focus: NetApp expanded its solutions to cater to specific industries, such as healthcare, financial services, and manufacturing. Customizing solutions for industry-specific needs helped the company tap into niche markets.
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Ecosystem Partnerships: NetApp embraced partnerships with other technology providers, including cloud providers and software vendors. These partnerships enhance the interoperability of NetApp's solutions within larger technology ecosystems.
Evolution is fine but how does the company have continued loyalty that has allowed it to stabilize its revenues? Customer Experience Survey conducted annually by the NetApp Customer Experience Office gathers feedback from tens of thousands of customers and partners. Over the years, they have noted the five key reasons why their customers chose NetApp over other storage providers.
Solutions that meet the customers' needs , NetApp's customer-centric approach delivers stable products and mature technology, focusing on addressing customer pain points and business outcomes with a suite of relevant solutions.
Unparalleled product performance , One team using NetApp products stated that they’ve “never lost a single bit in 12 years".
Trustful relationship between the customers and NetApp , with the company approaching Walker's IT B2B Loyalty Quadrant Benchmark of 60%, and truly loyal customers is the cornerstone of NetApp's future business.
History of innovative technology , NetApp was responsible for many industry firsts (Ex: unified storage, deduplication, and FC/NVMe) and are able to maintain this innovation through a close partnership with their customers and listening to their feedback.
A stellar customer experience, NetApp's customer-centric approach, supported by solutions, services, and collaborative support, ensures a streamlined customer experience that spans from initial engagement to cloud transitions, meeting customer needs and priorities while delivering unparalleled consistency.
Why it's on my watchlist and not on my buy list?
Growth has stalled and I am not sure what levers they will be able to pull to change this. I like their profitability but you can only squeeze so much before you run out of options. They have had stable operational cash flows which can be used to further shrink their float which can then end up boosting their stock price. But there is another data point that concerned me.
In the last year, we have only seen net sales by the insiders of the company. While insiders buy mostly for one reason (when they believe the stock could go up), they can sell for multiple reasons. So, this could just be a false signal and may have nothing to do with their outlook. But I want to exercise caution especially since their outlook shows their growth downtrend further. They are releasing their earnings on August 23 and this is what they presented in their last earnings call.
- The consensus EPS Estimate is $1.07 (-10.8% Y/Y) and the consensus Revenue Estimate is $1.41B (-11.3% Y/Y).
- Over the last 3 months, EPS estimates have seen no upward revisions and 15 downward revisions. Revenue estimates have seen 0 upward revisions and 13 downward revisions.
I for one, will be on the sidelines to see if the company is able to surprise the consensus estimates and keep this company on my watchlist for the next few quarters before making an investment.
For further details see:
NetApp: A Technology Stock That Is On My Watchlist