2023-04-11 08:35:47 ET
Summary
- The most bullish consideration is that NetApp is returning more than 100% of its free cash flow to shareholders.
- However, despite being positioned in a rapidly growing industry, NetApp's business appears to be struggling to gain traction.
- NTAP stock is cheap, its capital returns are strong. But I suspect that over time, its multiple will compress as the business continues to report shrinking revenues.
Investment Thesis
NetApp ( NTAP ) provides data management software. The business is well positioned for the growth in data volumes and storage demand. However, despite the industry rapidly growing, NetApp is underperforming its sector.
The one compelling aspect of NetApp is that the business has a very strong balance sheet and is determined to return all of its free cash flow to investors.
But that consideration aside, the business is not living up to expectations and I suspect that going forward its multiple on its stock (P/E or similar) will shrink. I'm staying firmly on the sidelines.
Objective Insights for Investing in NetApp
NetApp is an IT storage provider. NetApp provides software to manage, protect and optimize data cloud resources.
While nobody debates that there's been a step function acceleration in the demand for digital transformation products, what investors have to form a view over is whether NetApp is a company that's well positioned to participate in this rapidly expanding opportunity?
Let me put it another way, there was a jump in cloud spending in pandemic years, but now customers are being forced to cut back on costs as the economy contracts, leading customers to question every IT budget line, as customers inevitably search for fewer and simpler solutions.
In the past two years, public cloud storage has rapidly fragmented and become incredibly competitive, particularly as SMBs are seeing their own business contracts. Naturally, by extension, this drives less consumption for cloud storage products.
Further, on top of all the above considerations, keep in mind that leading public clouds, including Microsoft ( MSFT ) Azure and Amazon ( AMZN ) AWS, also provide similar offerings as NetApp, taking market share away from NetApp. After all, cloud storage infrastructure and data services are already natively available on Azure and AWS.
Consequently, how much pricing power will NetApp be able to pass on to its customers when fully managed cloud storage is already available on these large public and hybrid cloud platforms?
This leads me to question NetApp's fiscal 2024 growth rates.
Will Fiscal 2024 See NetApp Return to Growth?
The graphic above doesn't inspire much confidence. We are in midst of a dramatic secular shift in the need for storage solutions, and yet, NetApp's fiscal 2023 is expected to end fiscal Q4 2023 with negative y/y growth rates.
Even if its outlook for later in fiscal 2024 should improve, as the NetApp comes up against easier comparable quarters, there's no way that anyone can confidently argue that this is a growing business.
And the problem with investing in tech, is that either the business is still rapidly growing or it's dying. Indeed, investing in tech is brutal, with few businesses lasting more than 25 years. And with NetApp already more than 30 years old, it's well past its prime.
What's more, this has impacts on NetApp's ability to hire and retain top talent. But is it all bad news? No, it truly isn't.
Capital Allocation Policy
NetApp finished fiscal Q3 2023 with a net cash position of approximately $700 million. Given that NetApp makes slightly over $300 million of free cash flow per quarter, this allows NetApp to return substantial free cash flows back to investors.
During its earnings call , NetApp's management stated,
From a capital allocation perspective, we remain committed to returning more than 100% of fiscal ’23 free cash flow to investors through dividends and share repurchases.
Case in point, in fiscal Q3 2023, NetApp returned $308 million back to investors. And on an annualized basis, that means times this quarterly return by times 4, amounts to a combined total return of 8.6%, via share repurchases and dividends.
The Bottom Line
At the heart of the matter is that NetApp's fundamental prospects are not aligning with its own narrative. Allow me to provide a final example.
NetApp fiscal Q4 2022, June 2022
At the end of fiscal 2022, NetApp was guiding for 7% y/y growth rates at the midpoint of its guidance. While right now it's expected to end fiscal 2023 with perhaps around 1% topline growth.
Meanwhile, NetApp continues to cut back on expenses and downsize its business. I'm all up for cutting back on costs. But it's important to know which costs to cut back for the business to still grow and thrive. Because cutting back on costs, simply to improve its bottom line is likely to cause more problems than it solves.
In sum, I praise NetApp's efforts. But I prefer to wait to see evidence that NetApp is regaining its footing in the first instance before I chase this name.
For further details see:
NetApp: I'm Not Chasing This Stock