Time to Buy NetApp as It Continues to Show Growth

NetApp (NTAP, Financial), the provider of cloud storage date infrastructure and data management services, released the results of its first fiscal quarter of 2019 yesterday, beating the top-line and bottom-line estimates.

The company posted revenue of $1.47 billion, up 11.4% year-over-year. Analysts were modeling for revenue of $1.42 billion. The provider of storage infrastructure reported earnings per share of $1.04, beating the analysts’ earnings consensus of 80 cents a share.

For the second fiscal quarter ending September 2018, NetApp is guiding for mid-point revenue of $1.5 billion, almost in line with the Street’s consensus of $1.51 billion. The data infrastructure company is eyeing non-GAAP earnings of 97 cents a share for its second fiscal quarter, exactly in line with the expectations of the Street.

The market was apparently expecting extra growth as NetApp lost around 7% of its market cap in the after-hours trading following the earnings release on Wednesday.

What drove the top line?

Revenue was primarily driven by product sales, which increased 20% year-over-year to reach $875 million, making up around 60% of the total. The growth in product revenue was fueled by NetApp’s all-flash array storage products with growth in excess of 50% in terms of annualized run rate.

Software services revenue has put pressure on the overall growth of the cloud storage player as the segment grew a mere 3% year-over-year to reach $229 million during the first fiscal quarter of 2019. Hardware services revenue also stayed flat.

Although revenue from hardware and software services didn’t witness growth, the management claims that it “should not be a headwind” during 2019.

What are the positives?

Although external storage – a key legacy market of NetApp – is expected to decline during the next few years, the cloud storage infrastructure provider is set to maintain growth due to its exposure to hyper-converged data center infrastructure (HCI) and all-flash array storage. It’s worth mentioning that the cloud infrastructure market is forecasted to grow at 28% per year during 2018 to 2021 amid rising adoption of hybrid cloud storage systems.

According to Dell’Oro Group, the external storage market will decline 3% per year until 2021. Internal server storage isn’t exactly lined up for healthy growth in the near future. Regardless, the shift towards converged storage infrastructure and all-flash array is keeping the growth alive in the overall enterprise storage market. International Data Corp. noticed growth in enterprise external storage market during the first quarter of 2018; the market grew 19.4% during the first quarter of 2018. NetApp surpassed Hewlett-Packard (HPQ, Financial) to claim the second spot in the enterprise storage market during the first quarter of 2018.

All-flash array storage market also holds promise for NetApp. The total flash array market was up 54.7% year-over-year during the first quarter of 2018. According to Dell’Oro Group, the market for all-flash storage arrays is expected to grow at a CAGR of 13% during 2017 to 2021.

NetApp is also among the leaders in object-based storage, according to IDC’s object-based storage vendor assessment of 2018. This specific market is expected to grow at 10.3% during 2017 to 2021. Another focus of NetApp, the hyper-converged infrastructure market, is expected to grow at an astonishing CAGR of 42% between 2016 and 2023.

All in all, NetApp can benefit from the adoption of solid-state storage and hyper-converged infrastructure going forward, which can help offset the decline in legacy storage systems.

Due to NetApp’s exposure to flash-array and HCI, the growth trend is picking up pace. The storage player increased its revenue 12% during the first quarter of 2019 as compared to an increase of merely 2.4% during the first quarter of 2018.

The chart shows that year-over-year growth is rising with each passing quarter, which conforms to NetApp’s leading position in all-flash array and its strong position in converged storage market.

What are the negatives?

Although the outlook is rosy, there are several red flags. For instance, NetApp’s main client for its hyper-converged storage, Cisco (CSCO, Financial), is losing ground in the HCI market. During 2017, Cisco was one of the leaders in the HCI market, according to Gartner. It dropped from leader to a challenger category during 2018 though. This means NetApp revenue can come under pressure if Cisco doesn’t pick up its game in the HCI market.

Moreover, on the all-flash storage front, NetApp is a leader but lags behind Pure Storage (PSTG, Financial). Given that all-flash array and HCI are the key growth segments of NetApp, it’s of utter importance for investors to track the competitive performance of NetApp in these two areas going forward.

Valuation reveals upside

Despite a high price-earnings ratio, NetApp is trading at a discount to its fair value. Assuming 10% per-year growth in earnings during 2020 to 2024 and 1% terminal growth, EVA valuation reveals a price target of $89 for NetApp.

Focus Equity estimates

The valuation shows that NetApp is trading at a 15% discount to its fair value. This valuation is based on an assumption of 10% growth in earnings while analysts’ consensus stands at 15%.

Takeaways

• NetApp’s double-digit growth in the first fiscal quarter of 2019 demonstrates its ability to ride on the growth of HCI and all-flash storage while legacy storage including network attached storage (NAS) declines.
• Although the company is not the only leader in solid-state storage, and its client Cisco is lagging behind competition in converged infrastructure market, there’s room for more than one player in the market.
• Thanks to the post-earnings sell-off, NetApp is a potential bargain in the cloud storage industry.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.