February 16, 2005
Fools, take note: "Great results" do not always translate into a great buying opportunity. Whenever a company's share price gets too far ahead of its fair value, even the smallest sign of a slowdown in growth can send the share price south.
That's what's happened to Network Appliance (Nasdaq: NTAP ) . Despite delivering a great set of third-quarter results yesterday, the company had nearly 12% sheared off its valuation. The company announced it expects revenue to grow sequentially by 6% to 9%, while Wall Street is expecting 9% firm. Management showed some uncertainty about the future -- and Network Appliance investors got punished.
Even so, it's hard to find fault with the Q3 numbers. Net income climbed 50% as demand for Network Appliance's data storage products drove top-line growth higher. Revenue for the quarter soared 39% to $412.7 million, up from $297.3 million in the previous year's quarter. Even better, Network Appliance kept pumping out plenty of free cash flow. It already boasts a hefty $900 million cash balance, and at its current rate of FCF generation, that balance could double to $1.8 billion by the end of 2007.
Network Appliance is benefiting from changes in data storage technology. It sill appears to be grabbing market share from the likes of IBM (NYSE: IBM ) and Hewlett Packard (NYSE: HPQ ) . Leadership problems at HP could turn into even more gains for Network Appliance -- and for its bigger data storage rival EMC (NYSE: EMC ) -- over the long term.
Business fundamentals are great, and the stock is priced 12% lower than it was yesterday morning. But that doesn't mean it's a bargain. At $30.25, Network Appliance sports an enterprise value (EV) of $11.3 billion. Producing about $300 million in annual FCF, Network Appliance has an EV/FCF ratio of 36. If that doesn't convince you that the shares are pricey, consider this: It sells for more than five times 2005 estimated sales and 39 times expected 2005 earnings.
Back in August, I reckoned that the shares, trading at less than $20 then, were well worth owning. Indeed, investors who tucked away some Network Appliance will have plenty to cheer about -- even after yesterday's price drop. Those who didn't should still wait for a better price to come along.
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Fool contributor Ben McClure doesn't own shares of any companies mentioned in this article.