Shares of on-site and cloud-based storage hybrid NetApp (NTAP 3.51%) are down over 20% from recent highs after the company reported end-of-year results last week for its 2019 fiscal year (the 12 months ended April 26, 2019). Management cited issues with sales execution as well as foreign currency exchange rates that went against them.
Nevertheless, the enterprise storage company has made a lot of headway over the last few years, and the stock has tripled since the beginning of 2016. Headwinds to progress have mounted, but the reset on expectations might be just what value investors were hoping for.
A mixed year in review
First, the bad news. NetApp CEO George Kurian expressed disappointment in how the company finished out its fiscal year. Business renewals with existing customers under-performed internal expectations in the fourth quarter, and the company's original equipment manufacturing (OEM) segment declined and is not expected to rebound. Though OEM is a small portion of the whole, Kurian said the poor showing will have a negative impact over the next 12 months.
Additionally, data-center deals are taking longer to develop than in the recent past. NetApp is going to funnel more money toward its sales efforts to help with execution, but a slower sales cycle appears to be the new norm. Paired with a stronger U.S. dollar against foreign currencies during the last year, NetApp's final results didn't quite measure up to expectations.
Metric |
12 Months Ending April 26, 2018 |
12 Months Ending April 27, 2019 |
Increase (YOY) |
---|---|---|---|
Revenue |
$5.91 billion |
$6.15 billion |
4% |
Gross profit margin |
63.5% |
65% |
1.5 p.p. |
Adjusted earnings per share |
$3.56 |
$4.52 |
27% |
The good news is that, despite the sluggish top line, NetApp's profitability continues to soar. High profit margin on new product and solutions -- especially for the data center and cloud segments -- is translating into double-digit earnings growth when adjusting for one-time items. Those bottom-line increases are getting put to work in the form of a dividend (which was hiked by 20%, now good for a 3.2% annual yield) and share buybacks (which totaled $500 million in the last year alone, representing 3.3% of the company's total current market cap). That is some serious return of value to shareholders.
What's next for NetApp?
NetApp's top team told investors to expect more sluggish top-line gains, somewhere in the low- to mid-single-digits in the year ahead. Nevertheless, because of strong profit margins, management said it thinks another double-digit rise in earnings is doable -- this time in the low teens before accounting for more share repurchases.
That's a decent outlook. So why the negative reaction by shareholders?
For one, the digital memory industry is still overall in a slump that may not end for at least a couple more quarters. It's also worth noting that NetApp shares could suffer along with other tech manufacturers after trade disagreements between the U.S. and China worsened. However, NetApp pointed out during its last earnings call that it has already altered its supply chain and does not expect tariffs to have an impact on results going forward. Well played, NetApp.
What we're left with is one inexpensive stock. Industry headwinds haven't yet derailed the tech company -- at least according to the outlook -- and shares have been left trading at a humble 13.5 times trailing-12-month price to free cash flow. Shares are valued at 11.0 times price to earnings using one-year forward expected profits. That's inexpensive if the company can deliver another year of double-digit bottom-line expansion.
With NetApp executing a solid strategy of returning cash to shareholders via dividend and share repurchases, a double-digit rise looks feasible. That's why now looks like a good time to give careful consideration to a buy-the-dip purchase.