How Sensitive Is NetApp’s Stock To Changes In Its Storage Product Margin?

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NetApp (NASDAQ:NTAP) had a positive year with a solid revenue growth through the year. NetApp’s enhanced focus on its Strategic Product line, which primarily includes Clustered ONTAP, E-Series storage products and SolidFire all-flash storage arrays, led to the revenue growth. As a result, its share in the external storage systems market expanded from 10.8% in 2016 to over 13% in 2017.

NetApp was the only large player in the market to observe an increase in market share. Furthermore, an increasing mix of strategic products, which include certain high-margin flash storage products, helped drive product gross margins higher. NetApp’s non-GAAP product gross margin has improved by almost 3 percentage points through the year. This was the first time since 2014 that product gross margins improved. We forecast margins to improve through another 1 percentage point through 2018 and stabilize going forward.

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The customer response to the company’s strategic products has been impressive through last year, with NetApp reporting more than 20% revenue growth in strategic product sales through the first three quarters of 2017. If this trend continues through 2018, it could help NetApp post higher than anticipated product gross margins for the year. The company’s ability to further improve its product gross margin is important for its valuation. We have created an interactive model that details how a change in its storage product gross margin can impact the company’s value. You can modify assumptions such as projected revenues or gross margin to see how the EPS or estimated valuation changes. The image below shows one of the key steps in identifying NetApp’s stock sensitivity to change in its gross profit. We detail how change in share impacts revenue, which then impacts EPS and subsequently the valuation (assuming the P/E multiple doesn’t change).

We find that a 2 percentage point improvement in NetApp’s storage product gross margin would imply a 2.4% upside to its near-term valuation, which we estimate using projected EPS and a forward P/E multiple. Our sensitivity analysis assumes that the increase in market share would not impact NetApp’s forward P/E multiple, which currently stands at 10.5 based on Trefis estimates (P/E based on Non-GAAP EPS). However, if you disagree with that assumption, you can make changes to all input variables on the interactive dashboards platform to gauge the impact of all changes on our price estimate and EPS.

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