Up 27% Over The Past Year, Will Higher Margins And Cloud Sales Drive NetApp Stock Higher Post Q3 Earnings?

NetApp (NASDAQ:NTAP) a company that provides on-premises data storage systems and public cloud services, is poised to report its Q3 FY’24 results toward the end of February. We expect the company’s revenues for the quarter to come in at about $1.6 billion, slightly ahead of estimates, and about 4% ahead of the last year.  We estimate that earnings will come in at about $1.69 per share, in line with the consensus estimates.

NetApp’s bread-and-butter Hybrid Cloud business has been witnessing some headwinds of late due to weaker information technology spending and cost optimization by large businesses. Over Q2 FY’24, NetApp’s revenue fell by 6% year-over-year to $1.56 billion, down from $1.66 billion in FY’23, with adjusted earnings remaining roughly flat. NetApp’s Hybrid Cloud segment saw revenue drop to $1.41 billion, compared to $1.52 billion in the second quarter of fiscal year 2023. It’s likely that the trend could reverse slightly over Q3’FY’24. We expect the company’s public cloud business to continue gaining traction. Over Q2,  revenues were up about 8% year-over-year. Although the business remains small, with sales at about $154 million, or under 10% of total revenue, the segment remains important to the company given the industry’s push toward cloud-based storage and away from on-premise systems. NetApp should also continue to make progress on the margins front. Over Q2, the company reported record adjusted consolidated gross margins1 of 72%.

NTAP stock has shown strong gains of 30% from levels of $65 in early January 2021 to around $85 now, vs. an increase of about 35% for the S&P 500 over this roughly 3-year period. However, the increase in NTAP stock has been far from consistent. Returns for the stock were 39% in 2021, -35% in 2022, and 47% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that NTAP underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Information Technology sector including MSFT, AAPL, and NVDA, and even for the megacap stars GOOG, TSLA, and AMZN. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could NTAP face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

So, is NetApp stock still worth a look despite the current headwinds? We believe it is. The company has taken steps to cut costs and boost profitability in the face of weakening demand, indicating that it would lay off about 8% of its workforce.  NetApp’s hybrid cloud business could also benefit given the greater control that it offers. NetApp is also strong in the traditional storage space, particularly in areas such as all-flash arrays, and this could help the company as technologies such as artificial intelligence (AI) continue to expand. We also believe that NetApp’s valuation is attractive, with the stock trading at a little over 14x consensus FY’24 earnings. While our price estimate for NTAP stock stands at about $88, roughly in line with the market price, we will be revisiting our price estimate post Q3 results. See our analysis on NetApp Valuation: Is NTAP Stock Expensive Or Cheap? for more details on what’s driving our price estimate for NetApp.

[1] Returns as of 2/16/2024
[2] Cumulative total returns since the end of 2016

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