NetApp: No More Short-Term Good News – Downgrade to Hold (NASDAQ:NTAP)

We discount NetApp (NASDAQ: NTAP) to a hold as we believe the positives from memory/storage recovery have priced into the stock, with shares valued near all-time highs. I last updated NTAP to a buy when the stock was trading at $91 per share last December; now the stock is trading at $120 and has hit a high of ~$135. We believe our positive thesis on NAND flash strength and demand recovery have played out, driving NTAP’s performance over the past three quarters. In the last four quarters, NTAP has done beaten EPS estimates three times and revenue estimates four times the same time as memory prices recovered in 1H24, confirming our belief that the positives from the supply-demand balance recovery and price recovery were baked into the stock. We demoted microns (MU) earlier this month, and now comes NTAP.

We recommend investors reduce exposure to memory/storage names at year-end as we believe memory/storage recovery has priced in the peer group. Trend Force actually reported in late June that “NAND Flash prices rebounded strongly as manufacturers kept production under control in the first half, helping them regain profitability.” This statement is later followed by: “However, with production ramping up and retail demand sluggish, wafer spot prices have fallen significantly. hiking.” We are more conservative on NTAP in 2H24 as we see no clear near-term catalyst for final demand recovery. Therefore, we see a limited positive surprise from NTAP.

1Q25 Review and 2Q25 Preview

NTAP’s business is that it “offers a wide range of storage-related products and services for both on-premises and cloud data storage and management,” with major exposure to the Flash market. The company reported its fiscal 2025 first quarter earlier this week, announcing revenue of $1.54 billion, slightly beating the consensus estimate of $1.53, and adjusted EPS of $1.56 versus the consensus estimate of $1.45 . Management now guides revenue of $1.57 billion to $1.72 billion in Q2, compared to a consensus of $1.62 billion. Investors didn’t react well to the results, despite management raising FY2018 revenue and profit guidance to a range of $6.48bn-$6.68bn for FY25 revenue, compared to a consensus of $6.55bn USD. Net income was $1.54 billion for the quarter, up from $1.43 billion in the year-ago quarter, up 8% y/y, and billings rose 11.5% y/y. a, up to $1.45 billion, but down significantly from $1.8 billion in the 424th quarter. .

For the quarter, NTAP reported hybrid cloud revenue of $1.38 billion and public cloud revenue of $159 million, both up Y/Y, but the first quarter down from $1.5 billion in last quarter. The focus is indeed on all-flash ARR, which was up 21% y/y to $3.4 billion, but down from $3.6 billion a quarter earlier, despite the introduction of the “new AFF family of high performance A series. flash arrays” used on GenAI workloads. The company maintains strong margins near all-time highs, with 1Q25 consolidated gross margins reaching 72% and guidance for Q2 consolidated gross margins of 71% to 72%. We emphasize management’s outlook on shares, as we believe it will help determine whether or not the company outperforms expectations.Our previous positive sentiment on NTAP played out so well, in part because of the conservative outlook for the company which expectations are higher, but the likelihood of an end-demand environment that can sustain performance is lower.

The following chart shows 1QFY25 NTAP results and guidance.

Additionally, NTAP derives just over half of its total revenue by geography in the Americas, making it more sustainable in the US end demand environment. We think it will be at least three quarters after the Fed’s potential rate cut when we see a healthier final demand environment materialize.

Valuation and Word on Wall Street

NTAP is relatively inexpensive compared to its peer group. On a P/E basis, the stock trades at 17.5x C2024, compared to a peer group average of 32.2x and a ratio of 15.3x when we last wrote on the stock in December. The EV/Sales ratio is more similar to that of NTAP trading at 3.7x C2024 versus a group average of 7.5x and a previous ratio of 3.0. We don’t think this valuation is a bargain for the stock’s short-term risks. We recommend that investors stay on the sidelines as we don’t see stocks outperforming the S&P 500 in the second half of the year.

The following chart shows NTAP’s rating against the peer group average.

Wall Street shares our more cautious sentiment about NTAP. Of the 21 analysts covering the stock, six have a buy rating, 14 have a hold rating and the remaining are rated a sell; interestingly, this is exactly the same as at the time of our December notification. In terms of a sell price target, the stock is priced at $120 per share, with an average and median price target of $130 for an upside potential of 8%.

The following chart shows the stock’s sell ratings and price targets.

What to do with the stock?

We expect NTAP to have limited near-term upside and therefore recommend investors stay on the sidelines in 2QFY25. We think the stock will be an in-line performer. We believe that what management referred to on the call as the “innovation rate in software applications driving AI” remains intact, TAM’s AI opportunity is growing, and NTAP’s all-flash portfolio is well positioned within it. Our concern is the lack of a near-term catalyst to support the outperformance in 2H24, given the upside of the recovery in which they were priced, recognized by the elevated outlook and share price over the past three quarters. We recommend that investors stay on the sidelines until we see a turnaround in spot prices, which could happen around mid-2025, as NAND flash industry revenue is expected to grow 29% in 2025, reviving investment and cost pressure. We will change the stock back to a buy once we see price data points to support the next step of outperformance.