Morningstar | NetApp Posts Operating Margin Improvements; Weak Guidance; Lowering FVE to $54. See Updated Analyst Note from 13 Feb 2019
No-moat NetApp's fiscal third quarter revenue of $1.56 billion (up 2% year over year) came in below our expectation of $1.6 billion. NetApp's fourth-quarter guidance is essentially flat year over year, giving us pause about NetApp's growth. Although NetApp is executing on its stated intentions to expand gross and operating margins, we believe that the firm is in a critical growth period as customers migrate to all-flash storage and cloud-based networking systems. After lowering our revenue projections due to expected competitive pressures, we have decreased our fair value estimate to $54 per share from $60. With shares down 7% afterhours to $62, we advise investors to wait for a pullback before investing.Product revenue grew by 1.6%, software maintenance by 8.1%, and hardware maintenance and other declined by 2.5%, compared with the previous year. NetApp's strategic product group grew by 2.6%, which we attribute to customers migrating to flash-based storage arrays and more software-based solutions. The all-flash business grew 19% compared with last year, and we see a lot of room for customers to adopt all-flash as only 15% of NetApp's installation base is using all-flash arrays. The company's gross margins increased by 60 basis points to 62.8% from last year. Declining NAND prices should continue to expand gross margins and help NetApp's operating profile. Due in part to a keen focus on operating expenditures, NetApp's operating margin increased sequentially by 100 basis points, to 19.9%.
Management stated that the uncertain macroeconomic environment caused a slowdown in purchasing behavior across its full product spectrum in January. We forecast slight revenue growth alongside prudent operating expenditures in the fourth quarter, but we expect NetApp's future years to be impacted by these near-term headwinds. NetApp paid out $99 million in dividends and while buying back $550 million worth of shares in quarter with $2.4 billion still available for buybacks.
NetApp is the data authority for the hybrid cloud. The company's product, services and solutions portfolio include: cloud data services, which include the NetApp Data Fabric, which manages, secures, and protects the data of its customers from on-premises to public to hybrid cloud; cloud infrastructure, which helps customers build cloud-architected data centers; storage systems and software, which enables customers to modernize their IT architectures with cloud-connected flash to free the resources necessary; and support services, which enable a portfolio of technical services including independent support services, support account managers, residency services, and managed services.
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