Barclays Capital upgraded rating of the data storage equipment maker NetApp, Inc. (NTAP) to 'overweight' from 'equal weight' and increased its price target to $67 from $56.
Even with shares up over 58 percent year-to-date (up 16 percent for NASDAQ), our very recent checks indicate storage demand is trending better than expected right now and NetApp’s momentum is continuing with a new product cycle. In addition to stronger-than-expected industry demand, we also believe that there is clearly room for more in this momentum name for four reasons, said Ben Reitzes, an analyst at Barclays Capital.
Reitzes believes NetApp should continue to be a long-term winner from the shift toward virtualized, cloud computing environments, with strong growth prospects in its unified networked storage systems.
Reitzes believes the company’s ONTAP operating system offers a scalable and homogenous interface versus the multiple storage environments offered by all of its peers, including International Business Machines Corp. (IBM), Hewlett-Packard Co. (HPQ) and EMC Corp. (EMC).
Reitzes finds it hard to ignore the consolidation argument for NetApp given its growth prospects and the ability for a larger acquirer to cut a significant amount of operating expenses to warrant a hefty price.
Reitzes said he wouldn’t be surprised if NetApp were to raise its long-term operating margin target in March to over 18 percent (each point in margin equates to about 10 cents in EPS) given that its top line is now benefiting from significant scale.
The brokerage increased its 2011 EPS estimate for NetApp to $2.04 on revenue of $5.01 billion from $2.00 on revenue of $4.96 billion, and its 2012 estimate to $2.28 on revenue of $5.81 billion from $2.24 on revenue of $5.68 billion. The brokerage introduced its fiscal 2013 EPS estimate of $2.63 on year-over-year revenue growth of 15 percent to $6.65 billion.
With regard to earnings power, we see upside in EPS towards $3 per share in FY13 (our estimate is $2.63), with free cash flow being much higher than non-GAAP EPS in the $3.50 range. Given prospects for future growth in storage demand and share gains for NetApp, we are raising estimates in FY11 and FY12, said Reitzes.
We view risks to the story including the typical economic worries around government and European exposure, as well as increased competition from EMC, said Reitzes.
While there is potential for revenues to decelerate in Europe and in government, Reitzes believes that NetApp will be able to execute better than peers in both government and Europe given the cost benefits of its technology.
With regard to the EMC threat, Reitzes believes that it is somewhat unlikely to believe that only one of these companies can grow. Both seem ahead of their more server-centric peers and NetApp should still win with those storage buyers who want one scalable system with one interface.
Reitzes said the other risk could be that NetApp may need to do an acquisition to improve its software portfolio. The company recently hired a new M&A chief, which could signal more deals – but Reitzes believes any deals are likely to be well below $3 billion in price, and likely targeting management software and security.
None of these risks seem likely to deter the long-term story. In fact, in the face of these 'risks', Reitzes believes NetApp can still have a very upbeat analyst meeting on March 22, 2011, perhaps introducing a new margin structure given its scale and growth.
Storage is also an attractive growth market long term, since data should continue to climb at a rapid clip. We see data growth continuing to grow and should likely exceed our current expectations. We continue to believe that the foundations for data growth and storage demand remain solid despite subdued expectations for other areas of IT spending, said Reitzes.
IDC reported that total external Terabytes shipped in the storage industry grew over 54 percent-plus year-over-year in third quarter of 2010, with external system revenue growth above 19 percent year-over-year.
Reitzes currently estimates that the external storage market will grow 17 percent year-over-year to $21.0 billion in 2010. Given the view that storage systems revenue will continue to grow due to the expansion of data, Reitzes believes that his estimate for external systems growth of 8 percent year-over-year to $22.7 billion for 2011 is very conservative.
For 2012, Reitzes estimates the external systems market will grow 7 percent year-over-year to $24.3 billion. Reitzes also sees continued strong growth for data capacity throughout the next several years.
NetApp shares closed Monday's regular trading session up 2.64 percent at $55.58 on the NASDAQ stock market, while in the after-hours the stock rose 0.56 percent to $55.89.