NetApp stock (NASDAQ: NTAP) is up around 25% since the beginning of 2020, and at the current price of $76 per share, we believe that NetApp stock has around 15% potential downside.
Why is that? Our belief stems from the fact that NetApp stock is up nearly 1.3x since the end of 2018, and up more than 2x from its low in March 2020. Further, after posting mixed Q3 ’21 results, it’s evident that NetApp did not benefit much from the pandemic. Our dashboard What Factors Drove 28% Change In NetApp Stock Between 2018 And Now? provides the key numbers behind our thinking, and we explain more below.
The stock price rise since 2018-end came despite a 9% drop in revenue from $5.92 billion in FY 2018 to $5.41 billion in FY 2020. However, this was outweighed by a 14% drop in the outstanding share count, that led to revenue per share rising from $22.09 to $23.53 over this period.
NetApp’s P/S (price-to-sales) multiple rose from 2.72x in 2018 to 2.82x by 2020 end, and has since risen to 3.25x, riding the rally in technology stocks, but given NetApp’s mixed Q3 2021 results, there is possible downside risk for NetApp’s multiple.
So what’s the likely trigger and timing to this downside?
The global spread of coronavirus and the resulting lockdowns in early 2020 have seen a surge in online activity, due to a rise in new blogs and websites and has also led to a lot of businesses shifting online. NetApp operates in the cloud data services and data management segment, and thus the pandemic has actually helped NetApp’s revenues. The company posted Q3 2021 revenue of $1.47 billion, up from $1.4 billion for the same period last year. However, higher operating expenses saw operating income drop from $268 million to $258 million, and pre-tax income fell further from $276 million to $247 million over the same period.
With online activity continuing to surge and the need for cloud storage rising by the day, NetApp will continue to see revenue growth in the near to medium term, but if the company is unable to control expenses, we believe the stock will see its P/S multiple decline from the current level of 3.25x to around 2.8x, which combined with a reduction in revenues and margins could result in the stock price shrinking to below $65, a downside of more than 15% from the current price of $76.
While NetApp stock does not seem attractive currently, 2020 has created many pricing discontinuities which can offer further trading opportunities. For example, you’ll be surprised how the stock valuation for Activision Blizzard vs. D.R. Horton shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.