In today’s uncertain investing world, I believe it is extremely important to first and foremost focus on safety and quality. Since my primary investment focus is now on dividends and dividend growth, safety to me is primarily about valuation along with dividend coverage and predictability. Most long-term followers of mine know me as Mr. Valuation, and as a result, they also know that I believe that attractive valuation is one of the best risk mitigator’s at the prudent investor’s disposal.
As it relates to dividends and dividend safety, a strong balance sheet (cash on hand), cash flows and a safe payout ratio engender confidence. Although these factors have always been important to me, in today’s uncertain economic environment (thanks to COVID-19), they have taken on an even more important role than ever. Consequently, I have been searching for companies that can provide me confidence that the current dividend will not be cut and should be expected to grow in the future.
As a result, the current market climate has motivated me to step-up my research efforts with a renewed focus on dividends and dividend safety. Not only am I looking for attractive opportunities as I normally do, I am also looking to discover replacements for holdings that might need to be replaced due to exposure to the virus. This renewed strategy is partially related to how difficult it was to find attractive valuations in the long running bull market we were experiencing prior to the recent crisis.
In short, I am seeing more attractively valued stocks of all kinds currently available that I had not seen in quite a long time. Therefore, I would consider it imprudent to not re-examine my holdings. One of the great things about investing in liquid assets like common stocks is that it is analogous to a horse race but with the advantage of being able to change horses anytime you want. However, I believe this strategy should only be applied when extraordinary circumstances require extraordinary actions. In other words, the prudent principal supporting long-term investing should not be easily disregarded.
NetApp: Dividend Safety – Attractive Valuation – High-Yield
When examining high-quality dividend growth stocks currently available, the enterprise data management and storage solutions provider NetApp (NTAP) stood out. As I alluded to in the title, NetApp is on the Dividend Kings Master Valuation/Total Return Potential List. At the Dividend Kings marketplace service on Seeking Alpha, our co-founder Dividend Sensei classifies dividend growth stocks based on dividend safety and overall quality.
NetApp earns a quality score of 10 out of 11, and a dividend safety score of 5 out of 5. Additionally, NetApp’s dividend free cash flow payout ratio stands out at 43% compared to the technology sector industry safe payout ratio guideline of 60%. On the other hand, the company’s debt to capital ratio of 54% is a little high in comparison to the industry safe debt to capital guideline of 40% (see screenshot below). However, as I will elaborate later, I believe this company possesses a fortress balance sheet that significantly overcomes the debt to capital deficiency.
NetApp: Company Overview – Courtesy Zacks Investment Research:
“Headquartered in Sunnyvale, CA and founded in 1992, NetApp Inc. provides enterprise storage and data management software and hardware products and services. The company’s product line comprises two storage platforms – FAS storage platform and E-Series platform.
FAS Storage Platform is based on the NetApp Data ONTAP operating system, which combines storage efficiency, data management and data protection. The FAS product line includes FAS6200, FAS3200 and FAS2000 series. The E-series platform helps in the deployment of Hadoop Big Data infrastructure. The E-series product line comprises EF540 Flash Array and EF550.
Moreover, the company’s Cloud Volumes ONTAP storage data management service helps in data protection and storage competence. The company has built relationships with over 300 cloud service providers and hyperscaler providers, which includes Amazon Web Services (AWS), Google, IBM SoftLayer and Microsoft Azure. Further, Cloud Volumes ONTAP offers data access, insights and control to aid customers to move traditional database applications or legacy NAS applications to the cloud.
Leveraging these solutions the company addresses both the Storage Area Network (SAN) and Networked Attached Storage (NAS) markets. A networked storage necessarily provides external data repository that can be shared through LAN, thus freeing local storage space. Also, network storage also supports automated backup programs that prevent data loss.
NetApp also offers support, consulting and training services. The company markets and distributes products worldwide through a direct sales force, value-added resellers, system integrators, original equipment manufacturers and distributors.
Rule On geographical basis, NetApp generated 56% of revenues in fiscal 2019 from the Americas (the United States, Canada and Latin America), 30% from Europe, Middle East and Africa (EMEA) and the remaining 14% from Asia Pacific (APAC).
NetApp faces stiff competition from companies like HP Inc., Dell, IBM and Oracle.”
NetApp: Positives and Negatives
NetApp is very focused on expanding its product offerings to cloud-based solutions and opportunities. For example, today it was announced that they acquired CloudJumper, a leader in desktop infrastructure and remote desktop services. On March 9, 2020 they announced the acquisition of Talon Storage, which will strengthen their storage infrastructure to public clouds.
NetApp operates in 3 segments, products 61% of fiscal 2019 revenue, software maintenance 15% of 2019 revenue and hardware maintenance with the remaining 24% of fiscal 2019 revenues.
The company also has strategic partnerships with technology giants Microsoft, Amazon and Google offering software storage and data management tools for their clouds. According to MorningStar “this strategy allows NetApp to sell itself as the glue for an enterprise’s storage and data in a multicloud environment, while the hyperscale providers benefit by gaining additional workloads.”
However, potential negatives could be that certain enterprises that are currently migrating to public clouds may not require NetApp’s software and the possibility exists that the above hybrid cloud providers could end up promoting their own generic offerings in the future.
Fierce competition and the risk that they will not be a substantial storage refresh cycle after the current low flash technology adoption runs its course could hurt the company in the long run. In the meantime, the company appears extremely well-positioned to prosper for at least the intermediate term given the current migration to the cloud.
NetApp’s Fortress Balance Sheet
An examination of NetApp’s balance sheet over the last twelve quarters shows that the company does possess a fortress balance sheet. Total assets per share and cash per share dwarf total debt per share.
In their last quarterly report ending on January 2020, NetApp reported over $3 billion in cash versus less than $2 million in total debt. Even though cash has been dwindling due to acquisitions, NetApp still holds more cash than total debt.
Cash Flow Statement
As you can see, NetApp’s free cash flow per share (purple bar) strongly supports the company’s dividends per share (light blue bar).
NetApp Attractive Valuation Mitigates the Risk
NetApp has gone from being extremely overvalued in September 2018 to being extremely undervalued in April 2020. Note that NetApp has a fiscal year ending in April and the company has announced their upcoming quarter’s ending announcement date to be held post the markets close on May 20, 2020. As indicated on the earnings and price correlated FAST Graph below, adjusted operating earnings are expected to fall from $4.52 in fiscal 2019 to $4.12 for fiscal 2020, a 9% decline.
It should be further noted that the most previous consensus estimate reported by FactSet was for $4.17. Nevertheless, this recent weakness in earnings seems to be the primary catalyst that took NetApp from an overvalued stock to its current undervalued levels. As a result, I believe that the risk is currently priced in.
NetApp: FAST Graph Analyze Out Loud Video
In the following analyze out loud video I will provide a deeper interactive look at the “fundamentals at a glance” of NetApp. In addition to adjusted operating earnings, I will also look at valuation through the lens of cash flows and several other valuation ratios.
Summary and Conclusions
I contend that much of the risk associated with investing in NetApp at the current extremely low valuation is already priced in. Although the company has only been paying a dividend since 2014, it has grown rapidly and the company’s current payout ratio very conservative. Furthermore, I believe the primary reasons that the stock has fallen so much since it peaked in August 2018 relates to current earnings headwinds. The company is expected to report on May 20 and earnings for this year are expected to be down. However, they are expected to recover slightly in 2021 and then begin growing again.
Finally, I believe the company has a significant amount of financial leverage and a seasoned management team capable of keeping the company relevant. I do believe that long-term oriented investors will be well-rewarded through both capital appreciation and dividend income by taking a position at today’s valuation. However, I further believe that continuous monitoring and due diligence is required. Technology can change rapidly, and with it the prospects of even well entrenched enterprises like NetApp.
Disclosure: No Position.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.