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Stock Analyst Update

NetApp's Turnaround Delivers, Raising Fair Value

The company's second quarter was marked by strong product revenue growth and impressive margin expansion.

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 NetApp (NTAP) reported an impressive performance in its second quarter of fiscal 2018, thanks to strong product revenue growth and impressive margin expansion. The company put a lot of work into improving product gross margin, which was evident this quarter as it reached 51.8% on an adjusted basis, a level we have not seen since second-quarter 2016. NetApp is also weathering an increase in DRAM prices better than some of its peers, thanks to existing supplies and supplier commitments. We also like NetApp’s focus on adding public cloud capabilities, such as its recent announcement of enterprise NFS on Azure cloud. Altogether, NetApp’s turnaround is delivering tangible results and we are increasing our fair value estimate to $46 from $36 for this no-moat company. With shares surging 11% in the aftermarket action, we recommend potential investors wait for a pullback.

Total revenue was $1.42 billion, up 6% year over year and 7% sequentially. Product revenue grew at a impressive clip, up 14% year over year and 12% sequentially as headwinds from legacy systems continued to dissipate. The firm also expects its services segment to turn to growth in the next fiscal year. Adjusted gross margin improved to 64.3% from 62.7% a year ago, due to better sales discipline, one-time items, and currency tailwinds. NetApp also improved its adjusted operating margin to 19.1% from 15.2% due to better leverage.

Third-quarter revenue guidance of $1.425 billion to $1.575 billion is above our expectations and we are raising our full-year revenue forecast. NetApp management expects adjusted gross margin to be in the 62.5% to 63.5% range and adjusted operating margin to be at 20%. Positively, the company expects the consolidated business to deliver low-single-digit revenue growth rate in the long run. 

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Ilya Kundozerov does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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