AI Storage And Cloud Services Dependence Will Increase Earnings Risk Over Time

Catalysts

About NetApp

NetApp provides data storage and data management solutions across on premises, public cloud and hybrid cloud environments, including offerings tailored for AI workloads.

What are the underlying business or industry changes driving this perspective?

• Enterprise AI projects rely heavily on high performance flash and GPU centric architectures. If AI projects stall or customers slow deployments after initial pilots, NetApp's recent AI focused wins and on premises AI configurations could translate into lumpier product demand and pressure on revenue growth.
• Public cloud storage services and Keystone storage as a service offerings are growing from a smaller base. If customers rationalize multi cloud usage or consolidate onto hyperscaler native tools, that mix shift could limit recurring cloud and services revenue and weigh on overall net margins.
• Rising DRAM and NAND component costs, combined with customer budgets that are typically set in dollar terms, increase the risk that price increases reduce future unit volumes or delay refresh cycles. This could cap product revenue and constrain gross margin expansion.
• Large agreements such as the Google Distributed Cloud deal and wins with neo and sovereign cloud providers concentrate expectations on a relatively small number of high value relationships. Any slowdown in follow on workloads or delays in new use cases could dampen support revenue and earnings growth visibility.
• The rapid shift of the portfolio toward all flash, AI centric solutions and cloud services requires continued high levels of R&D and go to market investment. If those costs rise faster than incremental sales from AI and cloud projects, operating leverage could soften and limit EPS growth.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on NetApp compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming NetApp's revenue will grow by 5.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 18.4% today to 20.5% in 3 years time.
• The bearish analysts expect earnings to reach $1.7 billion (and earnings per share of $8.65) by about June 2029, up from $1.3 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 17.4x on those 2029 earnings, down from 24.8x today. This future PE is lower than the current PE for the US Tech industry at 44.3x.
• The bearish analysts expect the number of shares outstanding to decline by 1.85% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.75%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Enterprise AI projects are already translating into around 1,100 AI and data preparation wins in FY '26, with 500 in Q4 alone. Management describes these as broad based across segments, which could keep AI driven storage demand firmer than expected and support product revenue and earnings.
• Public Cloud storage services on AWS, Azure and Google Cloud generated FY '26 Public Cloud revenue of US$688 million with 18% year on year growth excluding Spot and around 30% growth in first party and marketplace services. This recurring, high margin business could support total revenue and net margins even if some on premises spending slows.
• All flash revenue reached US$4.2b in FY '26, with Q4 all flash revenue of US$1.2b and continued conversion of the installed base. This shift toward higher value flash and AI centric workloads could help offset component cost pressure and support gross margin and operating margin.
• Keystone storage as a service revenue grew about 65% from FY '25, unbilled remaining performance obligations reached US$807 million and total remaining performance obligations reached US$5.65b. This contracted and recurring revenue base could underpin future cash flow, support revenue visibility and help stabilize earnings.
• FY '26 was described as a record year with revenue of US$6.93b, gross margin of 71.3%, operating margin of 30.2%, EPS of US$8.13 and free cash flow of US$1.87b, alongside a net cash position of US$1.1b and plans to return up to 100% of free cash flow in FY '27. This combination of profitability, balance sheet strength and capital returns could limit downside risk to the share price through support for earnings and shareholder yield.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for NetApp is $121.86, which represents up to two standard deviations below the consensus price target of $171.75. This valuation is based on what can be assumed as the expectations of NetApp's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $200.0, and the most bearish reporting a price target of just $117.0.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $8.1 billion, earnings will come to $1.7 billion, and it would be trading on a PE ratio of 17.4x, assuming you use a discount rate of 8.8%.
• Given the current share price of $161.61, the analyst price target of $121.86 is 32.6% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.