Super Micro Computer: Is There Upside Left?

Seeking Alpha04-29

In this article, I consider the upside potential for SMCI stock.My analysis suggests that with continuing growth, SMCI could reach a fair value of $830-1,119 exiting this year.Conditions are also ...

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Given the stock’s great performance, it is worthwhile to revisit whether SMCI still has the potential to generate excess returns for investors going forward, or if it is too late to jump in now.In this article, I evaluate the upside potential for SMCI both this year and over the next few years. My analysis suggests that there is still plenty of upside this year, and that SMCI could reach a fair value of $830-1,119 exiting 2024. I also think that SMCI’s business has significant tailwinds that could lead to solid growth in 2025 and beyond. Overall, I maintain my strong buy rating for SMCI stock.Previous RatingI last wrote about SMCI in January after the company released preliminary results for fiscal Q2 2024. I had rated SMCI a strong buy at the time, and provided the following rationale for this assessment:At the time of writing, SMCI trades at $340 in premarket. That works out to a little under 16x SMCI’s run rate EPS. Although SMCI’s share price has rocketed over the past year, 16x earnings is not exactly expensive. And once we note that SMCI just grew its top line by 71% and its bottom line by 59% sequentially, 16x earnings seems like a rather low multiple.Overall, to me SMCI looks like a clear buy at these levels. SMCI’s fundamentals are improving rapidly, and the multiples at which it trades are probably too low—a great combination for earning excess returns.I think it's fair to say that the market has arrived at a similar conclusion regarding SMCI’s valuation multiples, and that the run-up in SMCI’s stock price has brought us to valuation multiples that better reflect SMCI’s fast growth. That part of my thesis seems to have played out.However, SMCI’s fundamentals are still improving rapidly. So now it is worth taking a more detailed look at how far SMCI’s fundamentals can be expected to improve this year and beyond. Below is my analysis.SMCI’s Revenue Exiting 2024Let’s start by estimating SMCI’s revenue run rate exiting the year.SMCI's rapid top-line growth since last year is mainly attributable to demand for data center GPUs, which has been at a fever pitch. SMCI has now been supply-constrained for multiple quarters—so much so that during the last earnings call, management disclosed new plans to add “two new production facilities and warehouses… which will be operating in a few months.” SMCI also raised $1.75 billion in capital to fund (i) the capacity expansion and (ii) increased working capital requirements as SMCI scales up. Management expects these moves to increase SMCI’s annual production capacity by 25%, from $20 billion to $25 billion worth of servers and associated systems.Given that SMCI has been supply-constrained due to enormous demand for AI hardware and is making an aggressive push to ramp capacity, it seems fair to conclude that SMCI will probably be able to sell whatever it can make. Hence, I think SMCI has a very good chance of achieving run-rate revenues of around $25 billion exiting the year.Currently, the main potential obstacle to SMCI reaching the $25 billion mark would be if Nvidia Corporation (NVDA) does not provide it with enough GPUs. However, Nvidia has been making very good progress toward expanding its H100/H200 capacity, and with Grace Hopper APUs ramping and next-generation Blackwell GPUs on the horizon, it seems likely to me that Nvidia’s output will grow at a solid pace this year. SMCI seems likely to benefit as Nvidia's supply expands. Readers can see my detailed outlook for Nvidia here.Moreover, SMCI can also get some chip supply from other chipmakers as well. Advanced Micro Devices (AMD) continues to ramp production of its MI300 accelerators, and next-generation Zen 5 CPUs are slated to launch in H2. Intel (INTC) is also scheduled to release its Gaudi 3 accelerators and Sierra Forest CPUs over the next few months. It therefore seems probable that SMCI will be able to support some of its upcoming growth without having to (completely) rely on Nvidia.In light of these considerations, for now, I think an expectation of $25 billion run rate revenues exiting the year is reasonable unless we receive new information to the contrary.SMCI’s Earnings Per Share Exiting 2024To estimate SMCI’s earnings per share exiting the year, we need to estimate the company’s net profit margin. This is a bit trickier due to countervailing factors pulling in different directions.On one hand, for the last few quarters, SMCI’s profit margins have declined as its revenues have grown. Per management, this is a deliberate strategic choice aimed at capturing market share and maximizing total profits. It is true that total profits have grown rapidly, so I am inclined to accept management’s explanation unless we see information to the contrary.It remains to be seen how far management might continue down this path and further reduce profit margins as revenue continues to ramp. In fiscal Q1, revenues were $2.12 billion and (non-GAAP) net profit margin was 9.4%. In fiscal Q2, revenues were $3.67 billion and (non-GAAP) net profit margin was 8.9%. If things continue along this trajectory, then SMCI increasing revenues by about $2.6 billion/quarter to reach the $25 billion run rate could lead to (non-GAAP) net profit margin declining to around 8.0%.On the other hand, though, SMCI should see profit margins improve with scale as its utilization rate increases (it was 65% as of the last earnings report). This has also been management’s expectation about the impact of scale. And so it is possible that SMCI could see profit margins plateau where they currently are, or even increase a bit, as revenue further ramps.We will have to wait and see exactly how things play between these countervailing factors. For now, I think it is better to be conservative: let’s say that SMCI can probably maintain net profit margins of 8%-9% exiting the year.With $25 billion in run-rate revenues, this would give us run-rate net profits of $2.00-2.25 billion. Using a share count of 60.3 million shares (which accounts for the dilution from SMCI’s capital raise in March), we arrive at run-rate earnings per share of $33.2-37.3 exiting the year. If SMCI achieves this run-rate in fiscal Q2 2025 (ending December 2024), then that would represent year-over-year EPS growth of 48%-67%.Given the strong growth, I think a multiple around 25x-30x run-rate earnings would be fairly reasonable. We would then arrive at a price target of $830-1,119 exiting the year. SMCI trades around $750 at the time of writing. From here, my price target represents upside of 11%-49% this year.At the midpoint, the potential return here is a good bit more than the indices tend to average, and I think there is a decent chance SMCI will come in on the higher side. I therefore think that there are still excess returns to be had with SMCI this year (at least given the current dip). But of course, the upside is diminished compared to a few months ago.It is possible that there could be more upside here as well. SMCI could potentially outperform on revenue if it adds even more capacity over the next few months. It could also outperform on margins if higher utilization has a more significant effect than assumed here. If so, my projection could turn out to be a bit conservative and the upside here could be a bit larger. But I tend to be conservative with projections, so I won't model any further outperformance for now.SMCI’s Growth Prospects In 2025 And BeyondGiven the ongoing uncertainty around artificial intelligence and the evolution of demand for AI hardware over the coming years, it is difficult to confidently predict exactly how much upside SMCI could see in 2025 and beyond. However, I do think that there are a few reasons why the company could continue to see very good growth over the next 2-3 years.First, although there's uncertainty about exactly what the growth rates for AI chips and hardware will be over the coming years, I still think that there will be solid growth in this area for the next couple of years (at least). The current expectation from basically all major tech firms is that there are going to be enormous investments toward AI infrastructure over the next several years. Nvidia predicts that trillions of dollars' worth of data center infrastructure will be built and upgraded for accelerated computing. AMD predicts that the market for data center AI accelerators will grow 70% annually to reach $400 billion in 2027. Taiwan Semiconductor (TSM) predicts that the market for AI processors will see 50% annual growth over the next 5 years.Although it is possible that current expectations may be somewhat inflated, I do still expect good growth in this area over the next few years as AI becomes more ubiquitous and improvements in both hardware and software lead to the development of more useful (and economically valuable) AI applications. Given this expectation of strong growth, SMCI could see solid top-line growth over the coming years, even if it can only hang on to its current market share. And if SMCI can keep growing its market share (as has been the case recently), then the upside for SMCI in 2025 and beyond could be even larger.Second, the power consumption of data center GPUs continues to increase in order to support higher compute performance. For example, Nvidia’s next-generation B200 accelerator will consume 1,000 watts of electricity, versus 700 watts for the next-generation B100 and current-generation H100, and 400 watts for the previous-generation A100. As power consumption increases, so does the heat generated, which further enhances the technical and economic value of installing liquid cooling systems in data centers. SMCI already has experience in this area and offers a variety of liquid cooling solutions. Increased demand for liquid cooling in coming years could help SMCI increase its value addition to the data center “economy,” which could give a further boost to the company’s top-line growth.Third, as competition among the chipmakers heats up and they look to accelerate their AI roadmaps, SMCI’s advantage in terms of being first-to-market could become even more valuable. With high-performance chips, timing is everything: a great chip design loses some or most of its value if it arrives too late. And so, for instance, if SMCI can bring to market systems based on AMD’s next-generation MI400 accelerators a quarter before other OEMs can, then that could be a non-trivial contribution toward helping AMD stay competitive. Similar arguments could be made for Nvidia or Intel. As the market for high-performance chips grows and the chipmakers make all out efforts to stay competitive, SMCI's significance as a partner could continue to grow.In light of these considerations, I do think that there are compelling structural reasons why SMCI could do very well over the next few years. Time will tell how things play out, but for now, it seems fair to say that SMCI has significant tailwinds that present a good opportunity for the company to continue to grow at a strong pace in 2025 and beyond.Risks To MonitorOverall, I would say that SMCI seems fairly likely to reach my estimates for 2024, while the outlook for 2025 and beyond is more uncertain. In my view, there are three major risks that could lead to underperformance, which investors should monitor closely:First, there is a risk that SMCI may continue to struggle with receiving enough GPUs from chipmakers. This was already discussed in more detail earlier.Second, SMCI's shrinking margins should be monitored closely. Since SMCI operates on razor-thin margins, an unexpected decline of even a couple of percentage points can significantly impact profitability. It is possible that SMCI’s margins could come under further pressure if demand for AI hardware softens or if price competition against other OEMs intensifies.Third, in 2025 and beyond, SMCI could see its competitive advantage in terms of early time to market come under pressure from competitors. Quite a lot goes into SMCI’s time-to-market advantage (deep partnerships with chipmakers; modular design; in-house production of components and subsystems; etc.), so I wouldn’t expect competitors to catch up overnight. As far as the upcoming generation of GPUs is concerned, SMCI is probably safe. But given the ballooning size of the market and SMCI’s expanding market share, it is possible that competitors will make a concerted effort to catch up to SMCI on the time to market front. We will have to wait and see exactly how things play out, and to what extent SMCI can maintain market share without this advantage (it wouldn’t necessarily be the end of the world if SMCI could only get servers to market at the same time as the competition).TakeawaysOverall, I think that the conditions are favorable for SMCI to continue to grow both this year and beyond. For this year, my price target of $830-1,119 represents good short-term upside potential; and although it is difficult to predict confidently beyond this year, I think that there is a good chance that SMCI could see very good growth in coming years too. Consequently, even though the upside potential for SMCI is diminished compared to a few months ago, I still think that SMCI is a strong buy.Investors should also expect further volatility around earnings (due on Tuesday, April 30). SMCI stock had plummeted some days ago because the company did not pre-release preliminary results this quarter (which may signal that there wasn’t a large beat this time). But SMCI’s revenue this quarter will be determined primarily by GPU allocation from Nvidia, which has tended to be a bit unpredictable quarter to quarter, so I am not sure if investors should take SMCI’s revenue this quarter (if it is lower than expected) as a good signal of where the company is headed. I think the approach I have taken is better for prediction purposes, and it suggests that SMCI is still a compelling investment regardless of exactly where revenue lands this quarter (unless there's a huge negative surprise).Of course, if the market responds poorly to SMCI’s earnings without a significant negative surprise, then investors may be able to buy at an even better entry point.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":3,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2430277850"}