ARM Q4 Preview: Cure To AI Energy Shortage?

seekingalpha04-27

Arm is positioned well in the custom AI chip market, with big tech companies like Amazon, Microsoft, and Google using their designs.Arm's energy-efficient chips are crucial in addressing the ...

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At the heart of this is their position, particularly with their highly efficient AI chips designed for energy-conscious applications. I believe the company's strategic alignment with the growing global demand for energy-efficient solutions positions it well, especially given new concerns that AI data centers may cause stress on US power grids. Arm's chips are crucial in addressing the significant energy demands of advanced AI operations, offering superior efficiency compared to open-source alternatives like RISC-V. Heading into earnings, I'm optimistic that key chip architecture features such as energy efficiency will make Arm a key part of the future of chips. But I have concerns about their fairly high valuation multiples, even in an industry known for stretched P/E ratio. With this, and despite high market expectations reflected in its current valuation, Arm's role in enabling energy-efficient AI and computing technologies could justify a more optimistic investment stance if upcoming earnings confirm strong financial performance and growth prospects. I am starting coverage at a 'hold' but am open to upgrading to a 'buy' pending the next quarter's results, which will be pivotal in assessing the company's ability to meet or exceed market expectations. Q4 2024 Expectations For the fourth quarter of the company's FY 2024, Arm has set ambitious financial targets with an impressive guidance increase of $95 million from the previous quarter: Thank you, Rene. I'm going to briefly touch on guidance for the fourth quarter and full year. Starting with revenues. For fiscal Q4, we are guiding to a range of $850 million to $900 million with a mid-point of $875 million. This represents a raise of over $95 million compared to our prior implied guidance for the fourth quarter. When combined with our strong Q3 performance, the full year revenue guidance rises to $3.155 billion to $3.205 billion, an increase of $160 million at the midpoint versus prior. -Excerpt From The Q3 Call. Management strikes me as bold by raising guidance by 10%. I like this. The consensus among Wall Street analysts points to expectations centering around an earnings per share (EPS) of $0.30, compared to a range of $0.29 to $0.32 as estimated by 18 analysts for when the technology company reports (slated for after the bell on May 8th). Revenue projections for the quarter are centered around $878.41 million, with analyst estimates ranging from $849.50 million to $925.00 million, according to 19 analysts' forecasts. For myself, I'll be watching to see how management addresses recent Big Tech and energy executive concerns that data center power may become a binding constraint for the industry. Energy Is The Key To Their Chips While not immediately evident, the tech industry has a problem: new data centers are going to be massive electricity consumers. The drive for energy-efficient solutions in the tech industry is increasingly critical. I recently wrote about this with a utility construction company, Primoris (PRIM). Their business is booming, partially (I believe) on strong construction demand for infrastructure to support all these new AI-driven data centers, which are expected to see a substantial increase in energy consumption. The U.S. alone could witness a rise from 126 terawatt hours to an alArming 390 terawatt hours by 2030. With this, I believe this really underscores the vital role of efficient chip architecture like what Arm offers, which are engineered to significantly cut energy usage, thereby mitigating broader environmental impacts. Microsoft's (MSFT) approach complements this story by integrating nuclear energy solutions to sustain its expansive AI operations. While I think their strategy is not only innovative and long run economically advantageous, as nuclear power can be up to 70% less expensive than traditional coal power, this is a massive upfront investment. On a per-unit basis, it is much cheaper for companies to buy chips that are based on the Arm energy-efficient infrastructure than it is to put in mini-nuclear reactors in a data center. Microsoft can do this due to their scale, but most companies cannot do this. Arm's chips, known for their low power consumption and high efficiency, are at the forefront of addressing these challenges. They offer advanced power management features, including dynamic voltage and frequency scaling, which optimize power use in real-time, enhancing the overall efficiency of devices. I believe this capability is crucial in an era where energy conservation is paramount, and it positions Arm as a leader in the development of sustainable tech solutions. Why I Am A Hold To be clear, I'm pretty bullish on the long run, business Arm is building. However, their valuation feels like something the company needs to grow into at this time. The forward Price to Earnings (P/E) ratio for Arm is projected to land at 65.51 for FY 2025, which is expected to decrease to 41.72 by 2027. This downward trend suggests anticipated growth in earnings, or possibly a recalibration of market expectations. However, the current P/E ratio for FY 2024 stands at 83.07, reflecting the high expectations investors have for the company. For reference, the current forward P/E for the industry is 23.46. I definitely think the company is better positioned than the median stock in the space, but this doesn't mean I think it should trade at such a premium. Usually, I attempt to value a company when I am analyzing it. Since I'm a hold, however, I want to see how the company performs with earnings. Risks Arm is one of the clear leaders of Chip design and licensing. Their model of design and licensing is closed sourced, however, with the firm sporting over 9,000 patents at last count. With this, the biggest risk, I believe, is the adoption of RISC-V technology by companies such Meta (META). For much of the chip design industry, there is a broader trend towards open-source chip architectures. With this, however, and despite its benefits, such as customization and lack of licensing fees, RISC-V has inherent challenges due to its higher energy consumption architecture compared to more established technologies like Arm chips. During the earnings call, Zuckerberg did not specifically compare the energy consumption of RISC-V to Arm, but he emphasized the significant energy demands associated with Meta's advanced AI models and infrastructure, which are crucial for their ongoing AI initiatives. As we're scaling CapEx and energy expenses for AI, we'll continue focusing on operating the rest of our company efficiently, but realistically, even with shifting many of our existing resources to focus on AI, we'll still grow our investment envelope meaningfully before we make much revenue from some of these new products. -Q1 Meta Call Meta's strategic use of RISC-V is integral to their AI development strategy, particularly in powering their AI research and product development. The company's substantial investments in AI-including the deployment of their new AI model, Llama 3-highlight their commitment to leading in AI technology. Zuckerberg's commentary on the scalability of AI technology within Meta's infrastructure reveals a clear recognition of the energy-intensive nature of these advancements. As Meta continues to develop and implement AI at scale, the energy efficiency of the underlying chip architectures, like RISC-V, will remain a critical factor in their long-term sustainability and operational efficiency. As I mentioned, it still lags behind Arm in terms of energy efficiency. A big reason for this is Arm's mature ecosystem and continuous enhancements in power management techniques give it a competitive edge, ensuring it remains a preferred choice for applications where energy efficiency is a priority. I believe AI will be a core area where energy efficiency is a priority. Bottom Line Heading into the Q4 report, I believe Arm chips are central to addressing the energy challenges in AI and computing, offering significant energy efficiency. I remain concerned, however, with Arm's current forward P/E multiple valuation that I believe reflects a really high level of optimism that demands substantial growth in earnings to justify. Despite my bullish view on Arm's products and their importance in an energy-conscious world, I believe this high valuation calls for a cautious approach, leading me to initiate coverage at a 'hold' status.  I think the upcoming quarter is pivotal: a strong financial performance exceeding market expectations could justify a reassessment and potentially shift my recommendation to a 'buy.'","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":0,"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/2430781847"}