Zhitong
2024.05.15 06:52
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Is it the right time to bottom out the "hottest AI stock"? Analyst: AMD is undervalued

Super Micro Computer is undervalued, with the latest valuation analysis showing that the stock is still very cheap. KM Capital reiterated its "strong buy" rating on SMCI. The third-quarter financial report shows that SMCI's growth momentum is strong, with revenue doubling year-on-year and adjusted earnings per share more than doubling. Revenue growth may continue for a longer period of time

Is the "Hottest AI Stock" Super Micro Computer (SMCI.US) Undervalued?

In February this year, KM Capital issued a research report giving Super Micro Computer a target price of $885 and a "strong buy" rating. Since then, the stock price reached a peak of over $1000 per share, but it proved to be a strong resistance level as the stock price could not sustain above this psychological level for long. Subsequently, the stock price fell back and is currently around $820.

In their previous analysis, KM Capital emphasized many bullish indicators, including strong industry growth, SMCI's excellent capitalization on industry tailwinds, and strategic partnerships with leading semiconductor companies. Despite all these bullish indicators strengthening further in the third quarter of 2024, profit-taking by investors due to uncertainty about the sustainability of further growth in AI-driven sectors led to further selling pressure on the stock even after the latest earnings release.

As an investor who relies solely on fundamentals, analysts tend to overlook non-fundamental reasons for stock price movements. In their latest analysis, analysts described how recent developments positively impacted all the fundamental strengths they initially highlighted. Furthermore, the latest valuation analysis indicates that the stock is still very cheap, leading KM Capital to reiterate a "strong buy" rating on SMCI.

Fundamental Analysis

The third-quarter financial report shows that SMCI's growth momentum is very strong, with revenue doubling year-on-year and adjusted earnings per share more than doubling. The robust growth in earnings per share is attributed to the increase in non-GAAP operating profit margin, expanding from 8.7% to 11.3%.

According to the management discussion section of the latest 10-Q report, revenue strength is driven by the growth in customer demand for GPU servers, high-performance computing (HPC), and rack solutions (more complex systems). Therefore, the growth in average selling prices (ASPs) also positively impacted revenue growth.

In my view, there is a third important dimension to revenue dynamics, which is the breakdown between different regions. In the third quarter, revenue from all geographic regions showed strong year-on-year growth, indicating that the AI revolution is a global phenomenon. This suggests that revenue growth may continue for a longer period. All the world's most powerful economies are determined not to fall behind in the AI race, which could drive demand for SMCI solutions for a considerable timeSMCI's advanced applications require optimized rack solutions, and with the advancement of generative artificial intelligence technology, demand is surging. Recent reports indicate that this demand is expected to remain at a high level for a long time, as several large enterprises have recently announced investments of billions of dollars in data centers utilizing artificial intelligence technology. There have been recent reports that Amazon (AMZN.US) plans to invest $150 billion in data centers over the next 15 years, meaning it will average $10 billion per year on AI infrastructure. Additionally, Microsoft (MSFT.US) and OpenAI's second-largest project is projected to cost a staggering $100 billion. It is estimated that in 2024 alone, Google (GOOGL.US) will invest as much as $9.5 billion in data centers in the United States. Therefore, analysts expect strong demand for SMCI products. Of course, SMCI is not alone in this field, as competitors will certainly try to secure a place in these projects. However, SMCI's growth rate in recent years has been ahead of the industry, allowing the company to effectively absorb a large amount of data center spending from tech giants.

SMCI maintains a deep partnership with Nvidia, integrating the most powerful AI chipsets into its server solutions, including the latest news about using the Nvidia GH200 Grace Hopper superchip, positioning SMCI to be an early entrant in the market. In addition, SMCI has announced the integration of the latest Nvidia GB200 Blackwell superchip into its next-generation AI solutions. Apart from customizing servers based on Nvidia's products, SMCI also closely collaborates with other high-performance computing leaders such as AMD (AMD.US) MI300X and Intel (INTC.US) Gaudi AI accelerator.

Therefore, expectations for SMCI in the next quarter and fiscal year 2024 are strong. Management expects the midpoint of fourth-quarter revenue to be $5.3 billion, indicating a 143% year-over-year growth. The adjusted earnings per share guidance for the fourth quarter is $8.02, a 128% year-over-year increase and a 20% increase from the previous quarter. For the entire fiscal year 2024, management anticipates revenue to reach $14.9 billion, representing a 109% year-over-year growthFor the 2025 fiscal year, the market generally expects revenue to grow by 58%, with adjusted earnings per share increasing by 42%. This means that SMCI is likely to continue its impressive revenue growth and profit expansion trajectory, which is a strong bullish signal. Analysts point out that with large tech companies continuing to invest billions of dollars in artificial intelligence infrastructure, this optimistic sentiment seems reasonable. Specifically, analysts at Morgan Stanley predict that SMCI's revenue compound annual growth rate between 2023 and 2027 will reach 43%, as the company is expected to capture up to 15% market share in the artificial intelligence server field.

As discussed above, there are many strong bullish signs supporting SMCI's stock price. SMCI operates in a very hot market, collaborating with all the major semiconductor companies, especially NVIDIA, which holds an 80% market share in the GPU market. Given that all tech giants have made significant investments in data centers globally, the demand for data centers and high-performance chipsets will remain strong. SMCI adeptly leverages these favorable trends, leading to a significant expansion in EPS.

Valuation Analysis

It's hard to call a stock that has appreciated by 500% in the past year "cheap," but discounted cash flow (DCF) analysis shows that it still has solid upside potential. Analysts point out that based on DCF calculations, the stock is undervalued by 73% after the recent pullback. To calculate the upside potential, analysts built a DCF model with a weighted average cost of capital (WACC) of 8.8%. For the fiscal years 2024 and 2025, relying on Wall Street revenue estimates, forecasting longer periods is always complex, but with scale expansion, over 50% revenue growth is likely unsustainable. Therefore, analysts expect a significant slowdown in revenue after 2025. Given the importance of SMCI in the current long-term artificial intelligence transformation, analysts reaffirm a 5% constant growth rate for the terminal value ("TV") calculation. Some may argue that using a 5% fixed growth rate is too optimistic, as it is several times higher than the long-term average inflation level in the United States. However, NVIDIA CEO Jensen Huang's perspective, who refers to the current artificial intelligence trend as an "iPhone moment": as shown in the chart below, since the first release of the iPhone in 2007, Apple Inc. (AAPL.US) has had a compound annual growth rate of 21%. In this scenario, a 5% constant growth rate seems reasonableThe company has invested a large amount of funds in increasing production to meet demand, so analysts expect the free cash flow (FCF) profit margin to be very low by 2024, at 2%. However, the trend indicates that SMCI has been quite successful historically in converting accounting profits into free cash flow. Therefore, analysts expect this indicator to rapidly expand with strong revenue growth, increasing by 200 basis points annually. According to Seeking Alpha, SMCI has 58.6 million shares outstanding.

JPMorgan Chase announced an expected industry compound annual growth rate of 43% from 2024 to 2027, leading the company to be more optimistic about long-term revenue growth prospects, which is mainly beneficial for the upward adjustment of the stock price. KM Capital has set a new target price of $1385, a significant increase compared to the previous valuation analysis, which had a fair value of $1058. KM Capital emphasizes that their DCF is conservative, with a much lower compound annual growth rate used during the period from 2024 to 2027, at 33%.

To cross-check the results suggested by the DCF, the valuation ratios of SMCI compared to other semiconductor stocks also lead to the same conclusion. Although these companies are not direct competitors of SMCI, AMD and NVIDIA are also considered major beneficiaries of artificial intelligence, and since early 2023, these stocks have shown strong rebounds. As shown in the table below, SMCI is cheaper than NVIDIA and AMD in almost all valuation ratios. Furthermore, it is worth noting that AMD's TTM and FWD revenue growth has not even come close to SMCI. Therefore, the valuation ratio analysis also indicates that SMCI is undervalued.

Risk Factors

SMCI faces intense competition from well-known technology companies such as Dell (DELL.US), Cisco (CSCO.US), and HP Enterprise (HPQ.US) As emphasized in its 2023 fiscal year 10-K report, most of SMCI's competitors have longer operating histories, larger resources, higher brand recognition, and deeper market penetration. Therefore, SMCI should invest heavily to maintain its technological edge and establish a strong partnership with NVIDIA, which dominates the artificial intelligence chip industry. Despite being very successful in differentiating itself from competitors, as indicated by SMCI's recent and future financial performance, investors should be aware of significant competitive risks.

The recent stock price volatility indicates extreme instability, making it susceptible to deep sell-offs even without clear fundamental reasons. This is because after the stock price has risen several times since the beginning of 2023, the market is likely to perceive major beneficiaries of artificial intelligence as being massively overbought. Therefore, even high-quality companies like SMCI may face selling pressure when negative news about artificial intelligence growth or prospects emerges. Analysts suggest that investing in such highly volatile stocks is best done using dollar-cost averaging, which provides an opportunity to average down costs significantly in the event of a sharp decline.

Conclusion

SMCI is showing unstoppable revenue growth momentum, with its profitability expanding at an exceptionally rapid pace. Analysts are very optimistic about the company's further growth potential as tech giants continue to increase investments in data centers and due to its close collaboration with NVIDIA, a leader in the semiconductor field driving the artificial intelligence revolution. Therefore, analysts at KM Capital rate SMCI as a "strong buy," especially at its current levels, with a 73% upside potential