The stock’s current valuation is attractive, with a fair price estimate of $1,060 and a 23% upside potential.
Despite growing almost ten times within the last 12 months, Super Micro Computer (NASDAQ:SMCI) stock is less popular than other well-known hardware stocks. I want to share my analysis of SMCI with my readers because I think that this stock definitely deserves attention and that it should be added to the portfolios of growth investors. The company operates in a hot industry, which is expected to compound at a 51% CAGR by 2033, and my fundamental analysis reveals multiple strategic strengths SMCI has, which increases the chances for the company to absorb all the positive industry trends. The stock’s current valuation is very attractive, which makes it a “Strong Buy”.
According to the latest 10-Q form, Super Micro Computer is a provider of accelerated computing platforms that are comprised of application-optimized high-performance and high-efficiency server and storage systems for a variety of markets, including enterprise data centers, cloud computing, artificial intelligence (“AI”), 5G, and edge computing.
That being said, it means that SMCI has been one of the primary beneficiaries of the current secular shift towards digitalization, which the rapid expansion of AI functionality has massively fueled. Therefore, the company demonstrated solid revenue and operating income growth over the last 12 months.
The technological strength of SMCI is apparent to me because it partners with all the largest and most successful semiconductor companies of recent years, including NVIDIA (NVDA), AMD (AMD), Intel (INTC), Micron (MU), and Samsung Electronics (OTCPK:SSNLF). Having contracts with semiconductor leaders provides SMCI with a wide moat. It also is an excellent strategic strength that mitigates concentration risks for SMCI.
Another solid strategic point is that the company’s revenue exposure to the Chinese market is below 2%, which is crucial in the current “Cold War” between the U.S. and China, leading to a massive revenue drop for Micron in recent years for example. The company generates 78% of its revenue from the U.S. and Europe, which means that the lion’s part of the revenue is unlikely to be vulnerable to geopolitical risks, which is important amid the current uncertainty.
With a cash balance increasing each quarter and two times higher than the total debt, I believe the management has no headache from the capital allocation perspective. SMCI does not currently pay dividends, nor can it urgently deleverage the balance sheet. Therefore, the company will highly likely continue allocating spare financial resources heavily to R&D and expanding its facilities, which will contribute to long-term value for shareholders. Also, with a clean balance sheet like SMCI has, it is far easier to raise finance on favorable terms. For example, on February 23, SMCI priced $1.5 billion in senior convertible bonds due in 2029. More than 90% of the proceeds are expected to be used to fund working capital to address the rapid business expansion. Raising $1.5 billion with zero interest rate and conversion rate of 0.7455 shares per $1,000 principal amount of convertible notes looks like a very good deal for SMCI, in my opinion.
The vast potential of AI is a hot topic that has already been discussed across the internet, and it will be useless for readers if I spend their time discussing the prospects of this field. It is already obvious that generative AI is a disruptor and the potential it has. However, SMCI is not only exposed to AI but also to the accelerated computing industry, which is much broader, in my opinion. The hardware acceleration market is expected to grow at a very rapid 51% CAGR by 2033, which is a massive tailwind for SMCI.
Since SMCI possesses several strategic strengths, which include a strong financial position, partnership with all the semiconductor industry leaders, strong exposure to diverse end markets, and robust geographical presence, I think that SMCI has a great chance to benefit from the 51% expected industry growth. Therefore, I am very bullish about SMCI, but we need to look at valuation first, considering the massive rally the stock has demonstrated in recent months.
SMCI had a massive start in 2024 with a 202% year-to-date rally. Even NVIDIA’s rally was not that impressive in 2024, but we must remember the difference in market caps. While NVDA is close to $2 trillion, SMCI is slightly below $50 billion in market cap. Moreover, before the recent pullback, the stock demonstrated a tenfold increase in price over the last 12 months.
To figure out whether such a big rally was fair, I am running the discounted cash flow (“DCF”) model with an 8.8% WACC. As usual, I rely on consensus revenue projections for the two upcoming fiscal years and implement a notable deceleration for the years after FY2025. The TTM levered free cash flow (“FCF”) margin is slightly below zero, but for FY 2024, consensus EPS estimates forecast a massive 84% EPS expansion. Therefore, I incorporate a 2% levered FCF margin for the base year with a further 200 basis points expansion each year. Considering all the tailwinds I have mentioned in the fundamental analysis, I believe that a 5% constant growth rate for terminal value (“TV”) calculation is fair. According to Seeking Alpha, there are around 56 million outstanding SMCI shares.
According to my financial model, the stock’s fair price is around $1,060, meaning that the massive YTD rally was fair, and the recent pullback provides solid buying opportunities with a 23% upside potential.
Buying the stock after it tripled in price within just two months is inherently risky because it is very tempting for investors to start taking profits and dumping it. The rapid pullback after the stock hit a psychological level of $1,000 per share means that the market is not ready to accept the four-digit SMCI price. Therefore, it might take another stellar quarter with a guidance upgrade for the stock to break this psychological level sustainably.
I would also like to emphasize that the stock demonstrates massive movements in both directions. As seen above, the stock showed two big drops between February 18 and 23, with no adverse events. On the contrary, the stock demonstrated a big double-digit drop early last week, even though there was a big target price upgrade from Rosenblatt. Therefore, investors should be ready for potential substantial share price adverse movements even if nothing really bad happens. I believe that such big swings with no fundamental reasons behind them happen due to intraday traders trying to get profits from the high beta of the stock.
Moreover, all growth stocks are all about future expectations. Therefore, adverse changes in guidance or some pessimistic reports about the future of AI from reputable sources might lead to doubts about the sustainability of SMCI’s stellar growth. Since the DCF model vastly depends on revenue growth rates, even a slight change in the constant growth rate might lead to a big drop in fair value estimation. For example, decreasing the constant growth rate by only 100 basis points to 4% diminishes the 23% upside potential in full. On the other hand, this works in both ways. For instance, the stock might deliver another massive rally in case of positive news or guidance upgrades. Therefore, there is also a considerable risk of missing the effect of positive news. I usually resolve dilemmas like this by just dollar cost averaging my position in a highly volatile stock like SMCI.
Despite the notable risks of investors taking profits, I am initiating a position in SMCI and will dollar average it over the long run. The industry is expected to be hot over the next ten years, which makes SMCI a long-term “Strong Buy” for me. Considering all the competitive strengths of the company, I think that the probability of sustainable success and further stock appreciation is high.
