NVIDIA Corp (NASDAQ: NVDA) has undoubtedly stolen the thunder as the stock of 2023.
In a period of uncertainty where REITs are plagued by high interest rates, the world looking to the Fed in hopes of an easing, and it’s hard to imagine that there are still companies going up in multi-bagger strides.
Just like a few years back, when the world was fixated on Apple Inc. (NASDAQ: AAPL) becoming the world’s most valuable company, not many people realized how it also buoyed Taiwan Semiconductor Manufacturing Company (NYSE: TSM).
This little known stock rode the tailwind of NVIDIA and is up 217% YTD:
What does SMCI do?
I have never known about Super Micro Computer Inc (NASDAQ: SMCI) until their recent share price rally. So the first question that I will ask and look for, would be the company’s business.
Supermicro (SMCI) is headquartered in San Jose, California, and has manufacturing operations in Silicon Valley, the Netherlands, and Taiwan.
It is one of the largest producers of high-performance and high-efficiency servers, and its products are used by a wide range of customers, including data centers, cloud computing providers, and artificial intelligence companies.
What are servers, you might ask?
Well, a server is a computer program or device, that provides functionality for other programs or devices, called clients. Servers are used to host and deliver services, such as web pages, email, and databases.
And one of the basic blocks to build a server is in fact, computer chips. The AI chips that have propelled NVIDIA to dizzying heights need to be built into servers before ChatGPT, web pages can run or get stored.
SMCI produces various kinds of servers. It has a longstanding partnership with NVIDIA Corp., Intel Corporation (NASDAQ: INTC) and Advanced Micro Devices, Inc. (NASDAQ: AMD).
SMCI’s Revenue & Margin Trends
Judging from the revenue growth trend of SMCI, we can relate back to its YTD performances.
Over the last 10 years, I would say that revenue growth has been choppy – some good growth in the early part, and some slowdown as well. But for FY 2022 and YTD 2023, we see revenue growing in the 30%-40% region.
Gross margins and net margins are decent, but honestly, nothing worth shouting out loud. The recent growth in revenue has helped buoy its gross margins and net margins.
SMCI’s Cash flow & balance sheet
There are not many solid trends when looking at SMCI’s cash flow.
SMCI’s free cash flow over the last 10 years is largely affected by its change in inventory reconciliation. Particularly for Q4’23, cash flow used in operations was USD 9 million vs generated USD 198 million in Q3,23, due to higher accounts receivable, offset by lower inventory and higher accounts payable from backend loaded shipments due to supply constraints.
Debt-wise, even though there seems to be a surge for FY 2022, SMCI’s debt-to-equity ratio looks well-managed. In FY 2023, the total debt repaid amount was USD 1.39 billion, which parred down the debt-to-equity ratio down to 15.69%.
With the assurance that the company is not overutilizing its debt, the impressive improvement in its returns on equity can be attributed to better selling margins, not via an over-leveraged balance sheet.
Risks of SMCI’s business model
Predictability and the momentum of growth are key and inherent when a company is showing good growth.
Even though the AI tailwind that SMCI is riding on seems inevitable, it is not the only company in the server space. Its margins do not suggest it is a company with a strong economic moat.
SMCI’s business model of selling and providing servers is mainly one-off. Should demand or server take an unlikely dip, SMCI would be unable to adjust spending in time to compensate for any sales shortfall.
The semiconductor sphere is also notoriously cyclical – any downturns hurt the entire value chain.
SMCI Prospects: Is it worthy to be in your portfolio?
The year 2023 brought a prospect and a tailwind that no one foresaw 1 year ago.
In fact, one year ago, everyone was painting a bleak prospect for the semiconductor industry:
According to World Semiconductor Trade Statistics, the world semiconductor market will shrink in 2023 as server investments slow.
We saw cautious revenue and earnings guidance from Intel, TSMC, and Samsung. But not all firms saw a tough 2023.
SMCI saw its most impressive growth during that period, as revenue surged to a historical high.
According to Semiconductor Equipment and Materials International (SEMI), equipment spending for most regions is expected to return to growth in 2024. If the forecasts hold ground, SMCI and another semiconductor cohort might be beneficiaries of next year’s growth spurt.
SMCI’s Tough Competition
From the margins of SMCI, it can be deduced that the server market does not hold much competitive advantage. The market share analysis further confirms the thesis.
SMCI holds the 7th spot in terms of market share ranking. The top 3 market leaders hold some level of market share more than the rest of the players, but not with wide margins.
There are two sides of a coin to this. On one side, SMCI can quickly scale and acquire market share. On the flip side, SMCI would need to be wary of stiff competition as well.
SMCI’s growth rate since 2022 has been impressive and also worrisome – it had been growing above the industry average but has also seen headwinds whipsaw the growth rate.
Will I Add SMCI To My Portfolio?
Fundamentally, SMCI is a good company. Apart from the highly competitive industry that will limit margin expansion, the company has grown well and benefitted from the AI tailwind.
The concerns that could halt its growth, lie with the industry risk of cyclicity that cannot be hedged or mitigated. Buying at a discount would provide an ample margin of safety.
Then again, the bull camps would argue that if growth rates continue to ride on the semiconductor 2024 recovery, wouldn’t today’s price be a fair price to go long?
Food for thought. I am on the fence on this. What are your opinions?