Super Micro Computer Stock’s Turnaround Takes Legs (NASDAQ:SMCI)

Years ago, in 2018 we argued that shares of Super Micro Computer, Inc. (NASDAQ:NASDAQ:SMCI) is very cheap because investors are waiting for an audit, the cost of which will weaken profits and discourage some investors. trust the process.

That’s all history now. The company has since grown stronger, except during the pandemic years:

The growth numbers are still slightly inflated by the quick comps from the pandemic period, although in Q3/21 the company recovered from the previous high in profits (Q2/20). Since Q2/21, growth has been accelerating (remember their fiscal year ends in June).

Growth

The company develops high-performance, high-efficiency server technology, provides advanced server building block solutions for enterprise data centers, cloud computing, AI (artificial intelligence), and edge computing solutions.

The company has secular tailwinds from operating in markets that are in long-term secular growth cycles, such as cloud computing, edge computing, 5G, IoT, and AI. However, the company is actually growing faster than the industry (Q3 earnings deck):

What’s behind that relative recent outperformance? Basically, the company innovates and operates in the upmarket, providing total solutions for customers. Here are some of the current and future growth vectors:

• Total solution
• Universal GPU system and AI platform
• Green computing

The company has rapidly gained market share with this strategy, outscoring competitors 3 to 1 in the past four quarters and with increased margins to boot, the company is a winner so far.

Total IT solutions

The company has transformed from being a parts supplier to a Total Solution Provider, acting as a one-stop shop for customers.

One of the core ideas behind it is the plug-and-play modular system:

There are several advantages to being a total solution provider, especially based on plug-and-play modules:

• This lowers customer anxiety, enabling simple capacity flexibility and future-proofing solutions.
• This increases the customer’s stickiness as the company solves problems, instead of just selling the goods.
• This improves the value proposition to customers with a tendency to increase the gross margin (since sales have an increasing proportion of higher margin services and software).
• The company is able to have shorter lead times for customers, which increases the value proposition.

Later (Q4CC):

Our total IT solution approach streamlines design, deployment, solutions and integration, resulting in shorter lead times for our customers with optimized quality and performance. In addition, our total IT solution is simplified integrated [indiscernible] control.

Fellow SA contributor Mayank N Sharma highlights the importance of their universal GPU unit:

The Universal GPU Platform is universal because it is built to work with different GPUs by standardizing the design to accommodate different elements. For example, this system supports GPU interconnection between NVIDIA’s (NVDA) NVLink and AMD’s (AMD) Infinity Fabric that facilitates hyper-speed inter GPU communication, reducing bottlenecks caused by traditional GPU interlinks. This is one of the good products, which according to my analysis, will take most of the revenue share of SMCI in FY24.

And here is the Q4CC management:

Our strong growth was fueled by a recent run of design wins based on our rack scale total IT solutions, particularly in GPU solutions and AI platforms.

Overall solutions growth was mostly a US activity, with US revenue growing 41% sequentially. This gives the company many opportunities abroad.

Overall, management sees room to increase revenue from this total rack solution 4x in the coming years. Then there is the software, which makes things simple for clients (Q4CC):

In addition, our super cloud composer, orchestrator, security and other products can only help manage compute, acceleration, storage and network building cloud-enabled products including rich analytics. The data center operator can easily use this information [indiscernible] improving workload efficiency. Therefore, we are expanding our investment in our data center management software stack that enables drawing infrastructure as a service and secure monitoring as a service functionality for enhancing our overall capabilities and value of the solution. IT. This one stop shop approach aligns us with the emerging growth market across AI, machine learning, software-defined storage, networking, public and hybrid cloud, and 5G, IoT and telco.

The auto configurator seems to be especially helpful in their sales process.

Green computing

Management made some bold claims about their green computing initiatives (Q4CC):

Adopting our green computing solutions or other suppliers’ solutions with a similar energy vision could potentially save the IT industry more than $10 billion in electricity costs… we are focused on building and delivering greener rack-scale total IT solutions. From an industry perspective this is the biggest opportunity Super Micro has seen since our founding 29 years ago.

Due to the increase in energy prices, this is a benefit to their sales.

finances

The quarter was a blast with a revenue increase of 53% y/y and 21% q/q and there was also a non-GAAP gross margin expansion of 390bp y/y and 200bp q/q to 17.6%, which exceeded their long-term target (14%-17%) but management argues that this is sustainable. There are several reasons to support this:

• Continued favorable shift in product mix.
• Their facility in Taiwan is still plagued by supply chain problems and is operating well below capacity.
• There are still enough economies of scale to reap FY22 revenue of $5.2B while they have capacity of $10B-$12B.
• Shipping costs may drop further

There is also considerable operational leverage:

It is clear that OpEx is growing more slowly than revenue (+ 53%) and operating margins are also moving more than their long-term target (5%-8%).

All of this produced a remarkable non-GAAP EPS improvement (after doubling guidance for the year, adding a whopping $1.81 y/y and $1.07 q/q to $2.62.

The vertical that is growing the fastest is their 5G telco edge IoT segment at +172% y/y reaching 83M in revenues representing 5% of revenue in Q4 compared to 6% in the previous quarter.

dough

With strong revenue growth and expanding margins, it’s a little surprising to see that cash flow isn’t keeping up with growth, quite the contrary:

That number seems scary, but it is the result of a huge increase in inventories by a whopping $561.5M in the first nine months of the year. The reasons are not difficult to understand (10-Q):

We actively manage our supply chain for potential shortage risk by building inventories of critical components needed such as CPUs, memory, SSDs and GPUs to support our ability to fulfill customer orders. Our architecture, based on a “Building Block Solutions” design approach, also helped us during the pandemic, to qualify different components for the compatibility of our systems to help us overcome some deficiency.

As you can see above, the problem mostly occurred in Q1 and Q3, while they cut their inventories a little (3%) in Q4 while at the same time increasing receivables and decreasing accounts payable.

So the negative cash flow is primarily a working capital issue but it should be noted that the company swing comprehensively into negative net cash territory (on the right side of the slide above).

Not dramatic by any means, but noticeable when the company seems to be firing from all cylinders. This did not prevent management from instigating a $200M share buyback program.

CapEx

The company has the capacity to generate between $10B and $12B in revenues annually in the capacity to ship 6K of these plug-and-play racks that are selling like hotcakes these days (in Q4 they sold 1K+ so that they have more capacity to accommodate the expected increase in demand).

guiding

Q1 was seasonally weaker so there was a series of declines (also due to lingering supply chain problems).

Because of the rapid growth, management thinks it can reach its $10B annual revenue target sooner than they guided last year.

PURCHASE

The company’s forward earnings multiple is in the single digits (just) of the estimated non-GAAP FY23 EPS of $7.74. Its sales volume is historically high, so there appears to be an appreciation of the company’s turnaround from investors, but we don’t think it’s done yet.

Conclusion

The company has successfully transformed from providing products to providing solutions, and this has led to a rapid growth in revenue as well as margin expansion.

It looks like this development will run further, although the risk is that it could be derailed to some (we believe minor) extent by a deteriorating macro environment.

These low valuations are not surprising for a company that produces low margins but we feel that the acceleration of revenues and margin expansion is not sufficiently priced.

Because of the huge rally in the last two months, we are reluctant to advise you to buy Super Micro Computer wholeheartedly. It is probably better to wait for a pullback to support in the upper 50s, although there is no guarantee that this will happen.