Super Micro Computer: Super Financials And Undervalued (NASDAQ:SMCI)

Super Micro Computer, Inc. (NASDAQ:SMCI), or “Supermicro,” is a leading hardware company that provides servers and storage racks for compute-intensive workloads. The company produced super-strong financial results in its most recent earnings report. Revenue increased by 79% year-over-year and earnings per share increasing by an outstanding 490% year-over-year. Super Micro is poised to benefit from the growth in many industries, from Artificial Intelligence [AI] to 5G and the Cloud. The cloud industry alone is forecasted to be worth over $1.7 trillion by 2029 and grow at a rapid 19.9% compounded annual growth rate [CAGR]. In this post I’m going to breakdown its business model, financials and valuation, let’s dive in.

Business Model

At the root of the semiconductor supply chain, we have foundries such as Taiwan Semiconductor Manufacturing Company Limited (TSM) and chip designers such as Nvidia (NVDA), Advanced Micro Devices (AMD), and Intel (INTC). Then, at the other end of the supply chain, we have companies such as Super Micro which really combine and configure the best chips around to produce plug-and-play servers with power, cooling, and storage.

Super Micro’s solutions include; Artificial Intelligence [AI] and High-Performance Computing [HPC], 5G, IoT, and Hyperscale infrastructure. The company also is a certified partner and reseller of enterprise application software such as Redhat by IBM.

Super Financials

Super Micro reported strong financials for the first quarter of the fiscal year 2023. Revenue was $1.85 billion, which increased by a blistering 79% year-over-year and beat analyst estimates by $129.67 million. This growth was driven by strong demand across its multiple market verticals. Its Enterprise and Channel vertical which contributed to 51% of quarterly revenue, increased sales by 16% year-over-year. This was driven by strong demand from a variety of new product offerings.

Super Micro works closely with its enterprise customers to design solutions with both performance and energy efficiency. Its “Green Computing” solution has been particularly popular as it offers a lower total cost of ownership [TCP] for a data center, while also increasing compute capacity per rack. Offering a strong business case for its customers has resulted in increased adoption, which is surprising given the macroeconomic environment.

To give you an idea of the cost-saving benefits on offer, Super Micro estimates that if half of the I.T industry adopted its “Green Computing” solutions, it would save $10 billion in electricity costs. This is the equivalent of shutting down 30 fossil-fueled power plants or saving 8 billion trees, thus its “green credentials” is strong. Super Micro’s OEM appliance and data center segment achieved $921 million in revenue, which increased by a staggering 268% year-over-year. Its 5G/IoT segment reported $90 million in revenue, which increased by a solid 58% year-over-year.

Super Micro has established relationships with major chip designers such as Nvidia, AMD, and Intel. For example, I have seen interviews with the CEO of Super Micro and the CEO of AMD, at its facility. Therefore, the company gets early access to designs and early shipments, so it can start to “seed” engagements even before launch. For example, Super Micro also has many “large opportunities” already for Intel’s Sapphire Rapids CPU, which is expected to be released in February 2023. In addition, the company has followed a similar strategy with AMD’s Genoa CPU and Nvidia’s H100 GPUs. Super Micro has also developed unique solutions using Nvidia products for its Metaverse and Omniverse partners. For example, Super Micro plans to showcase a variety of new water-cooled rack systems for Nvidia GPUs. The metaverse industry was valued at $22.79 billion in 2021 and is forecast to grow at a rapid 39.8% compounded annual growth rate, up until 2030. Super Micro is poised to benefit from the growth in the industry and need for High-performance GPU-based solutions.

Super Micro generates the majority (92%) of its revenue from its Server and Storage systems, which increased by an incredible 102% year over year. This was driven by strong demand for its “Total IT” solutions. Its Subsystems revenue contributed 8% of its total and declined by 24% year over year. This was expected as the company prioritized its key customers with rack-scale applications.

Breaking revenue down by region, Super Micro generates 70% of its revenue from the U.S. and increased that by an outstanding 131% year-over-year. This is a positive sign given the increasing trend of Deglobalization and foreign exchange headwinds, which are impacting many businesses. Asia contributed 14% of revenue and increased by just 3% year-over-year. This was followed by Europe which contributed 13% of revenue and increased by 31% year-over-year.

Profitability and Margins

Super Micro reported a non-GAAP gross margin of 18.8%, which increased by 540 basis points year-over-year. This was driven by price discipline, as well as lower shipping costs and operating leverage from greater factory utilization.

Its GAAP earnings per share was $3.35, which beat analyst expectations by $0.64. On a Non-GAAP basis, the results were also solid, with EPS growth over 490% year-over-year to $3.42, up from just $0.58 in the prior year. This was driven by its Total IT solution and growing usage of its Taiwan manufacturing facility, which has helped to bolster its operating margin to 12.5%, up from just 3.7% in the prior year. This is a positive trend and I expect to see further increases as the company scales its operations.

Its Operating expenses only increased by 17% year-over-year to $127.4 million, despite the huge revenue growth, which means operating leverage is showing up in the business. Super Micro has a strong balance sheet with $238.3 million in cash and short-term investments. The company does have $271.9 million in total debt, but the majority of this ($148.6 million) is long-term debt and thus manageable.

Advanced Valuation

In order to value Super Micro, I have plugged its latest financials into my discounted cash flow (“DCF”) valuation model. Management has forecasted between $1.7 billion and $1.8 billion for the second quarter of fiscal year 2023. This implies flat to declining growth from the current of $1.85 billion. This looks to be driven mainly by the uncertain macroeconomic environment. I will conservatively take this into account in my valuation model. I forecast revenue “next year” which includes the next three quarters, declining by 10%. However, in years 2 to 5, I have forecasted an improvement in revenue growth of 10% per year. For context management has raised its guidance for the fiscal year 2023, from between $6.2 billion and $7 billion to a range of $6.5 billion to $7.5 billion. This would imply a 25% year-over-year growth rate at the low end of its estimate.

To increase the accuracy of the valuation, I have capitalized R&D expenses, which has lifted net income. In addition, I have forecasted its operating margin to increase to 12% over the next 8 years, as the company benefits from high operating leverage.

Given these factors I get a fair value of $151.83 per share for Super Micro. The stock is trading at approximately $82 per share at the time of writing and thus is 64% undervalued.

As an extra datapoint, Super Micro trades at a forward Price to earnings ratio = 8.33, which means the stock is ~43% cheaper than its 5-year average. Its Competitor/peer integrated systems vendors include Hewlett Packard Enterprise (HPE), International Business Machines (IBM), Cisco (CSCO), and Dell Technologies (DELL). Relative to those companies, Super Micro is trading at one of the cheapest levels, although it is substantially smaller.

Risks

Recession/Longer sales cycles

The high inflation and rising interest rate environment has caused many analysts to forecast a recession in 2023. Therefore, I forecast longer sales cycles, as decision makers are likely to delay any large infrastructure spending.

Final Thoughts

Super Micro Computer, Inc. is a tremendous technology company which has close relationships with some of the greatest chip designers in the world. It sits in a part of the supply chain where the company can add value through its setup and storage solutions. Despite the run up in stock price and huge growth, Super Micro Computer, Inc. is still undervalued intrinsically and thus could be a great long-term investment.