Intelligent Servers
In an age where digital transformation is no longer an option but a necessity, the server and storage solutions industry stands as a fundamental component in the modern technology landscape. This industry, vital for the infrastructure of data management and computing power, plays a crucial role in driving efficiency and supporting the operational needs of various businesses.
This industry is instrumental in catalyzing progress across various critical domains, from cloud computing to artificial intelligence (AI), and from 5G networks to the field of edge computing. The demand for robust and agile IT infrastructure has never been greater, with companies in this space positioned at the vanguard of a rapidly expanding market. Their products and services form the critical pillars that support expansive data centers and the complex computations required for cutting-edge AI developments.
As digital data becomes the world’s most valuable resource, enterprises and organizations continue to seek out advanced technologies to stay competitive, or even stay relevant. Thus, the entities that offer sophisticated solutions for data storage, processing, and management stand to reap considerable profits. The market’s growth is propelled by the increasing reliance on data centers and the surge in AI-driven analytics and operations, presenting a myriad of opportunities for leading companies in the industry.
We will present such a company, but first, let’s delve into a short update on the economy and markets, and the Smart Investor calendar.
Economy and Markets: Looking Forward
There are several important reports scheduled to be published in the next few days.
- On Friday, the University of Michigan will publish two important consumer-related reports: the preliminary November’s Michigan Consumer Sentiment Index and the preliminary UoM 5-year Consumer Inflation Expectations. The Consumer Sentiment report portrays the results of a monthly survey of consumer confidence levels, directly affecting consumer spending, which contributes about 70% of the U.S. GDP. The Inflation Expectations report is the result of the survey conveying consumers’ views of long-term inflation and is used as a component of the Fed’s calculations of the Index of Inflation Expectations.
- Next Tuesday will be busy with consumer inflation data, featuring October’s CPI and CPI ex. Food and Energy (Core CPI) reports. These reports measure changes in the retail prices of goods and services in corresponding data subsets. The CPI report is one of the two key inflation measures (the second one is the Personal Consumption Expenditures or PCE). Policymakers, businesses, and consumers closely watch the CPI report, as it reflects the price trends in the economy.
As for the stock calendar, the Q3 2023 earnings season for Smart Investor Portfolio companies is winding down, with no earnings reports scheduled until next week.
The ex-dividend date for Parker Hannifin (PH) is November 10th; for Archer Daniels Midland (ADM) and Jabil (JBL), it is November 14th.
Today, we are adding the stock of a key player in the server market, slated to be a clear winner in the AI infrastructure industry.
To make room for this valuable addition, we are letting go of a midstream energy services stock, whose earnings in the past two quarters came in below estimates, drawing attention to its less-than-stellar financial health.
New Addition: Super Micro Computer (SMCI)
Super Micro Computer, Inc. (aka “Supermicro”) designs, develops, manufactures, and sells high-performance server and storage solutions based on modular and open architecture. Its solutions cover a full range of offerings: complete servers, storage systems, modular blade servers, blades, workstations, full racks, networking devices, server sub-systems, server management software, and security software. Supermicro offers server subsystems and accessories comprising server boards, chassis, power supplies, and other accessories. Further, the company provides server and storage system integration, configuration, and software upgrade and update services; and technical documentation services, as well as identifies service requirements, creates and executes project plans, and conducts verification testing and technical documentation, and training services. Additionally, it offers help desk and on-site product support services for its server and storage systems; and customer support services, including ongoing maintenance and technical support for its products. The company provides its products to multiple different market verticals, such as enterprise data centers, cloud computing, artificial intelligence (AI), 5G, and edge computing markets.
Supermicro was established in 1993 in San Jose, California, as a producer of motherboards and energy-efficient power supplies to companies producing servers and personal computers. Within just one year, its products were used by a third of systems companies in the U.S. In 1996, the company began its international expansion, launching operations in Taiwan; its first European subsidiary was opened in 1998 in the Netherlands. As SMCI grew in size, it began providing customers with complete systems optimized for different workloads, offering products designed for high performance and featuring cutting-edge technological solutions. Over the years, the company became a leading supplier of entire application-optimized systems that address a wide range of workloads and vertical industries, providing complete rack-level system integration and total solutions with its plug-and-play (PnP) offerings.
In 2012, Supermicro’s annual revenues exceeded $1 billion, in 2016 they exceeded $2 billion. In 2018, it was ranked as the world’s third-largest systems supplier. Today, Super Micro Computer, Inc. commands a market capitalization of $13.5 billion, annual revenues of over $7.2 billion, and a workforce of more than 5,000 employees.
Despite its industry-leading offerings and fast growth, Supermicro largely flew under Wall Street’s radar until artificial intelligence technology came to the forefront with the introduction of Generative AI capabilities to the general public. As the AI “gold rush” intensifies, SMCI has drawn enormous investor attention, showcasing surging demand and investment volumes in data center hardware that supports applications that utilize artificial intelligence.
Basically, Supermicro supplies “picks and shovels” to the “gold miners” of AI. SMCI’s high-performance servers are the cornerstone of AI advancement, as their modularity, easy customization, and effectiveness provide it with significant advantages over its competitors. Supermicro is in a good position to capitalize on the increase in demand for large-scale GPU-driven systems that are necessary for managing data-intensive generative AI and machine learning workloads. The global AI market is expected to grow at a CAGR of ~20% in the next years, reaching ~$2.7 trillion by 2032, as the growing need for AI technology across various industries, including automotive, healthcare, banking and finance, manufacturing, food and beverage, logistics, and retail, propel the growth of the market.
In addition, the company’s high growth rates are supported by the ongoing digitalization of virtually everything, providing strong secular tailwinds to suppliers of servers, storage, and associated IT solutions.
Founded and headquartered in the U.S., the company has manufacturing operations in Silicon Valley, the Netherlands, and at its Science and Technology Park in Taiwan and operates in 100+ countries around the globe. The company partners with all global CPU, GPU, Memory, Storage, and other industry leaders, such as NVIDIA (NVDA), Intel (INTC), Advanced Micro Devices (AMD), and others, delivering the latest technology to customers in a wide range of industries and for any workload. In fact, SMCI produced NVIDIA’s very first data center system and remains NVIDIA’s closest business partner. Supermicro’s customers include tech titans like Meta (META) alongside hundreds of large- and medium-sized enterprises, as well as universities, medical, and research institutions around the globe.
Supermicro’s strong business expansion is supported by its stellar financial health. Its debt-to-equity ratio is under 7%, meaning that the company has virtually no debt. Its cash and short-term investments are almost four times larger than its total debt. Besides, its quick ratio of 1.2 and its current ratio of 2.2 indicate a healthy level of liquidity.
As for capital efficiency, SMCI features industry-beating metrics. Its Return on Equity (ROE) of 32.3%, Return on Assets (ROA) of 13.8%, and Return on Invested Capital (ROIC) of 27.2% are multiples of the industry’s averages. The company’s robust profitability is reflected in its operating margin of 9.7%, and net profit margin of 8.3%, which are much higher than the averages in the IT industry.
Over three-quarters of Supermicro’s total revenues originate from the U.S., with 11% originating in Asia, 9% in Europe, and 4% from the rest of the world. China is responsible for only 2% of total revenues; thus, SMCI is insulated from the economic headwinds in the country and is not influenced by the ongoing U.S.-China technology spat. The company cut its exposure to China and eliminated Chinese producers from its supply chain in 2019.
As a result of the surge in demand for Supermicro’s server systems and technologies, specifically those supporting AI and ML (machine learning) platforms, the company’s revenues doubled since 2021, while its operating income quadrupled, and net income grew almost sixfold. The share of AI-related revenues in the total top line reached almost 50% in the latest reported quarter.
In the past three years, Super Micro Computer, Inc. has grown its revenue at an annual pace of 26.3%, while its earnings surged by 89.8% a year. It must be said that these figures include the triple-digit growth registered last year, which was driven by the industry’s post-pandemic surge, as well as the company’s focus on AI-supporting systems. The company’s strong shift to AI allowed it to double its market share in the high-growth AI server niche at the expense of its two main competitors, Dell (DELL) and Hewlett Packard Enterprise (HPE), as these companies’ revenues have a far greater reliance on legacy systems and servers.
On November 1, SMCI reported its financial results for the fiscal Q1 2024 (ended September 30, 2023). While the company exceeded analysts’ revenue and EPS estimates, as it did in most quarters for which these estimates were available, the revenue growth slowed to 14.6% year-on-year, while adjusted net income grew 3%, and EPS rose by just 0.3%. The latest quarter’s slower growth is attributed to short-term headwinds, such as the ongoing GPU supply constraints (mostly from NVIDIA) and normal seasonality in the highly cyclical industry. As for capacity challenges, the company said it is working “diligently” to address GPU supply constraints, expanding its validation and production facilities. SMCI said that by the March quarter, it plans to complete the assembly of its dedicated capacity for manufacturing 100-kilowatt racks with liquid-cooling capabilities, enabling the expansion of production capacity to 5,000 racks per month in full-speed mass production.
At the same time, SMCI reported strong demand for its AI infrastructure products, as well as for its new computing and storage products. The fact that FQ1’s slowdown is regarded as a non-issue was underscored by its upwardly revised revenue guidance for the fiscal second quarter, which is now expected to come in well ahead of analysts’ estimates. The management also lifted its revenue outlook for fiscal year 2024, increasing it by 5%. The company’s management now expects FY 2024 revenue to increase by 40% to 54% from fiscal 2023. While the company hasn’t stated its earnings guidance for FY 2024, analysts expect adjusted EPS to increase ~40% year-over-year. In the long term, the company is expected to grow its earnings-per-share by 25% a year.
Supermicro’s stock has been traded on NASDAQ since 2007. In the past three years, the stock has delivered a gain of over 800%, versus Nasdaq Composite’s (NDAQ) increase of 15% over the same period. In the past 12 months, SMCI has gained 237% (very similar to NVIDIA’s 223%), while NDAQ has risen ~30%. The company’s stock reached its all-time high on August 7, after which it declined on profit-taking and general market turbulence. However, the company’s strong revenue outlook for this fiscal year has lifted the stock back up.
Despite the outperformance, SMCI remains modestly valued compared to its peers in the industry. It is now trading at a TTM P/E of 23.5 and a Forward P/E of 16.9, representing 2% and 32% discounts to the IT sector’s averages, respectively. These multiples are exceptionally low for a company expected to grow its revenues and EPS by double digits in the next years; they look staggeringly cheap for an AI company. For reference, NVIDIA, whose appeal is also intertwined with AI technology’s expansion, is selling at a P/E ratio of over 100. Thus, it can be concluded that SMCI currently represents a value bet in the AI niche.
In addition to stock gains, Supermicro compensates its shareholders through buybacks under its share repurchase programs. The current program of up to $200 million, effective until January 31, 2024, was announced in August last year. As of the end of fiscal Q124, the company had $50 million remaining of that program.
TipRanks-scored top Wall Street analysts see an average upside of 44.3% for Supermicro’s stock in the next 12 months. SMCI Industries carries a TipRanks Smart Score rating of 9/10 (“Outperform”) with a “Moderate Buy” recommendation:
Given all said above, we view Super Micro Computer’s stock as a winning combination of value, quality, and growth, and as such, a valuable addition to the Smart Investor portfolio.
New Deletion: Enterprise Products Partners (EPD)
Enterprise Products Partners LP is a provider of midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, refined products, and petrochemicals. The company operates through the following business segments: NGL Pipelines & Services, Crude Oil Pipelines & Services, Natural Gas Pipelines & Services, and Petrochemical & Refined Products Services.
EPD’s financial health is a concern, mostly because of its very high level of debt. While the company succeeded in reducing its debt load somewhat in the past two years, its net debt-to-equity ratio remains very high at 103%. Moreover, EPD’s short-term assets don’t cover its long- or short-term liabilities. In addition, the company’s lower-than-industry average Return on Equity (ROE) of 19.4% and Return on Assets (ROA) of 5.9% raise questions about its capital efficiency. Notably, the company’s profitability metrics, such as operating and net profit margin, are slightly lower than the Energy sector’s averages.
As energy companies’ stocks cannot be described as “high growth,” most investors hold them for their propensity to pay high dividends. EPD’s dividend yield of 7.4% is almost double the sector’s average, making it attractive to income investors. However, Smart Investor isn’t a dividend portfolio, therefore we must put more weight on the company’s financial health and long-term earnings growth prospects.
EPD earnings performance hasn’t been great in the past two quarters, missing analysts’ EPS estimates and registering year-on-year declines in earnings-per-share. In Q3 2023, the company also reported year-over-year declines in operating and net income, a decrease in adjusted EBITDA, and no change in distributable cash flow. No wonder the company’s stock fell on the news, cutting its 12-month gain to 5%.
Last quarter’s underwhelming results came even though the total amounts of oil and gas transported by EPD have increased by low single digits, as it was heavily impacted by lower natural gas prices – which are expected to continue to weigh on the company’s top- and bottom-line figures.
While the company has some growth potential over the medium to long term (it has some projects under construction), the near-term prospects are less optimism-inducing. We believe that EPD’s shares may trade sideways for some time, given that there are no immediate catalysts for investor enthusiasm (apart from high dividend yield). Thus, we believe it is appropriate to sell the stock.
Charter Members of the 30% Winners Club
*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
The markets delivered a strong performance in the past weeks, with the tide lifting most boats. Thus, our exclusive club’s ranks have expanded again, taking back two of the three members it lost during the market turbulence at the end of October.
Now, the Winners Club includes five stocks: the long-standing champions GE and AVGO, last week’s re-entrant ANET, and now also ORCL and CDW, with 33.7% and 31.6% gains, respectively, since purchase.
The ex-member of the Winners Club, TECK, is now the first in line to reenter with a 27.1% gain. Will it be able to close the gap, or will someone else outrun it to the finish line?
What’s Next?
Our next commentary will come out on Wednesday, November 15th, before the market opens.
Until then – we wish you a world of investment success!
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Disclaimer
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