Charles Liang, CEO, SuperMicro
It’s been a brutal year for tech stocks. The Nasdaq is heading for its worst drop since 2008 and poised to underperform the S&P 500 for the second straight year. Among the mega-cap tech stocks Amazon, Meta Spirit Tesla have each lost at least half of their value.
Investors looking for a sign of optimism can turn to a 29-year-old server maker based in the heart of Silicon Valley. shares of super microcomputer are up 89% in 2022, outperforming all other US tech companies valued at $1 billion or more. Supermicro has a market cap of $4.4 billion, up from $2.4 billion at the start of the year.
Supermicro makes computers and sells them to companies that use them as servers for websites, data storage, and applications like artificial intelligence algorithms. In the low-margin server business, Supermicro competes Dell, IBM Spirit Hewlett Packard Enterprise as well as lesser-known players like China’s Inspur. According to The Next Platform estimates, Supermicro had a market share of about 2.6% in 2021.
Supermicro has tried to differentiate itself in the market by allowing customers to more easily customize their computers. That makes it a more profitable proposition than standard servers.
The strategy worked. Supermicro posted 46% growth to $5.2 billion in revenue for its 2022 fiscal year that ended in June. Earnings per share increased to $5.32 in 2022 from $2.09 in 2021 and $1.60 the year before.
“The stock really just reflects the EPS increases that we’ve seen over two years,” said Nehal Chokshi, an analyst at Northland Capital Markets, who recommends buying the stock. Chokshi has a price target of $165, by far the highest among the five analysts tracked by FactSet.
Supermicro closed at $82.89 on Tuesday.
Chokshi said Supermicro’s profitability and growth are strong enough that it could earn a larger multiple. Yet even with this year’s rally, the stock trades at just 8.6 times earnings over the next 12 months, which is below its five-year average of 9.5, according to FactSet. Over the past 12 months, it has traded at 10.1 times earnings, compared to a five-year average of 17.8.
“There was still no multiple expansion,” Chokshi said. “Many investors, myself included, find this confusing because this is a name that has historically generated sales in excess of 20 percent and EPS growth that only trades at 10 [times] merits.”
Investors across the board have turned to tech multiples, reflecting concerns that rising inflation and interest rates will dampen enthusiasm for growth stocks for the foreseeable future. According to FactSet, the Nasdaq is currently trading at 26 times earnings compared to its five-year moving average of 35.
Supermicro shares started rising in July and continued their upward trend in August following the company’s full-year earnings report. They rose another 30% in November after Supermicro reported a nearly 80% year-over-year increase in revenue to $1.85 billion in the September quarter.
When manufacturing servers, many different parts are put together. Supermicro starts with its own motherboard, unplugs a processor intel or AMDor a graphics processor from NVIDIA, and adds a power supply, RAM, network, and any other parts that the computer might need. Supermicro sells the customer the motherboard, a fully assembled server, or an entire server rack.
Heading into 2023, the outlook for the server market is bleak, especially early in the year. Companies are tightening their belts and are likely to spend less on investments. Supermicro’s revenue growth is expected to slow to about 32% in fiscal 2023 and 9% the following year.
But the company has at least regained Wall Street support after a rough patch in the middle of the last decade. According to the SEC, Supermicro misrepresented financial statements from 2015 through 2017 and delayed releasing some key filings.
“They did a great job when they came back,” said Susquehanna’s Mehdi Hosseini, who has a hold rating on the stock. “I would say they are the comeback story of 2022. And that is reflected in the stock price. But the management team has to stay very aggressive with their goal.”
Hosseini says the comeback is partly due to confidence in CFO David Weigand, who has implemented strong internal financial controls since he took office in early 2021.
“They became compliant with the SEC filings in 2020, and it was just a straight-forward lineup,” Hosseini said. “You did really well.”
Supermicro CEO Charles Liang told CNBC that the company’s recent performance reflects the company’s size and its ability to offer a broader range of products, particularly in the area of customization.
According to Liang, while the company is rapidly expanding in Taiwan, part of its differentiation strategy is its headquarters in San Jose, California, where Supermicro still conducts the majority of its manufacturing.
Liang said it’s more expensive to build locally than overseas, but it allows the company to be physically closer and more responsive to the chip companies it supplies, as well as big customers like cloud providers and big websites.
“Silicon Valley enables us to provide better technology, faster time-to-market, and quick service and maintenance for our customers,” said Liang.
He said technology companies can move faster with Supermicro servers and are willing to pay for the company’s execution and design capabilities.
One area of notable growth is machine learning, or AI algorithms, which require a large amount of processing power and are typically centered on Nvidia or AMD GPUs. Supermicro makes motherboards and systems that can combine up to eight GPUs on a single board.
Last quarter, 45% of Supermicro’s revenue came from corporate sales, including AI and machine learning products.
Another specialized market Supermicro is targeting is servers for 5G or telecom applications, using a novel approach called OpenRAN.
Supermicro is targeting $8 billion to $10 billion in revenue for fiscal 2024. To achieve that goal, the company says it needs significant growth from AI products and needs to sell more complete systems or servers already installed in a rack.
The current growth is being driven by Supermicro’s large data center business, which has attracted larger customers and accounted for 50% of total sales in the September quarter, according to a November note from Wedbush analyst Matt Bryson, who has a neutral rating on the stock.
Supermicro said in November that a large unnamed customer was responsible for nearly 22% of the company’s revenue for the quarter. In recent years, Supermicro hasn’t had a single customer account for more than 10% of its sales.
“Much more careful”
There is some skepticism among analysts that the company can achieve its targets in a weaker economic environment.
Susquehanna’s Hosseini said he recently downgraded the stock “because I think it’s going to face headwinds next year” and the “growth targets are too aggressive.”
Intel and AMD have cast bleak prospects for the server market, and companies of all sizes are cutting costs.
“While welcoming the quarter, we are far more cautious as we consider Supermicro’s mid- to longer-term path, and in particular, view the company’s now-stated target of $8 billion to $10 billion in revenue in 2024 given the above Headwinds with concern,” Wedbush Bryson wrote.
Evercore analysts said in a note this month that they expect the server market revenue growth to slow to about 2.7% globally in 2023, from 13.5% last year. Server manufacturers like Supermicro have to carry large inventories and can come under pressure on margins when sales are slow.
Northland’s Chokshi said that Supermicro’s strengths, particularly in AI systems, could allow it to weather a market downturn better than its peers.
“While their peers are showing strong signs that there is a significant downturn in investment, their results are accelerating,” Chokshi said. “So far they are showing no signs of this cycle catching up to them.”
Liang is confident that Supermicro can continue to win new customers even as growth slows from its recent rapid pace.
“In a good year, growth will be around 80%,” he said. “Hopefully 20% in a bad year.”
SEE: Expectations for tech stocks are falling, but not fast enough