Super Micro Computer: Riding The AI Revolution (NASDAQ:SMCI)

While Super Micro Computer (NASDAQ:SMCI) doesn’t create the advanced chips leading the AI revolution, the provider of server and storage solutions is still participating in the same level of growth, if not faster. The stock recently had a remarkable month, leading to Super Micro topping $1,000 per share. My investment thesis is Neutral on the stock, especially after Super Micro plunged $200 to end the trading week down at $803, some $275 below the all-time high on February 16.

Riding The AI Wave

A few weeks ago, Super Micro reported FQ2’24 numbers where sales surged over 100% as follows:

So immediately, an investor has to consider that a large portion of the recent gains of Super Micro are warranted based on the massive sales growth. In addition, the stock had been flat for going on nearly a year before the company boosted guidance dramatically in mid-January, setting off the big stock rally.

While the sales growth was barely above 100%, the AI infrastructure player reported earnings only grew 70% to reach $5.59 per share. Most importantly, the March guidance didn’t include the sales slump that occurred last FQ3, with the revenue target updated to a high of $4.1 billion and an EPS target reaching $6.

Super Micro now forecasts revenue growth of nearly 200% in the current quarter, along with an EPS boost of at least 250%. The stock rallying from $250 to $800 is actually right in line with the forecasted EPS growth for the March quarter.

Quarterly revenue is forecast to approach $4 billion for a server infrastructure play that only topped $1 billion in sales for the first time in FQ4’21 and hadn’t topped $2 billion until FQ4’22. The stock has to rally considerably to match the reported growth rates.

The interesting part of Super Micro is that the company provides the rack solutions for data centers. While investors have to choose the GPU AI chip company to invest in whether NVIDIA (NVDA) or AMD (AMD), Super Micro has solutions for all of the related chips from both providers. The AI infrastructure company is even working with the Gaudi 2 and Gaudi 3 chips from Intel (INTC) to provide customers with complete AI server solutions for inference and LLMs.

Competitive pricing for GPUs will only increase demand for infrastructure solutions from Super Micro, as enterprises and hyperscalers buy more and more chips. The company offers innovative rack solutions with the latest technology, including liquid cooled racks via direct attached cooling to manage heat and lower energy costs from higher performance AI solutions.

The company will have the capacity to produce 5,000 racks per month and production is currently at utilization rates of only 65% despite the massive growth rates. Super Micro is even ramping up capacity in both Silicon Valley and Malaysia to meet an expected ongoing surge in AI data center server solutions in the years ahead.

Super Micro has vastly outgrown the industry, where sub-20% growth rates have existed throughout the Covid period. The company saw growth take off following work with Nvidia on AI infrastructure solutions and now Super Micro forecasts a total IT solution of software, services, storage, and security will provide a path to $25+ billion in sales.

The date center solutions company forecast FY24 revenues in the range of $14.5 billion, providing upside of an additional $10+ billion in revenues. The company is forecasting another 70% growth to reach this internal target.

One Red Flag

The biggest red flag is the limited gross margins due to the hardware business. Super Micro only reported FQ2 gross margins of 15.4%, down from 18.7% in the same quarter last year. The company is currently chasing business at the cost of margins.

The AI chip companies are the ones with gross margins in the 60% to 70% range due to the complexity of the chips and the limited competition. Ultimately, though, what matters to an investor is the valuation of the stock and the growth rate of the business, regardless of whether the gross margins are above 75% for Nvidia or 15% for Super Micro.

The only risk is that low margin hardware business can usually run into more competition due to the company not having the specialized technology to warrant a premium price. Other computer hardware companies like Dell Technologies (DELL) don’t offer similar growth rates while still generating double the gross margins, up at 32% due to a higher Services mix. Though, the stock trades at a minimal P/E multiple due to the growth issues.

After the $200 dip, Super Micro isn’t exactly an expensive stock anymore, with the rally only mirroring the massive earnings growth. The company is already far into FQ3’24 and investors will quickly start looking at the EPS targets for FY25. The stock only trades at 27.5x FY25 EPS targets of $29.22 with EPS set to expand at a faster clip.

The stock previously traded below 10x forward EPS targets, similar to Dell Technologies. Along with the risks of low gross margins, these hardware types of companies tend to sell at low P/E multiples as well.

The question investors have to answer is how long the AI Revolution lasts. AMD has claimed the AI chip market will surge to $400 billion by 2027, leading to several more years of massive growth, under which a scenario Super Micro would maintain these high P/E multiples with growth rates to support the growth in data center demands.

The company only needs to boost gross margins by 100 basis points in FY25 and operating income jumps by up to $200 million based on the nearly $20 billion revenue target. Even after taxes, Super Micro would boost EPS by $2 to $3 per share, based on the current diluted share count of only 58 million.

The stock is cheap and Super Micro could easily start generating higher gross margins via a total IT solution, as opposed to the current hardware solution.

Takeaway

The key investor takeaway is that Super Micro is definitely a tough stock to value right now. The massive growth rates don’t appear sustainable, and the company has taken a hit to gross margins to gain market share in an indication competition is fierce. Over time, though, Super Micro could use the additional market share and total IT solutions to squeeze out competition and push margins back higher, providing a big EPS boost.

Despite the large rally, the stock isn’t necessarily expensive here at $800. Investors should definitely use caution considering the volatile trading, but weakness likely provides an opportunity to own a big AI growth story over the next couple of years at a reasonable value.