This AI stock has outperformed Nvidia and is still reasonably valued

The AI revolution has been a boon for some tech companies. Nvidia has been the biggest winner, thanks to its high-performance GPUs, essential for the complex computations required in AI. However, it’s not just Nvidia benefiting. The AI supercycle is benefiting various types of companies in both the software and hardware markets. Super Micro Computer, or Supermicro ($SMCI), has been one of the biggest beneficiaries of this supercycle.

As you can see below, SMCI has actually outperformed Nvidia over the past twelve months, rising by over 300%.

Despite this impressive rally, SMCI is still fairly valued. Like Nvidia, Supermicro is set to massively benefit from the soaring demand for servers and computing platforms due to the intensive computational needs of AI applications. Let’s take a deeper dive.

The Nvidia Of The Hardware Space

Supermicro, formally known as Super Micro Computer, is a big player in the global hardware market, focusing on producing high-performance and high-efficiency server technology. The company, founded in 1993 and still founder-led, is renowned for its advanced server and storage solutions, catering to a diverse range of computational-intensive workloads. Supermicro's product portfolio is broad, including servers, storage systems, and networking solutions, designed to meet the specific needs of various markets including enterprise data centers, cloud computing, AI, 5G/edge computing, and more.

The AI and cloud computing revolution has been a boon for Supermicro. As these technologies demand powerful and efficient computing platforms, Supermicro's expertise in creating application-optimized servers and storage systems positions it well to capitalize on this demand. The company's products are designed to handle the intensive computational needs of AI applications and the scalability required by cloud computing environments. This has led to Supermicro being a go-to provider for enterprises looking to harness the power of AI and expand their cloud infrastructure.

There is plenty of competition in the server and storage solution space, including much larger companies such as Dell, HPE, Lenovo, and others. All of them are major players in the IT infrastructure space, offering a wide range of servers, storage solutions, and networking equipment. However, Supermicro has several competitive advantages. First off, it’s a white-box server provider, meaning it produces generic, unbranded servers built from off-the-shelf components and assembled by system integrators or the end users themselves. Unlike servers from well-known brands like Dell, HP, or IBM, white-box servers don't carry a premium brand name, and as a result, a premium price tag. Also, white-box servers offer a high degree of customization. Users can select specific components based on their requirements, allowing for a level of customization not possible with branded servers.

Given the massive increase in demand for servers due to the AI revolution, companies will need cost-efficient and tailored solutions to meet their needs, and Supermicro is best positioned to win. Its highly customizable servers are perhaps the main reason the company has formed exclusive partnerships with Nvidia and AMD to create powerful and efficient AI systems. These partnerships involve Supermicro incorporating Nvidia's and AMD’s latest GPU innovations into its server platforms, creating unique AI platforms.

Powerful Growth Ahead & Strong Profitability

Supermicro used to be a boring, unbranded server maker. As you can see below, its revenue growth had never been consistently strong due to the lumpiness of the hardware market. As a result, its stock price performance was quite disappointing in the past decade, as SMCI stock rose only 185% compared to a 237% increase for the S&P 500 index over the same period.

However, everything changed last year with the general availability of AI, which drove tremendous demand for chips capable of performing intensive AI computations. Along with Nvidia, SMCI was one of the biggest beneficiaries of this spike in demand for chips, advanced servers, and storage solutions. In FY 2023, which ended on June 30, 2023, revenue grew 37% to $7.12 billion, and this FY growth is expected to accelerate to 50% due to the accelerating demand for AI infrastructure and the company’s partnerships with Nvidia, AMD, and Intel.

FY24 revenue is expected to top $10 to $11 billion after management raised its full-year outlook by $500 million in the most recent quarter, on strong demand. But the company’s ambitions are much higher, as management has laid out its goal to grow to $20 billion in sales in the next couple of years, primarily thanks to AI.

As a hardware maker, SMCI has relatively low margins. However, its income margin has risen to new highs lately, despite the accelerating growth, a clear sign of strong operating efficiencies. In FY23, the gross margin came in at 18%, compared to 15.4% in FY22, indicating that the company has pricing power despite the stiff competition in the space, thanks to its partnership with Nvidia that allows it to develop advanced AI infrastructure. The operating margin increased to a record high of 10.7% in FY23, from 6.5% a year ago, a significant improvement thanks to strong organic growth and increased operating efficiencies.

SMCI is not only solidly profitable, but unlike its larger competitors Dell and HP, it’s almost debt-free and doesn’t pay a dividend. It currently has $543 million in cash and equivalents and only $105 million in long-term debt. In contrast, Dell has $8.3 billion in cash, $28 billion in debt, and a dividend yield of 1.92%, while HP is in a similar position. Their significant debt loads and dividends could prevent these branded hardware providers from innovating fast enough, creating a competitive advantage for SMCI, which has a healthier balance sheet and doesn’t pay a dividend.

What About Valuation

SMCI stock may have soared lately, but it still remains very reasonably valued as hyper-growth rates and increased profitability support the rise. At current prices of around $345 per share, it trades at a PE ratio of 32, while on a forward basis, it trades at a PE ratio of 18.4. This is a very reasonable multiple for a high-growth and solidly profitable company, with bright prospects.

Although SMCI is a low-margin hardware business, it can still trade at a higher PE multiple due to its stellar fundamental performance — accelerating growth and increasing profit margins. Assuming the forward PE rises to 25 in FY24 and based on the expected FY25 EPS of $19.45, SMCI stock could rise 40% from current prices to $484 by the end of this fiscal year.

What Else

SMCI used to be a boring, unbranded, and low-margin hardware business, but in the age of AI, it has transformed into a leading AI infrastructure player. Its close partnership with AI leaders like Nvidia and AMD can help it significantly increase its sales in the next couple of years and reach the management’s goal of $20 billion in annual revenues.

However, we shouldn’t forget that SMCI operates in a highly competitive space, traditionally dominated by branded leaders like Dell, HP, and IBM. If these companies develop more powerful, customizable, and cost-efficient AI infrastructures than SMCI, they could easily steal market share. On top of that, while SMCI may still be reasonably valued, high expectations are now baked into the stock, and if the company doesn’t overdeliver, shares could plunge, at least in the short term. Despite these risks, SMCI’s reasonable valuation and strong demand for AI infrastructure make the stock a good buy for long-term investors.

SUPER MICRO COMPUTER RATING

Short Term: Buy

Long Term: Buy

🎯 FY2024 Price Target: $484

Today I opened a new position in SMCI, and increased my positions in MNDY, HIMS, ODD, GLBE, and DUOL.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.