In late November, Goldman Sachs conducted an IT survey hoping to get a sense of corporate spending plans into year-end and for 2010. Almost 2/3rds of the respondents were expecting normal spending seasonality during Q4, up from 42% a year ago. More importantly, a large percentage of the respondents expect to replace their PCs next year. This is indicative of a strong pent-up demand for PCs and servers which should mark the start of a powerful PC/server refresh cycle in 2010. One of the best conduits through which to play this trend is a company called Super Micro Computer (SMCI). We believe that SMCI is at an important inflection point, one that should lead to positive estimate revisions, a higher multiple, and most importantly, a higher stock price.
SMCI designs and sells server solutions based on its modular and open-standard x86 architecture. Super Micro offers an array of server options with single, dual, and quad CPU capability that support Intel’s (INTC) Pentium and Xeon multi-core architectures. During the past three quarters, the company has introduced the strongest product line in its history. SMCI has seen its adoption rate for its Nehalem processor-based solutions improve of late and it continues to expect further gains over the next several quarters. SMCI has also been first to market with its launch of AMD’s Istanbul 6-core solutions.
Super Micro’s multiple product line launches and increased market share gains began to take hold in late October when the company bested earnings estimates by 60%. While sales were up only 3% year-over-year, sales grew 20% sequentially to $148.5M. With a stronger than expected outlook accompanying the beat in numbers, analysts were quick to raise numbers on the company. Analysts are now looking for the company to earn $0.68 in its fiscal year ending June of 2010 and $0.85 in its fiscal year ending in June of 2011.
As is often the case with companies at key inflection points, we feel analyst estimates are still too low for SMCI. Potentially, we see $1-$1.20 in earnings for its next fiscal year, as opposed to the $0.85 currently forecasted. Assuming SMCI can put together a few more quarters of better-than-expected numbers, you will see an expansion in the company’s valuation, a big potential catalyst down the road.
With almost $2 a share of cash on its balance sheet and its shares trading for less than 1x revenues, SMCI seems cheap. The biggest reason for the low price-to-sales valuation is its lowly gross margins of 15-16%. The company seems to have sacrificed a small cut in its margins to bring in extra sales. As long as margins do not go any lower from here, we are not too worried about this issue.
One of the biggest draws to the stock is the fact that it is sitting just below all-time highs. SMCI became public in the spring of 2007 at the tail end of the 2003-2007 bull market. Due to its ill-timed I.P.O. SMCI has been under the radar of most investors for the past few years. This should change in 2010. Noted value investors Dimensional and Renaissance are top shareholders. Their presence lends credence to buying into the name at current prices.
Should SMCI move through $12, this move to all-time highs will usher in a new and powerful up-leg for the stock. With an eye toward their next earnings report, we are patient buyers at current levels and on any and all pullbacks to $10-$10.50 in the coming weeks. Before all is said and done, we can envision SMCI trading to the mid-teens before this bull has breathed its last breath.
Disclosure: Long SMCI and getting longer....