Shares of Cadence Design Systems Inc. (NASDAQ:CDNS) are up over 25% from their opening price of $20.00 on the first trading day of 2016. Prices reached their 52-week highs of 26.45 on Monday after the stock was upgraded to a buy status from its previous neutral status by DA Davidson. The news comes as new analysis of electronic design automation (EDA) industry fundamentals and leaner operating models are causing renewed optimism in the long-term potential of EDA stocks and a new belief in the appropriateness of using a higher multiple to value premium semiconductor-related stocks such as CDNS.
A Highly Profitable Industry With Little Competition
Cadence produces software and design tools used heavily by semiconductor companies. Their revenue sources are largely based on software subscription fees making revenue predictions relatively predictable. Another benefit of Cadence's business is relatively stable demand in growth of semiconductor design and production. The number of electronic devices owned by consumers has continued to rise over the last few years and Cadence has benefited from it. Behind the design and testing of those semiconductors is typically once of three companies: Cadence, Synopsys (SNPS), or Mentor Graphics (MENT). With only three major players, the market is undersaturated in a business where demand is relatively quantifiable. One of the risks Cadence faces is a loss of new users to new market entries. The industry is one with high barriers to entry that requires engineers to hold lots of specialized knowledge and experience mitigating those risks or, at least, making new competitors visible early on in the process of entering the space.
400G, USB Type-C and DSC Protocol Support.
On Monday, the company further announced a new set of software features aimed at allowing engineers to more quickly verify that designs produced in Cadence's design software meet the specifications for the latest standard protocols. The new features allow for the facilitation of growth in bandwidth-intensive products such as streaming video and cloud computing in consumer products such as cars and trucks, mobile phones and tablets, business and consumer products and more. The company's reach spans just about every electronic device related consumer industry. They are very much a seller of shovels in a gold rush.
By adding updated standards, Cadene allows for expanded production of in-demand consumer protocols such as 400G Ethernet, USB Type-C, and Display Stream Compression (DSC), a technology which compresses images and videos making file sizes smaller in turn reducing data costs and increasing accessibility for mobile users.
Cadence Is In A Strong Financial Position In A Growth Industry.
Among the reasoning behind the decision to upgrade the stock's ratings comes from newly found appreciation for the relative stability and improved cash flow metrics of the market as well as the shrugging of the perceived volatility of the industry. Cadence's strengths lay in balance sheet fundamentals such as reasonable debt levels, revenue growth, return on equity (21.48%) and stock price performance. The firm's 50-day moving average is $25.20 with the 200-day moving average hovering at about $24.45. It is important to note, however, the stock's 52-week low is $18.32 compared to its 52-week high of 26.44, which was set this morning.
Despite the new sentiment, however, EDA stocks are still trading significantly lower relative to engineering software giants Autodesk (NASDAQ:ADSK) and Ansys (NASDAQ:ANSS), which places Cadence's stock in a unique position due to EDA software's critical role in semiconductor chip design in a market that's likely to see growth with the increasing automation of cars and the growth of IoT products. The company has had below industry growth in net income (14.52% net margin) which has been holding the stock price back creating the opportunity for the recent rally.
The Bottom Line
In the last quarter, RBC Capital Markets and Bank of America have restarted an "outperform" rating with targets of $29 and $30, respectively, while hedge funds such as Invicrus RG, Daiwa Securities Group, Strs Ohio and Penserra Capital Management have increased their positions in the stock. Cadence offers strong business fundamentals, positive cash flow, and the luxury of being at the center a growth industry. CDNS is a buy opportunity for investors interested in a stock that reflects the growth of consumer electronic devices.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.