Server Manufacturer Outperforms Tech Peers with 90% Increase in 2022

This has been a tough year for tech stocks. The Nasdaq is on track for its worst slump since 2008 and looks set to underperform the S&P 500 for a second consecutive year. Among mega-cap tech stocks, Amazon, Meta and Tesla have each lost at least half their value.

Super Micro Computer, a 29-year-old server maker located in the heart of Silicon Valley, has seen its shares soar 89% in 2022. This puts it ahead of all other U.S. tech companies valued at $1 billion or more in terms of percentage growth. Supermicro has a market cap of $4.4 billion, up from $2.4 billion at the start of the year.

Supermicro manufactures computers that are sold to companies to be used as servers for websites, data storage and applications like artificial intelligence algorithms. In the low-margin server business, Supermicro competes with Dell, IBM and Hewlett Packard Enterprise, as well as lesser-known players such as China’s Inspur. According to estimates from The Next Platform, Supermicro had a market share of about 2.6% in 2021.

Supermicro has sought to differentiate itself in the market by allowing customers to more easily customize their computers. This makes for a more profitable offering than off-the-shelf servers.

Supermicro's strategy is paying off. The company reported 46% growth in its fiscal 2022, which ended in June, to $5.2 billion in revenue. Earnings per share climbed to $5.32 in 2022 from $2.09 in 2021 and $1.60 the year before that.

"The stock price is simply reflecting the EPS increases we have seen over the past two years," said Nehal Chokshi, an analyst at Northland Capital Markets. Chokshi has a price target of $165 for the stock, which is significantly higher than the targets set by any of the other five analysts tracked by FactSet.

Supermicro's stock price closed at $82.89 on Tuesday.

Chokshi said that Supermicro's profitability and growth have been strong enough that it might deserve a larger multiple. Yet even with this year's rally, the stock is only trading at 8.6 times earnings over the next 12 months, which is lower than its five-year average of 9.5, according to FactSet. For the past 12 months, it trades at 10.1 times earnings, which is below its five-year average of 17.8.

Chokshi noted that there has still not been any multiple expansion for the company. He stated that many investors, including himself, find this perplexing because the company has a history of generating 20% or more in revenue and EPS growth, yet it is only trading at 10 times earnings.

Investors have slashed tech stock valuations in recent months, as concerns about inflation and rising interest rates have dimmed the outlook for growth stocks. The Nasdaq currently trades at 26 times earnings, compared to its five-year average of 35, according to FactSet.

Supermicro's stock price has been on the rise since July, following the release of the company's annual earnings report. In November, the stock price soared by 30% after Supermicro reported a nearly 80% increase in year-over-year sales for the September quarter, totaling $1.85 billion.

Supermicro manufactures servers by assembling various components. Its motherboards serve as a foundation for processors from Intel or AMD, or a graphics processor from Nvidia. Supermicro also adds a power supply, RAM, networking and any other necessary parts to complete the server. Customers have the option of purchasing the motherboard, a fully assembled server, or an entire rack of servers from Supermicro.

The outlook for the server market in 2023 is uncertain, especially in the early part of the year. Companies are likely to spend less on capital expenditures, which could impact Supermicro's revenue growth. Supermicro is expected to see moderate revenue growth of about 32% in fiscal 2023 and 9% the following year.

Supermicro has regained the support of Wall Street after a rough stretch in the middle of the last decade. According to the SEC, the company has misstated financial statements and published some key filings late.

"I think they've done a great job of bouncing back," said Mehdi Hosseini of Susquehanna, who has a hold rating on the stock. "I would say they're the comeback story of 2022. And that's what's reflected in the share price. But the management team has to remain very aggressive with their target."

Hosseini believes that the company's recent rebound is partially due to confidence in CFO David Weigand, who has put strong internal financial controls in place since taking the job in early 2021.Hosseini said that the company became compliant with SEC filings in 2020 and has seen steady growth since then. He added that the company has done well overall.

Supermicro CEO Charles Liang told CNBC that the company’s recent performance reflects the size of the business and its ability to offer a wider array of products, particularly around customization. This allows Supermicro to better meet the needs of its customers and continue to grow its business.

Supermicro is rapidly expanding in Taiwan, and one of the company's differentiation strategies is its San Jose, California, headquarters, where most of its manufacturing takes place. This allows Supermicro to maintain a high level of quality control and to respond quickly to customer needs.

According to Liang, it is more expensive to build chips locally than overseas. However, by doing so, the company is able to be physically closer and more responsive to the chip companies it supplies, as well as major customers like cloud providers and big websites.

According to Liang, Silicon Valley provides the ideal environment for developing better technology and getting products to market quickly. This quick turnaround time also benefits customers by providing them with faster service and maintenance.

He said that tech companies can move faster with Supermicro servers and are willing to pay for execution and the company's design skills.

Supermicro's motherboards and systems offer impressive capabilities for machine learning and artificial intelligence applications. They can support up to eight GPUs on a single board, making them ideal for high-performance computing.

Supermicro's enterprise sales, including AI and machine learning products, accounted for 45% of its revenue in the latest quarter.

Supermicro is also targeting servers for 5G or telecom applications using a new approach called OpenRAN.

Supermicro is targeting $8 billion to $10 billion in revenue for fiscal 2024. The company says it needs substantial growth from AI products and has to sell more complete systems, or servers already installed in a rack, to reach that goal.

Supermicro's large data center business is currently driving growth, landing bigger accounts and comprising 50% of total sales in the September quarter, according to a November note from Wedbush analyst Matt Bryson. Bryson has a neutral rating on the stock.

Supermicro announced in November that a major unnamed customer was responsible for nearly 22% of the company's sales in the quarter. This is a significant increase from previous years, where no single customer accounted for more than 10% of Supermicro's sales.

Some analysts are skeptical that the company can hit its targets in a softer economic environment.

Hosseini from Susquehanna recently downgraded the stock because he believes they will face difficulties in the next year. He also believes that their growth targets are too ambitious.

Intel and AMD have both issued downbeat prospects for the server market, and companies of all sizes are cutting costs in response. This has led to a decrease in demand for servers, which is likely to continue in the short term.

We are pleased with Supermicro's performance in the quarter, but we are much more cautious when considering the company's prospects for the next few years. We are particularly concerned about Supermicro's goal of achieving $8-$10 billion in revenue by 2024, given the challenges it faces.

Evercore analysts said in a note this month that they expect global server market revenue growth to slow to about 2.7% in 2023, from 13.5% last year. Server makers like Supermicro may face margin pressure if sales slow, as they need to carry a lot of inventory.

Supermicro's strengths in AI systems could allow it to weather a market downturn better than its rivals, according to Northland's Chokshi.

"Their competitors are facing a significant capex down cycle, but their results are accelerating," Chokshi said. "So far, they're showing no signs of this cycle catching up to them."

Liang is confident that Supermicro can continue to gain new customers, even if growth slows from its recent rapid pace.

He said that in a good year, growth will be around 80%. In a bad year, hopefully 20%.

Investors are becoming increasingly cautious about tech stocks, but expectations are still too high, according to analysts.