Super Micro Computer: Growth May Slow In 2025 (NASDAQ:SMCI)

Super Micro Computer (NASDAQ:SMCI) remains in a high-growth capacity as the firm continues to build out scale to cater to heightened demand for AI-enabling infrastructure. The data center space grew by 26% in CY23 and is anticipated to maintain its growth as regional data centers are constructed to cater to companies’ and sovereign governments’ needs. Though I anticipate this growth to continue throughout the duration of eFY24, I do anticipate some slowdown in eFY25 as the macroeconomic landscape continues to dim. As SMCI’s revenue is nearly 50/50 enterprise to hyperscaler, I do anticipate hyperscaler demand to offset some of the weakness that may be found from more budget-conscious enterprises. As a result, I maintain my BUY recommendation on SMCI shares with a lower price target of $1,420/share based on 4.32x eFY25 price/sales.

Super Micro Computer Operations

To be blunt, SMCI’s operations aren’t going to look pretty in the coming quarters as the firm positions itself for future growth. As the firm undergoes this transformation, working capital may continue to pressure the firm’s ability to generate free cash flow, as seen quarter-to-quarter since q4’23. I anticipate the pressure to free cash flow to remain elevated as the firm spins up its new facilities in q4’24, which should allow SMCI to destock inventory to a more normalized level. For reference, the cash conversion cycle increased from 116 days in q2’24 to 162 days in q3’24, primarily driven by days inventory growing from 116 days to 151 days for the period.

I believe that the inventory build will benefit SMCI on two fronts. The first is to help maintain stock to ensure SMCI can cater to their customers’ needs and the second is to protect the firm from further supply chain challenges as a result of geopolitical factors. I anticipate that once the three facilities in Silicon Valley, Taiwan, and Malaysia are running at capacity, the firm will have the flexibility to move more inventory through the channels and reduce working capital. This should have a positive effect to free cash flow in future periods and may turn to a positive cash inflow in late eFY25. I do, however, anticipate macroeconomic pressures to slow SMCI’s growth in eFY25, which may counter the firm’s efforts to balance out working capital investments, which I will discuss later in this report. In the meantime, I anticipate significant cash outflows that may appear worse than they actually are. As a result, I believe it would be prudent to focus on the income statement for any signs of weakness in revenue growth and margin compression.

Looking to the operating statement, SMCI undershot my initial forecast for revenue growth by -$128mm, though grew at an exceptional pace of +200%. Management forecast growth for q4’24 in the range of 133-152% as the firm’s DLC and direct air cooling solutions remain in high demand as enterprise data centers and hyperscalers continue to spin up at an accelerating pace.

As of q3’24, Oracle (ORCL) was in-line to spin up 22 data centers with new orders coming in from Microsoft (MSFT) during the quarterly results. Given regional data privacy laws and regulations, I anticipate continued growth in data center build-outs as GenAI is further adopted across enterprises, sovereign governments, in hyperscalers.

One of the biggest challenges faced across AI-enabled infrastructure in the data center is the increased power demand.

We’re considered a mission-critical facility. The customers we’re serving are very energy-conscious.

Stuart Lawrence, Stream Data’s vice president for product innovation and sustainability

CBRE reported that the US data center space expanded by 26% in 2023 with no expectations for the growth to stop. The challenge the data center space is faced with is power supply, driving data center developers to focus on securing contracts with utilities as well as investing in on-site generators to ensure no downtime risk. According to SMCI’s management, their DLC technology can save upwards of 40% on power usage, posing a valuable business case for data center customers. Though this doesn’t resolve the problem entirely, I believe that data centers having the proper cooling systems can help mitigate some of the risk.

With this in mind, SMCI’s AI server racks offer a strong proposition to enterprises and hyperscalers as a plug-and-play asset as the infrastructure takes minimal onsite configuration once built out. Given SMCI’s omnichannel scale across Nvidia (NVDA), AMD (AMD), and Intel (INTC), customers can customize their server rack to suit their needs prior to delivery, allowing the firm to implement the infrastructure in days vs. weeks. I believe that this strategy is highly appealing considering that enterprises are seeking to manage down costs while bolstering their high performance compute needs. This will both mitigate installation and configuration costs as well as minimize installation time to allow the enterprise and hyperscaler to spin up their data-driven applications. Taking into consideration verbiage from Hewlett Packard Enterprise (HPE) and Dell Technologies (DELL), AI-enabled infrastructure is growing at a rapid pace as traditional server infrastructure remains in a destocking phase. According to the two firms, one of the major challenges is sourcing Nvidia’s GPUs; however, this challenge is expected to be overcome by the end of 2024 as Taiwan Semiconductor (TSM) doubles their CoWoS capacity, debottlenecking the supply chain. Though Nvidia GPUs appear to be hard to come by given verbiage from HPE and Dell, SMCI hasn’t voiced the same concerns, making me believe that the firm has ample supply of GPUs to cater to customers’ needs. I believe that this will put SMCI in a strong position as a reliable source for high performance computing needs and should benefit the firm as they scale their facilities to cater to higher growth.

Given that SMCI is heavily stocking inventory and building out their facilities, I believe the only major risk is being caught flatfooted by macroeconomic forces that have the potential to delay future growth at the enterprise level. As inflationary pressures persist on slowing GDP growth, there may be some budgetary constraints to be mindful of at the enterprise level going into the end of CY24 and into CY25.

PMI readings don’t offer much hope on new business as companies are facing a slowdown in new orders.

In addition to this, the TIPP Economic Optimism Index in the US fell to 41.8% in May 2024 with the 6-month outlook dropping sharply to 35.7%, levels last seen in 2008.

The catch-22 in the matter is whether firms will invest in AI capabilities in 2h24 and 2025. On the one hand, AI applications have the ability to save on costs through business optimization and automation. On the other hand, AI applications require high upfront costs if built internally and can be costly given the consumption model used by cloud providers. Given that hyperscalers’ competitive edge and ability to drive business is having the ability to cater to customers’ AI needs, I do not anticipate demand to wane at this level. Enterprises would be the segment most impacted by economic woes. Given that enterprises drove 49% of sales for SMCI in q3’24, this could potentially impact SMCI’s future growth by a significant proportion. The bull case for this matter would be that hyperscalers can offset these headwinds as they continue to build out their regional data center footprint.

Tying this back to SMCI, I do not expect an immediate impact to operations; however, I anticipate pressures from enterprise customers to begin in CY1h25. This may impact margins and push out positive free cash flow as a result of tighter operating margins. For these reasons, I am adjusting my forecast up for the duration of eFY24 and lowering my growth forecast for eFY25.

SMCI Valuation & Shareholder Value

Given the macroeconomic outlook as it pertains to SMCI’s growth, I believe there remains certain upside potential for the stock; however, I am lowering my growth forecast and price target when compared to my previous report. I am maintaining my BUY recommendation with a new price target of $1,420/share based on 4.32x eFY25 price/sales, a reduction from my previous $1,700/share price target. This still provides significant upside for shares going forward as the firm continues to realize significant demand for their data center infrastructure; however, I do anticipate some slowdown at the enterprise level.

On a company comparative basis, I do believe SMCI’s growth in the AI space justifies its higher premium when compared to its data center peers. I believe SMCI’s AI infrastructure growth far outpaces its competitors; however, I do anticipate DELL will have the ability to catch up as the firm focuses its attention further on the space.