Cadence Design Systems Is a Hidden Gem
As earnings season progresses, investors and analysts are starting to get a true sense of COVID-19 damage.
Despite this turbulence, there are always some great buys in the market.
One of those great buys is Cadence Design Systems, Inc. (Nasdaq: CDNS, Rated “B”). Their most recent quarterly financial results, reported in July, exceeded all key metrics. Managers raised the outlook for 2020 sales and profits.
The San Jose, Calif.-based business is rare. It makes electronic design automation software and hardware. It may seem a bit complicated, but what you need to know is the company helps other businesses design integrated circuits, printed circuit boards and systems on chips.
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These little circuits, boards and systems on chips are behind every interaction on our electronic devices. Every time we swipe on a screen or turn on our modern TV or washing machine, some set of instructions is routed across a maze of circuits, boards and processors.
Without these systems, increasingly designed using Cadence gear, there would be no digital revolution.
For the past five years, Cadence has been a consistent 6% to 9% annual revenue growth business. The company logged $2.3 billion in revenues during 2019. Then, several longer-term bets began to pay off. Next-generation telecommunications equipment infrastructure and networked computing moved to new architectures.
When CEO Lip-Bu Tan guided analysts sales estimates higher at the end of 2019, he noted continued growth across all segments of the business. Data center and 5G reported solid gains. However, Tan was most enthusiastic about AI and machine learning, a part of the business he felt might eclipse the core business over time.
Big data and algorithms are prompting demand from what he called new domain specific accelerators. These tasks demand custom silicon. Increasingly newer and smarter systems on chips and printed boards are being developed for specific healthcare, transportation and manufacturing applications.
This development echoes what is happening at Adobe Inc. (Nasdaq: ADBE, Rated “B”). The company makes no hardware. In a modular new world of public clouds and software as a service, Adobe works in a narrow niche. Still, managers are considering building custom systems on chips. Their partner of choice is Cadence.
The new chip business punctuated spectacular second quarter financial results. In a corporate press release, the company announced revenue reached $638 million, up from $580 million a year ago. Operating margins swelled to 24%, even as the company continued to invest in collaborations and its “Cadence Cloud”, a system that lets partners design and verify next generation chips in a secure, virtual environment.
The infrastructure shift was opportune. Before the pandemic, Cadence operated from 50 cites across the globe. The company now functions as a distributed network, operating out of 8,000 sites. Many of these are highly skilled Cadence employees working from home.
Despite the splintered nature of its post-COVID-19 workforce, business is booming.
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The firm now expects 2020 revenue in the range of $2.59 to $2.62 billion, an 11% increase over 2019. Operating margin should be 22%. Given the state of the world, these numbers are shockingly good. Investors sent the stock up 4% in after-hours trading.
Cadence is a rare business because it operates in a niche that is mostly untouched by near-term macroeconomic events. Its customers operate on longer cycles.
For example, Cadence announced in July 2018 that it was awarded a contract by the Defense Advanced Research Projects Agency. The company will help the Pentagon research group automate the design of the next generation of specialized processors and printed circuit boards. That project is moving full steam ahead despite the pandemic.
Cadence trades at 38.2 times forward earnings, near $110.57. Its market capitalization is still only $30.7 billion.
Investors need to keep this on their radar and to use pullbacks as opportunities.
Jon D. Markman