In the world of corporate triumph, Cadence Design Systems (NASDAQ: CDNS) unveiled the compelling narrative of its third-quarter earnings in late October, aiming to sustain the impressive momentum built over the last year. Surpassing analyst expectations, the earnings showcased a robust 13.4% surge in revenue, reaching a significant $1.02 billion and outpacing the consensus of $1 billion. Simultaneously, the adjusted earnings per share (EPS) ascended from $1.06 to a noteworthy $1.26, effortlessly surpassing the predicted $1.22 and achieving a notable accomplishment on its top and bottom lines.
Despite the applause for this financial prowess, the company’s shares experienced a brief descent in the aftermath of the report, primarily attributed to the next quarter’s revenue guidance of $1.06 billion, coming in slightly below the consensus. However, undeterred by the market’s reaction, CEO Anirudh Devgan expressed his satisfaction with the company’s formidable Q3 performance. Emphasizing its unwavering commitment to driving innovation and ensuring customer satisfaction, Cadence continues to carve a compelling path in the electronic design landscape.
Technical
On the 1D chart, an uptrend has sustained, as the share price has found buyers at the dynamic support of the trend. The 25-SMA (green line) has crossed above the 50-SMA (blue line) and 100-SMA (orange line), confirming the shorter-term trend. However, with a recent breakout from the ascending channel resistance and the RSI indicating potential overbought conditions, a pullback may be on the cards.
If the current breakout’s momentum fades, the retracement could look for support at the breakout level close to $255.78. This could be a critical level, as the share price could either find buyers to confirm the strength of the breakout or move back within the channel in a potential reversal of the current momentum. If this support level fails, the share price could move lower toward $247.45, where a change in polarity may provide support to the price at a prior psychological resistance. At this level, the multiple SMAs are close by, which could make it a challenging level for the buyers to break down.
However, the current trend could continue if the price stays above the support at $255.78. The 161.8% Fibonacci extension at $272.12 could be a hurdle to cross in this case before the share price could converge with its estimated fair value of $275.05, which provides a 4.2% potential upside from its current levels.
Fundamental
Cadence, a trailblazer in crafting design solutions for the electronics industry, stands as a testament to the transformative wave of artificial intelligence (AI), high-performance computing, and autonomous driving. Amid a challenging financial landscape marked by stringent monetary conditions, a corporate spending downturn, and inflationary challenges, Cadence has defied the odds. Remarkably, its share price has surged by an extraordinary 130% in the past three years, eclipsing not only its industry peers but also outshining the Nasdaq 100, which posted a comparatively modest 31% return during the same period. This phenomenal performance prompts the question: in the wake of such a remarkable ascent, does the horizon still hold untapped potential for growth for this design powerhouse, considering the recent geopolitical drama in the Middle East and the US government’s expanded restrictions on the exports of certain semiconductor chips and systems for data centres to China?
Firstly, the company has shown modest revenue growth over the last few years, as shown in the chart below. Its latest quarterly report showed a 13.4% expansion to $1.02Bn, with custom integrated circuit (IC) design and simulation attributing 22% of its top line, while digital IC design and sign-off contributed an additional 28%. Functional verification accounted for 26% of its top line, with another 11% coming from intellectual property (IP) and system and design analysis rounding it off with a 13% contribution. Its backlog declined from $5.8Bn but remained healthy at $5.4Bn, while its CEO remains bullish on the company’s prospects. The company’s growth prospects lie in generational trends, including AI, as it provides semiconductor design software solutions. Management acknowledged this, showcasing their excitement around the momentum of its JedAI platform-based generative AI applications that are delivering breakthrough results for its customers. Clearly, a runway for growth in this lucrative industry exists, but is Cadence positioned to invest and benefit from this potential sustainably?
Its cash flow and balance sheet positioning certainly suggests so. Due to the company’s asset-light business, scale advantages, and impressive competitive positioning, it has been able to grow its free cash flow (FCF) at a healthy rate, with its FCF margin expanding over the last few years, as shown below. After generating $373.9M in free cash flow in its latest quarter, a 37% expansion from the year-ago period, Cadence now stands with an impressive $1.24Bn in free cash flow generated over the last twelve months, reflecting over 31% of revenue. Additionally, it holds $962M in cash, putting it in a lucrative position to continue pursuing its high-growth strategy, as it can invest heavily into growth prospects while potentially providing additional returns to shareholders in the form of dividends. In short, the company has a clear runway for growth and holds sufficient resources to pursue these opportunities sustainably.
Summary
Cadence Design Systems has caught the market’s attention over the last few years with a stellar bullish run. Secular trends in AI and the broader electronics industry have provided the company with lucrative growth opportunities, and investors have noticed its financial health, which allows the company to pursue potential ventures that could unlock additional growth. With an estimated fair value of $275.05, upside potential remains despite the recent bullish run that has sent the share price to new heights. However, with the current interest rate and inflation environment in the US markets, the technology sector is teetering on the edge of caution, as an upside inflation surprise in Tuesday’s release could heavily distort the markets.
Sources: Koyfin, Tradingview, Yahoo Finance, Investor’s Business Daily, Cadence Design Systems, Inc.
Piece written by Tiaan van Aswegen, Trive Financial Market Analyst
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