Super Micro Computers (NASDAQ:SMCI) stock was among the names that skyrocketed on artificial intelligence (AI) hype. In March, SMCI stock touched all-time highs of $1,229. There has been a deep correction from those levels for the AI-driven infrastructure solutions provider. Currently, SMCI stock trades at $540.98.
However, I would prefer to stay away from SMCI stock since better investment options are available in AI. True, a forward P/E of 14.8 looks attractive. Yet, the markets have ignored the P/E metric, and there are fundamental reasons for the stock remaining subdued.
Notably, after a massive correction from all-time highs, SMCI stock is higher by 80% for year-to-date (YTD).
So, is a market valuation of $30 billion justified?
Let’s uncover the potential concerns that make SMCI stock one to avoid. Investors may want to keep the stock on the radar, closely watching the industry dynamics and the company’s execution.
Markets Unimpressed by Top-Line Growth
Super Micro Computers has been on a high-growth trajectory. For financial year 2024, the company reported revenue growth of 110% year-over-year (YOY) to $14.9 billion.
For fiscal year 2025, the company has guided for revenue growth in the range of $25 billion to $30 billion. This would imply YOY growth of 74% to 101%. The company has future expansion plans that would boost revenue to $50 billion. At this growth rate, a forward P/E of 14.8 would generally indicate that the stock is deeply undervalued.
But, note two important points. First, on revenue of $14.9 billion, Super Micro Computers reported cash used in operations of $2.479 billion. Therefore, cash burn is significant, and gross margin declined significantly in Q4 FY24.
Further, the company’s cash from financing activities amounted to $3.9 billion in FY24. The balance sheet currently has convertible notes worth $1.7 billion, and I expect further fund raising to support accelerated growth. Accounts receivable and inventories stood at $7.1 billion with accounts payable at $1.5 billion. The overall balance sheet health doesn’t bode well. Thus, markets seem to be waiting for positive cash flows associated with stellar growth.
The Overcapacity Concern
Charles Liang, President and Chief Executive Officer of Super Micro Computer believes that the company is “well positioned to become the largest IT infrastructure company.” As SMCI targets revenue of $50 billion, it would require significant capital expenditure over the next 24 to 36 months. This would be through equity dilution or leveraging.
Besides the margin factor discussed above, I believe that overcapacity is a concern. Currently, companies are investing on the back of the AI hype. I am not suggesting that AI will not have an impact. However, there are genuine fears of over investment in IT infrastructure.
It’s worth noting that companies generally rely on leasing space from third-party data center than building their own facilities. Super Micro Computers generates 95% of its revenue from server & storage systems.
In December 2023, Oracle (NYSE:ORCL) CEO Larry Ellison indicated that the company is in the “process of expanding 66 of its existing cloud data centers and building 100 new cloud data centers.” Companies like Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) rely on wholesale providers and also build their own IT infrastructure. If major companies increasingly invest in their own infrastructure, there is a case for overcapacity and will impact growth and margins.
Bottom Line: Wait For Positive Cash Flows
SMCI stock has declined sharply from all-time highs. A key reason for this correction is margin contraction and significant cash used in operations. Ultimately, businesses are valued on the basis on the cash flow potential. While Super Micro Computers is on a high-growth trajectory, margin expansion is need to boost cash flows.
Therefore, I prefer to remain on the sidelines and prefer to see relatively subdued growth with better margins and positive operating cash flows. For now, the deep correction does not make SMCI stock worth investor consideration.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.
