A Sneaky Way To Play The Booming Chip Industry

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Sometimes the most interesting stocks aren’t the most popular.

We’ve covered plenty of the top names like Shopify and Salesforce.

But it was during that research we came across a large cap name with little recognition – Cadence Design Systems (CDNS).

And it ties into a broader theme we see in the markets.

The demand for chips jumped during the pandemic causing massive supply chain issues. To help boost chip production in the U.S., the Senate passed the Chips Act. While that will benefit certain chip makers, it’s surely going to help chip design companies like Cadence Design Systems (CDNS). 

More and more big tech companies are developing their own chips and will need help with the design. But does that mean CDNS is a stock worth buying and owning?

Our magic eight ball says yes, and here’s why.

Cadence Design Systems’ Business

Cadence Design Systems (CDNS) develops and markets design software for integrated circuits and electronic systems. 

It provides software, hardware, services, and reusable, integrated circuit designs worldwide. Think of them like the software behind microprocessor design.

CDNS serves 5G communications, aerospace and defense, automotive, industrial and healthcare, mobile, consumer, and hyper-scale computing markets. It generates revenues through the sale of licenses and maintenance services, design software, integrated circuit verification, simulation, and performance control systems, consulting, training, system design and development, and technical assistance.  

The company announced double-digit growth across all product categories for Q2 2022. 

In addition, it reported $858 million in revenues, compared to $728 million for the same period in 2021. 

Traditionally, CDNS served big chip companies like Intel and AMD. However, the potential market opportunity has vastly increased with Apple, Google, and other players getting into the game.

Financials

CDNS has nearly doubled its revenues from 2014 to 2021, going from $1.58 billion to $2.98 billion. 

Its 12-month trailing revenues currently stand at $3.28 billion, as the firm is on pace to have another record-breaking revenue year. 

Based on its most recent quarter, CDNS has $1.03 billion in total cash and $348 million in total debt. It has a current ratio of 1.59x, implying it has more than enough liquid assets to cover its short-term liabilities. 

Valuation

While CDNS has consistently experienced solid growth through the years, it isn’t necessarily a cheap stock. The firm trades at a P/E GAAP of 62.4x, notably higher than its 5-year average of 48.4x, and a non-GAAP of 45.14x. 

However, unlike most high P/E tech stocks, CDNS has outperformed the overall market in 2022, as shares are down modestly at -6.2% year-to-date. 

CDNS trades at a price-to-sales ratio of 14.5x, significantly higher than its 5-year average of 10x. 

Furthermore, its price-to-sales ratio is higher than competitors Synopsys (SNPS) at 10.5x, ANSYS (ANSS) at 11.3x,  Axcelis Technologies (ACLS) at 2.7x, and Autodesk (ADSK) at 9.7x.

However, there is good reason for this.

Profitability

CDNS is in a high gross profit margin business. The firm has a gross profit margin of 89.7%. It’s right in line or better than its competitors, SNPS at 80.7%, ANSS at 90.3%, ACLS at 43.9%, and ADSK at 91.6%. 

At an EBITDA margin of 34.5%, CDNS scores higher than its competition, SNPS at 26.8%, ANSS at 33.6%, ACLS at 23.7%, and ADSK at 20.8%. 

CDNS has a return on equity of 30.1%, notably better than SNPS at 19%, ANSS at 10.5%, ACLS at 27.5%, but not as strong as ADSK 53.9%. 

Growth

CDNS has grown revenues at 13.5% (YoY), which is not as strong as some of its competitors, SNPS at 21.4%, ACLS at 57.4%, and ADSK at 17.4%. However, CDNS consistently has grown its revenues year after year. Forward growth is still expected to hit 14.4%.

Our Opinion 8/10

CDNS is a great company with high-profit margins and double-digit revenue growth. 

However, it’s trading at a relatively high P/E multiple. But Wall Street doesn’t seem to have a problem with it. Shares are modestly lower year-to-date. 

Furthermore, the demand for chips should remain strong for years to come, as well as, the demand for chip design. The company has proven resilient, and we have no reason to believe that will change in the future. We believe that CDNS should be bought on weakness, ideally down near $140-$150 per share, as its prospects for the future seem bright.