A Scenario Where Super Micro Stock Could Fall 50%

Super Micro Computer stock (NASDAQ: SMCI) has seen a big sell-off in recent months, falling from highs of nearly $1,200 per share in March to about $445 presently. There have been a couple of trends driving the sell-off including concerns about gross margins, some supply chain issues, and the company’s delay in filing its Form 10-K with the SEC, after short-seller, Hindenburg Research accused the company of irregularities with its accounting. Despite these setbacks, the stock remains up by about 7x from 2022, driven by surging demand for server systems fueled by the generative artificial intelligence wave. However, with these challenges, the stock could decline further, possibly touching around $200 per share.

Super Micro stock trades at just about 18x trailing earnings and 12x forward earnings at the current price level. Although this isn’t a very high multiple, there’s a very real possibility that Super Micro’s earnings could decline after a couple of years of stellar growth. Moreover, the uncertainty relating to compliance-related matters could weigh on the stock. This analysis outlines how the stock could decline by about 50% in the next few years by looking at the company’s potential revenue growth, net margins, and price-to-earnings multiple. While this article spotlights the downside case for the stock, the upside case can be seen here: Can Super Micro stock fare better than AI bellwether Nvidia?

SMCI Rallied Big But Witnessed Considerable Volatility

SMCI stock has generated better returns than the broader market in each of the last 3 years. Returns for the stock were 39% in 2021, 87% in 2022, and 246% in 2023. However, the stock has also declined by roughly 60% since March 2024 making it a relatively volatile bet. In contrast, the Trefis High Quality Portfolio, with a collection of 30 stocks, is considerably less volatile. And it has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and multiple wars, could SMCI see a strong jump?

Revenues Could Fall As Server Investment Cycle Turns

Super Micro Computer is a data center solutions provider, which sells server systems, server boards, storage, networking solutions, management software, and installation and maintenance services. SMCI is projected to grow its revenue by close to 90% in FY’25 (the current fiscal year) to levels of about $28 billion, per consensus estimates, as data center-related spending remains strong, with tech companies continuing to invest in AI and accelerated computing capacity. However, the current euphoria might be masking the fact that the server market can, in fact, be cyclical and things could take a turn for the worse.

The underlying economics of the end market for the broader AI ecosystem remain weak, and most of AI customers remain loss-making. Large language models are also very expensive to build and train. We could very well be in a phase where companies are seeing so-called FOMO, compelling them to invest in AI just because their rivals are doing so, without a thought about the return on investments. As shareholders seek better returns, we could see capital spending cool off, impacting the likes of Super Micro. Moreover, most AI companies are going through the compute-intensive training phase at the moment, and there’s a real possibility that demand for computing power and servers could cool off once these companies move to the less compute-intensive deployment phase. The server market is also very commoditized. While Super Micro does have some competitive advantages, given that its products are seen as being more customizable, the company’s lead in these areas is hardly insurmountable and competition could mount considerably. Considering a potential cooling of demand and higher competition, if SMCI’s revenues decline by about 15% each year over FY’26 and FY’27 revenues could stand at $20 billion by FY’27. Looking for more companies that can benefit from increased digitization and AI deployment?

Combine this weaker-than-expected revenue growth with the possibility that Super Micro’s adjusted net margins (net income, or profits after all expenses and taxes, calculated as a percent of revenues) can decline a bit. Although margins expanded from 6% in FY’22 to about 9% in FY’24, driven by higher economies of scale, they could decline meaningfully if sales drop and competition mounts reducing the company’s volumes and pricing power. Moreover, SMCI has seen its gross margins face some pressure in recent quarters as it sells a higher mix of liquid-cooling systems, which are proving expensive to produce and this trend could also continue. Considering this, it may be reasonable to assume that Super Micro’s adjusted net margins could decline from an estimated 9% this year to about 6.5% by FY’27, or about 0.72x current levels.

Valuation Multiple Could Contract

If revenues decline by about 0.7x between FY’25 and FY’27, with margins contracting by about 0.72x over the same period, this would imply that earnings could fall by about 0.5x. Now if earnings fall by 50%, the P/E multiple is bound to take a hit as investors re-assess SMCI’s overall long-term earnings growth prospects. If SMCI’s P/E multiple gradually shrinks from a multiple of about 12x based on FY’25 earnings presently to about 10x, this could translate into a decline in SMCI stock to levels of under $200 per share by 2027. What about the time horizon for this negative-return scenario? In practice, it won’t make much difference whether it takes 2 years or 5 - if the competitive threat plays out and SMCI sees the demand cycle turn, we could see a correction. And a sizable one at that.