China And Hardware Challenges Will Fuel AI And IP Potential

Key Takeaways

• Conservative guidance reflects challenges in China and competitive pressures, suggesting modest revenue growth and stable operating margins.
  
• Limited demand visibility for hardware sales in 2025 may impact revenue growth despite strong initial performance.
  
• Cadence Design Systems' strategic partnerships, AI advancements, and IP expansion position them for revenue growth and improved margins amidst rising demand for semiconductor innovations.

Catalysts

Provides software, hardware, and other services worldwide.

• The company anticipates flat revenue from China in 2025 due to ongoing macroeconomic uncertainties and export control regulations. This stagnation in a major market could hinder overall revenue growth.
  
• While Cadence experienced strong revenue and profitability in 2024, the guidance implies a deceleration in recurring revenue growth from significant prior-year growth rates, suggesting potential softness in the core EDA business which could limit future earnings expansion.
  
• There is prudent caution regarding hardware sales in 2025 due to limited visibility into demand beyond the first half of the year, potentially impacting hardware-related revenue despite strong initial performance.
  
• Management's guidance reflects a conservative approach, likely influenced by challenges with China and competitive pressures, which suggests an expectation of modest revenue growth, potentially keeping non-GAAP operating margins within a similar range as 2024 rather than expanding significantly.
  
• With anticipations of heightened design activity, especially outside China, the company remains conservative in its fiscal outlook, indicating that broader conditions may restrain revenue upside, impacting earnings per share growth.

Cadence Design Systems Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Cadence Design Systems compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Cadence Design Systems's revenue will grow by 8.7% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 22.7% today to 19.0% in 3 years time.
• The bearish analysts expect earnings to remain at the same level they are now, that being $1.1 billion (with an earnings per share of $4.85). The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 85.4x on those 2028 earnings, up from 68.7x today. This future PE is greater than the current PE for the US Software industry at 28.3x.
• Analysts expect the number of shares outstanding to grow by 0.73% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.64%, as per the Simply Wall St company report.

Cadence Design Systems Future Earnings Per Share Growth

Risks

• Cadence Design Systems' strong partnerships and collaborations with major technology companies like NVIDIA, Qualcomm, and Samsung indicate potential revenue growth through expanding their ecosystem and customer base.
  
• The growing adoption of AI-driven products and services, demonstrated by the proliferation of AI-powered products such as Cadence Cerebrus, SimAI, and Allegro X AI, could lead to revenue enhancement as AI becomes more integral to their offerings.
  
• The significant expansion of their IP business, with a 28% year-over-year growth in Q4, could result in continued revenue increases and potential improvement in net margins given the strategic focus on high-growth IP areas.
  
• The successful positioning in the AI super cycle and 3D-IC technologies suggest that Cadence is well-equipped to capitalize on future demand for semiconductor innovation, which could positively impact their earnings.
  
• Record backlog and commitments in their core EDA and hardware segments, driven by increased complexity in system designs and first-time right silicon demands, can contribute to steady revenue streams and potentially enhance profit margins.

Valuation

• The assumed bearish price target for Cadence Design Systems is $277.88, which represents one standard deviation below the consensus price target of $315.94. This valuation is based on what can be assumed as the expectations of Cadence Design Systems's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $355.0, and the most bearish reporting a price target of just $200.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $6.0 billion, earnings will come to $1.1 billion, and it would be trading on a PE ratio of 85.4x, assuming you use a discount rate of 7.6%.
  
• Given the current share price of $264.65, the bearish analyst price target of $277.88 is 4.8% higher. The relatively low difference between the current share price and the analyst bearish price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.