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Morningstar | Cadence Shrugs Off Geopolitical Concerns; System Design Underlies Growth; Shares Overvalued

Cadence Design Systems posted a solid second-quarter result with the firm recording revenue in line with our expectations and margins slightly higher than what we were expecting. Despite the geopolitical turmoil during the quarter, management noted that activity remained healthy and that its system design strategy continued to expand sales opportunities, with customers pursuing burgeoning growth around artificial intelligence, 5G, autonomous vehicles, and the Internet of Things. Given the quarter, management slightly raised the midpoint of its full-year revenue and earnings forecast. Still, the modest increase does little to our expectations and we maintain our $42 fair value estimate and narrow economic moat rating. Even with shares down a little in afterhours trade, we see Cadence as significantly overvalued and would avoid investing new capital in the company.

For the quarter, total revenue rose 12% year over year to $580 million. Product & maintenance revenue was up 12% to $548 million while services revenue was up 6% to $32 million. Digital and sign-off products performed well in the quarter as customers adopted new advanced nodes. System design and verification also saw good hardware adoption and custom analog design was boosted by new product launches such as Spectre X Simulator, which significantly accelerates client’s design simulation. Geographically, China constituted 12% of revenue in the quarter, up from 10% in the first quarter and 8% from the year ago period. While the impact of Chinese trade restrictions wasn’t particularly notable in the quarter, we expect it to be more apparent in the second half of the year, and management is forecasting the remainder of the year to be impacted by ongoing trade restrictions as they exist today.

Non-GAAP operating margins were stronger than we had expected, up 380 basis points year over year to 33.6%. Still, the company noted that the margin result was a little peculiar and it expects to see normalization in the second half of the year. The second quarter benefited from some unexpectedly positive mix around hardware and services, which isn’t expected to persist. Meanwhile, Cadence is forecasting approximately 30% non-GAAP margins in the back half of the year as it ramps investment with customers and absorbs annual employee compensation increases which start in July. As a result, we think the firm’s full-year margin will be within guidance of 31%-32%.