Cadence Design Systems: Long-Term Revenue Growth Play (NASDAQ:CDNS)

Cadence Design Systems, Inc. (NASDAQ:CDNS) is an impressive growth story in the semiconductor designing market. Its revenue is expected to grow at a CAGR of around 6% in the next five years, driven by its highly advanced chip-designing products. Semiconductor designing activity is expected to remain modestly strong in the long term, which will keep Cadence’s revenue growth momentum strong. Long-term investors can buy the company’s shares during pullbacks.

Cadence offers its software, hardware, services and reusable IC design blocks to its electronic systems customers and semiconductor customers. The company’s technology is used by its electronic systems customers to develop ICs (integrated circuits) and PCBs (printed circuit boards). Its semiconductor customers develop memory chips, systems-on-chips (SoCs) and analog chips.

Growth Drivers

EDA Business

Cadence’s primary growth driver is its EDA (electronic design automation) business. The company’s EDA tools help engineers build different types of ICs and SoCs. According to a report:

The electronic design automation market revenue was accounted for USD 11.5 billion in 2020 and is projected to reach USD 18.1 billion by 2026, at a CAGR of 7.7% during the forecast period.

The increasing demand for complex integrated circuits (“ICs”) and technologically advanced consumer electronics along with growing adoption of connected devices are the major driving factors for the growth of the electronic design automation market.

Cadence’s EDA business is fueled by its customers’ investments in new products and new designs of existing products. The most promising new opportunities for the company exist in the areas of augmented reality (“AR”), virtual reality (“VR”), industrial internet of things (“IIoT”), hyperscale computing, artificial intelligence (“AI”), machine learning (“ML”), and edge computing. Existing opportunities belong to the areas of smartphones and networking equipment, communications (including 5G networks), automotive, aerospace and defense, and industrial and healthcare subsystems.

Cadence’s EDA tools are designed to offer its customers a competitive edge in developing ICs and SoCs. The products offer optimized performance for customers’ products, reduced power consumption, and shortening of time to market. As a result, the products enjoy rising demand in the marketplace, and perform well in competitive environment. The company’s EDA tools will drive long-term revenue growth for the company.

Competition

Cadence belongs to a highly competitive industry. The company’s competitors include Synopsys (SNPS), Keysight Technologies (KEYS) and Analog Devices (ADI). Cadence competes on the basis of product quality, customer service, and price.

The company’s primary competitive advantage lies in the fact that its products offer its customers various differentiation, capabilities and benefits in their businesses. Rapid pace of innovation is bringing new opportunities for Cadence’s products, such as addressing key challenges associated with electronic product development, like power consumption, product performance, chip area and cost. The company is applying machine learning within its products to enhance quality of results (“QoR”), productivity, and performance of its products. These are the reasons the company’s products will drive long-term revenue growth for the company.

The company’s other competitive advantage is that it offers its IP (intellectual property) assets in the form of software, hardware, services, and reusable IC design blocks to its customers for manufacturing their ICs. In this way, the company’s customers accelerate their product development processes. As a result, the company’s IP assets enjoy strong demand in the market.

First Quarter 2022 Financial Results

Cadence delivered first quarter 2022 revenue of $902 million, compared to revenue of $736 million in the year-ago period. This is a year-over-year increase of 22.55%. The company’s non-GAAP net income was $324 million, which translates into an EPS of $1.17, which was a year-over-year increase of 41%.

The company delivered an excellent result for the first quarter of 2022. Top-line expanded driven by broad-based strength across the company’s diverse product portfolio. Bottom-line expanded driven by the company’s clients’ robust design activity, and accelerating growth in the company’s core and new systems businesses. I expect the company will soon start offering dividends resulting from strong and consistent bottom-line expansion. Bottom-line will grow due to rapidly expanding customer base of the company driven by its Intelligent System Design strategy which aligns well with the growing market of electronic product development.

An explosion of data is being created driven by generational trends in the fields of hyperscale computing, 5G communications, autonomous driving and AI/ML. These trends are driving the demand for next-generation computing, connectivity, storage and data analytics solutions, which in turn are fueling solid and consistent design activity. I expect these trends will continue to remain active over the next five years, which will drive Cadence’s long-term revenue growth.

Valuation

The company’s peer group companies include Synopsys, Keysight Technologies, Analog Devices, Microchip Technology (MCHP), and Power Integrations (POWI).

	CDNS	SNPS	KEYS	ADI	MCHP	POWI
Non-GAAP (FY1) P/E	38.49x	35.80x	19.44x	15.88x	10.62x	19.65x
TTM Price/Sales	13.07x	9.84x	4.95x	7.17x	4.70x	6.37x
TTM Price/Cash Flow	33.86x	27.57x	21.76x	20.98x	11.32x	17.78x

(Data Source: Seeking Alpha)

The company’s valuation is expensive compared to its peer group companies. The company has a cash-rich balance sheet comprising of cash and equivalents of $1,134.8 million and total debt of $347.8 million. The company’s valuation is expensive because demand for the company’s products supporting IC and SoC design activities will continue to remain modestly robust in the next five years, although I believe economic activities in the macro level will remain soft in the same time-frame. I expect depressed economic activities won’t severely hinder the development of products related to AR, VR, AI, and ML. This will keep Cadence’s valuation in the upward trajectory despite downward market movements could create lucrative buying opportunities for the company’s stock. I am bullish on the company’s stock in the long term, and I believe the stock is “buy on dips.”

In the last five years Cadence’s revenue has grown at a CAGR of 10%, and I expect revenue will continue to grow at a CAGR of around 6% in the next five years (factoring in lukewarm macro activities). The company’s trailing 12-month revenue is $3,154.00 million, and at a CAGR of 6% the company’s mid-2027 revenue will be $4,220.00 million, or $15.30 per share. In the last five years, the company’s shares have traded between the price to sales multiples of 5x and 18x. I believe the company’s price to sales multiple will remain at a high of around 12x in the next five years, due to longer term revenue growth opportunities of the company. Applying a price to sales multiple of 12x on Cadence’s mid-2027 revenue per share, I get $183.60 as the company’s mid-2027 share price.

Risks

In future, the company will generate revenue from its installed customer base, which will consist of traditionally generated new license, service and maintenance revenue. The company’s existing customers might not purchase or license its products and services in the coming months and years, which could negatively impact the company’s long-term revenue growth.

The company’s future success will depend on its ability to manufacture new products, and to enhance existing products. For remaining successful, the company must be able to grow its EDA and IP products line-up in the long term. If the company fails to do this on a consistent basis, its future revenue growth could be negatively impacted.

Conclusion

Robust design activity of the semiconductor players in the next five years will fuel Cadence’s long-term revenue and profitability growth. Creation of new products in the computing and electronics fields will boost design activity of semiconductor players. This will ensure Cadence will remain as a leader in its area of operations. Long-term growth-oriented investors can buy the company’s shares during pullbacks to maximize their profit.