Cadence Design Systems Stock: AI R&D Upside Risk (NASDAQ:CDNS)

summary

The semiconductor sector is an essential part of the modern economy, providing the infrastructure for the software that runs everything from smartphones to airplanes, e-commerce, banking, and generative AI. At the same time, there is a lot in the chip sector. It includes not only the sub-sectors (analog, microprocessors, microcontrollers, DRAM and flash), but also the long supply chain, from chip developers to foundries and equipment manufacturers. Cadence Design System (NASDAQ:CDNS) is Nvidia (nvidia) to utilize EDAs (Electronic Design Automation) and semiconductor sectors to deliver steady growth and high cash flow margins. Competition for AI capabilities is likely to increase R&D spending, and Cadence could see accelerated growth exceeding current market consensus, which could lead to continued stock gains. Despite its already premium valuation.

Performance

Over the past decade, Cadence has outperformed most suppliers to semiconductor designers, such as Taiwan Semiconductor Manufacturing (TSM) and ASML Holding (ASML), as well as the Philadelphia Semiconductor Index (SOX). In comparison, rivals Synopsys (SNPS) and Lam Research (LRCX) have been keeping pace over the past five years.

Premium Rating

Synapsis and ARM (ARM) are the closest competitors, but we’ve also listed several other application software companies to see valuation and growth across the sector. As you can see in the table below, comparable companies are trading at a PEG (PE to EPS growth) of more than 3x, while earnings and EPS growth rates vary and the companies’ margins are very high.

In the preceding chart, I compared Cadence forward PE to the PE of the broader technology market, such as the Nasdaq 100 (NDX), the semiconductor sector, and several key and high-profile vendors, and found that the EDA provider had the highest PE. evaluation. This can be caused by low cyclicality, robust growth, and high margins. Additionally, Cadence’s PE has steadily increased from 30x to over 50x, while Nasdaq’s has remained relatively flat (22x to 28x). The components and charts help us understand that the market is willing to pay for Cadence stock, and while we do not expect or consider further multiple expansion, we believe that current valuation metrics are sustainable as long as the company and the sector deliver. It’s reasonable to assume: expectation.

Price rise after 2024

The consensus price target is US$320, currently priced at 75x P/E and 57x P/Cash Earnings. This is a better indicator and puts it back at 2.7x PEG. Applying a 2.5x PEG to YE25 cash earnings raises the target price to US$434, or over 40% upside from current levels. I provide a rationale for using cash receipts in subsequent segments.

Growth through semiconductor R&D

Cadence provides EDA software and hardware solutions to chip designers in other segments classified as research and development expenditures. We compared Cadence’s financial growth with the R&D spending of some major semiconductor companies and found that demand for EDA is likely to increase. Nvidia and Advanced Micro Devices (AMD) increased their R&D spending by more than 20%, while others, such as Intel (INTC), increased their R&D spending by less than 7%. The need for AI computing power may require higher R&D, and companies not currently participating in this space may need to step up their R&D. In my view, there are upside risks to Cadence’s revenue growth that could materialize in 2024.

Cash flow is higher than revenue

Net income underreports earnings power primarily due to stock-based compensation. Cadence is not a new technology company that needs to pay for inventory to retain employees while its business expands. But it’s still paying out about 8% of its revenue in stock, which is equivalent to 30% of its net income and cuts into its reported EPS. This stock compensation is a non-cash expense and is added back to cash flow to repurchase stock, fully offsetting any future dilution. As you can see in the table and chart below, the company’s cash flow has grown faster than its earnings, and its net share buybacks are twice its stock compensation.

financial summary

Below is a financial summary with consensus estimates for 2026. The market estimates that revenue will continue to grow by less than 15% with margin growth driving much faster EPS and cash flow growth. As previously mentioned, there is a positive risk that EDA revenue and demand will grow more than expected as the semiconductor sector scrambles to participate in AI demand.

conclusion

I rate Cadence a Buy. The company offers investors stocks with high earnings elasticity and high free cash flow that need to keep pace with, if not exceed, semiconductor R&D spending in the race to meet AI computing power. The biggest downside is that since it is already a very valuable stock, you may need a longer holding period to reap significant returns.