Company Overview: Cadence Design Systems Inc. (NASDAQ: CDNS) offers solutions that help customers to design complicated and innovative electronic products. The company offers hardware and software, via its System Design Enablement (SDE) to electronic system providers and semiconductor customers. The key product line of the company consists of (1) Functional verification products, (2) Digital IC Design and Signoff, (3) Custom IC Design and Simulation, (4) Systems Design & Analysis segment, and (5) Under the IP segment.

CDNS Details

Robust Product Adoption & Expanding Customer Base: Cadence Design Systems Inc. (NASDAQ: CDNS) is engaged in providing products and tools that assist customers in designing electronic products. The market capitalization of the company as on 3 May 2021, stood at ~36.07 billion. The company remains on track with its robust implementation and ongoing impetus in its core business along with accelerating growth in its system business. The company continues to launch new products to meet the increasing demand of electronics and semiconductor companies. New product releases augur well for CDNS’ revenue growth. In the beginning of 2021, the company unveiled numerous new products, which consisted of Palladium Z2 emulation platform, Protium X2 prototyping platform, and next-generation Sigrity X for systems assessment. These products are designed to handle the growing difficulties of designing advanced applications along with augmenting time to market for such products. Currently, NVIDIA and Advanced Micro Devices are deploying Palladium Z2 and the Protium X2 systems for validating SoC and GPU designs. The company expects these two products to be available from 2QFY21.

The company is also seeing robust demand for its verification and digital design solutions from clients that continuously invest in new design concepts as well as projects. The company also invests in Internet of things (IoT) and augmented and virtual reality, which augurs well for CDNS. Apart from Palladium and Protium, CDNS’ Verification Suite features products like JasperGold, and Xcelium. Notably, in 2020, the company’s Palladium Z1 won 24 new customers, whereas Protium X1 won 13 new customers in the same time span.

In order to widen its System Design and Analysis portfolio and expand the engineering talent, the company successfully completed the buyout of NUMECA and Pointwise. This, in turn, aided the company to offer more capabilities and enhances customer’s value, thus increasing its total addressable market.

Looking at the past 4 years, the company has reported revenue CAGR of 10.24%. Also, the company witnessed a CAGR of 30.6% in its net income, over a period of 4 years (FY16-20).

Key Trend (Source: Company Reports)

Despite the COVID-19 led uncertainties, a robust pipeline of its digital & signoff, custom as well as analog and IP solutions is likely to aid the company’s financial performance, going forward. Additionally, strong adoption of the CDNS’ latest Clarity 3D Solver solution by companies like Ambarella augers well for the company’s performance. It is worth mentioning that companies including L&T Technology Services Limited and Global Unichip Corporation (GUC) has also opted for Clarity 3D Solver solution.

1QFY21 Key Financial Highlights: During the quarter, the company reported non-GAAP earnings of 83 cents per share, depicting a rise of 38.33% from the prior corresponding period. Revenues during the quarter came in at $736 million, up 19% on pcp, partially driven by Product & Maintenance segment that stood at $699 million in 1QFY21, up 20% on pcp, followed by Services segment increase by 2.8% YoY to $37 million. On a geographical basis, revenues contribution from Americas, China, Other Asia, Europe, Middle East, and Africa (EMEA) and Japan was 46%, 12%, 18%, 18% and 6% respectively. During the quarter, the company’s total non-GAAP costs and expenses came in at $456 million, depicting a rise of 8.8% on pcp. Non-GAAP gross margin came in at 90.4%, up 50 basis points YoY, while non-GAAP operating margin was expanded 590 bps on pcp.

1QFY21 Key Highlights (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders together form ~42.14% of the total shareholdings while the Top 4 constitutes the maximum holding. The Vanguard Group, Inc. and MFS Investment Management are holding a maximum stake in the company at 11.41% and 8.57%, respectively, as also highlighted in the chart below: 

Key Metrics & Decent Liquidity Position: CDNS is a cash-rich company with a strong balance sheet, which guarantees protection and rewards shareholders from its deep cash balances. The company exited Q1FY21 with cash and cash equivalents of ~$743 million, with long-term debt amounting to $347 million. Operating cash flow in 1QFY21 stood at $208 million, up from $136 million reported in 4QFY20. Free cash flow stood at $191 million in 1QFY21, up from $105 million in 4QFY20. Notably, in 1QFY21, CDNS repurchased shares worth around $172 million and had $566 million shares remaining under its buyback approval as of 3 April 2021. The share repurchases are a good way of returning cash to investors while at the same time providing a boost to the bottom-line.

In 1QFY21, the company’s EBITDA margin stood at 32.6%, higher than the industry median of 8%, indicating higher profitability. In the same time span, net margin and operating margin of the company stood at 25.4% and 27.7%, higher than the industry median of -4.3% and 0.5%, respectively. During the quarter, ROE of the company stood at 7.4% as compared to the industry median of -0.9%. In 1QFY21, Debt/Equity Ratio of the company was 0.14x, as compared to the industry median of 0.28x.

Profitability and Leverage Profile (Source: Refinitiv, Thomson Reuters), Analysis by Kalkine Group  

Key Risks: Stiff competition, adverse forex impact and a volatile macroeconomic environment poses serious threat to the company’s financial position. Further, the company’s financial performance can be battered by increasing headcounts and personnel costs. Also, rising investments on portfolio expansion and product developments are expected to weigh on the company’s margins. The company continues to acquire large number of companies which adds to integration risk. It is worth noting that a major portion of the company’s revenue is focused on a limited number of customers. Therefore, loss of one or more top ten customers, may decrease orders for the company’s services, and may dampen its financial stability. Also, the company expects hindrance in the supply chain of chip and second wave of COVID-19 situation in India to adversely impact revenues in the IP segment in FY21. 

Outlook: The company has raised its outlook for FY21 as it expects revenues to be in the ambit of $2.88-$2.93 billion, up from the prior guidance of $2.86-$2.92 billion. This depicts a YoY rise of ~7.7%. CDNS now expects non-GAAP earnings to be in the range of $2.99-$3.07 per share, up from the prior outlook of $2.95-$3.05 per share. For FY21, non-GAAP operating margin is expected to be in the ambit of 35-36%. Further, operating cash flow is expected to be in the range of $900-$950 million and expects to use 50% of free cash flow generated to buy back shares in FY21.

Coming to 2QFY21 outlook, the company expects revenues and non-GAAP earnings to be in the range of $705-$725 million and 74-78 cents per share, respectively. Further, non-GAAP operating margin is expected to be ~36% for 2QFY21.

Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative) 

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group 

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks. 

Stock Recommendation: Over the last one month, the stock went down by ~8.4%. The stock made a 52-week low and high of $75.27 and $149.08, respectively. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a target price of an upside of low double-digit (in percentage terms). We believe that the company can trade at a slight discount as compared to its peer average, considering its stiff competition, adverse currency translations, volatile macroeconomic environment, and customer concentration risk. For the purpose, we have taken peers like Synopsys Inc (NASDAQ: SNPS), ANSYS Inc (NASDAQ: ANSS), to name a few. Considering the company’s track record of robust liquidity position, decent 1QFY21 performance, acquisition synergies, robust product adoption, encouraging outlook and valuation, we give a “Buy” recommendation on the stock at the current market price of $129.62, down by ~1.63% on 3 May 2021.  

From the technical analysis standpoint, CDNS prices are trading in an upward trend. Prices have recently taken correction from higher levels and now are trading near the upward trendline support. RSI (14) is hovering near 70.79 levels which indicates the healthy momentum for the stock price. Prices are trading above the trend indicator 21 and 50 period SMA on monthly chart, which also support the bullish price action.

CDNS Monthly Technical Chart (Source: Refinitiv, Thomson Reuters)

Note: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.

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