It’s been a rough few months for Super microcomputer (NASDAQ:SMCI)whose shares have come under pressure this year for various reasons. The stock fell for the first time in April after a mixed reaction to third-quarter fiscal 2024 results. This trend continued until the fourth-quarter earnings release in early August, with declining margins worrying investors .
The company was then the subject of a short selling report in late August from Hindenburg Research, which accused the company of accounting manipulation, sanctions evasion and self-dealing with related parties by management. Not to help matters, the company delayed filing its 10-K shortly after the brief report, although management has denied any wrongdoing.
On September 26, the stock fell even further after a report of The Wall Street Journal claim that the Department of Justice (DOJ) is also investigating the company. Neither the DOJ nor the company have confirmed the investigation.
And most recently, Supermicro completed its 10-for-1 stock split on October 1. These various developments have all made the stock highly volatile, with shares down 66% from their March peak. But Supermicro is still up over 45% year to date, which begs the question: what should investors do with the stock now?
So what does it do Want to do Super Micro Computer anyway?
Supermicro designs and produces servers and storage systems. It assembles so-called white box servers, which are basically the generic branded versions of servers, using commercially available computer parts. It competes with other white box server providers as well as branded offerings Dell, LenovoAnd Hewlett Packard Enterprise.
The company has benefited from massive data center expansions as part of the artificial intelligence (AI) craze. The company’s revenue grew 143% in the fourth quarter of fiscal 2024 (ended June 30) to $5.31 billion. Supermicro has credited its next-generation air-cooled and DLC rack-scale AI GPU platforms for its strong growth. These systems are used to prevent servers from overheating and failing, while also reducing energy costs.
While Supermicro has had strong AI tailwinds, it ultimately finds itself in a highly competitive, low-margin business without much differentiation. Sales may have soared last quarter, but gross margin fell to 11.2%, compared to 17.0% a year ago and 15.5% in the previous quarter. The company blames the margin pressure on a combination of product mix, lowered prices to win new designs and the cost of ramping up its rack-scale direct liquid-cooled (DLC) AI GPU clusters. Management expects gross margin to gradually improve in fiscal 2025 and return to a range of 14% to 17%.
An 11% gross margin is small, and even 17% isn’t exactly robust. By comparison, the chip companies that are driving the buildout of AI infrastructure have much higher gross margins at both Nvidia And Broadcom with gross margins of at least 60% in the past quarter.
Should Investors Be Worried About a Possible DOJ Investigation?
At this point, the allegations in the brief report against Supermicro are just that: allegations. And investors should be aware that Hindenburg Research issued the report in hopes of lowering the stock price in favor of the short position. The company has succeeded.
In the meantime, the DOJ investigation continued The Wall Street Journal has still not been confirmed by DOJ officials and company management.
That said, Supermicro has run afoul of US regulators in the past. The SEC fined the company in 2020 over accounting issues after accusing the company of shipping products to warehouses at the end of the quarter and recognizing it as revenue before the products reached customers. The company ultimately agreed to pay a $17.5 million fine without admitting or denying details of the SEC investigation.
Given this history, the Hindenburg report and the DOJ news are a bit concerning. However, Supermicro still sells real products, has real customers, and benefits from rapid AI development.
Time to buy the shares or stay away?
Even before the company’s latest troubles, I didn’t think Supermicro was a particularly good investment, given its margin profile and expensive stock. After these reports, the bull case becomes even harder to accept.
However, in terms of valuation, the recent sell-off has made the stock a lot more attractive with a price-to-earnings (P/E) ratio of less than 10 and a price-to-earnings-growth (PEG) ratio of just 0.2. . A PEG ratio of less than 1.0 is generally considered undervalued. However, as the chart below shows, it has been quite common in the past for stocks to trade at even lower valuations.
Given the uncertainty surrounding the stock, I would stay on the sidelines. However, this isn’t a situation where investors should rush to sell their positions, given Supermicro’s current valuation and the growth in AI-related spending.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
Super Micro Computer shares plummet on recent news. Time to buy or stay away? was originally published by The Motley Fool
