Cadence Design Stock Soars on Earnings. It’s an ‘Essential’ Play on Chips.

Cadence stock soared more than 9% on Tuesday morning. (Dreamstime)

Cadence Design Systems , a key player in the chipmaking ecosystem, reported better-than-expected second-quarter earnings results on Monday afternoon, beating analyst estimates up and down its income statement, providing good guidance for the third quarter, and raising its annual outlook. The stock is up 9% to $364 in early Tuesday trading.

Cadence and its close competitor, Synopsys , make software and hardware that speed up the process of designing chips, and they have become indispensable, having an “essential role in the semiconductor value chain,” according to Piper Sandler analyst Clarke Jeffries’s Tuesday research note. For example, Microsoft only recently decided that it wanted to make custom artificial-intelligence chips for its Azure cloud service. Without Cadence or Synopsys, this would be a much more arduous task, and Microsoft might have decided to forego these efforts.

Cadence and Synopsys are seeing an added boost from all the AI research-and-development investment.

The importance of these chip-design platforms was underscored by their brief role in the trade war. At the end of May, Cadence and Synopsys received notices from the U.S. Department of Commerce informing them that sales to China would require licenses. The licenses typically are not granted, although there are exceptions, such as the recent one for Nvidia’s AI chips. In the case of Cadence and Synopsys, the license requirement turned out to be a U.S. bargaining chip, and it was negotiated away about a month later.

That meant that for about a third of the second quarter Cadence and Synopsys were unable to sell to China, where Cadence got 12% of its 2024 revenue, and that interruption of sales added a bit of drama to Cadence’ earnings report. Sales to Chinese customers were a little soft, at 11% of revenue in the second quarter, but the worst fears that a third of Chinese sales could go missing did not materialize.

Cadence is riding a wave of hardware upgrades. The first half of 2024 was a little rough, with customers holding back on hardware purchases in anticipation of a new generation, which began shipping about a year ago.

“The second year in a hardware cycle is historically the strongest in terms of growth rate, and the current hardware cycle should at least run for three years,” wrote Needham’s Charles Shi in his analysis of the second quarter. Shi raised his price target to $390 and maintained a Buy rating.

Other analysts are similarly bullish on Cadence’s prospects, projecting long-term double-digit earnings growth. Of the 15 analysts that published new Cadence notes on Tuesday, only one did not raise his price target, according to Factset. The average price target is $362 and the average rating is Overweight.

“We view CDNS as a top-pick in the multi-year secular [artificial intelligence and high performance computing] proliferation trend,” wrote Stifel’s Ruben Roy in his Tuesday note to clients. “We think the more-conservative near-term guide offers an attractive near-and-long-term entry point.”

But Piper Sandler’s Jeffries reduced his rating from Overweight to Neutral on valuation concerns, even while raising his price target. “Our revised $350 [price target] already reflects a low-teens growth [compound annual growth rate] over the medium-term and operating margins approaching 50%. As of today, we would be hard-pressed to embed growth or profit outcomes beyond that trajectory without demonstrable changes in semiconductor market demand.”

Cadence is near the top of its valuation range for the past three years, with a price-earnings ratio for the next twelve months of 48.

Write to Adam Levine at adam.levine@barrons.com