2023-03-29 13:02:31 ET
Summary
- We’re buy-rated on Arista Networks.
- We expect Arista to outperform, driven by higher ASP and demand tailwinds as the industry transitions to 400G.
- Still, we expect Arista to experience a more mixed data center and enterprise spending environment in 1H23.
- We expect Arista to experience a stock rally in the long term. We see favorable entry points into the stock at current levels and recommend investors buy in.
We're bullish on Arista Networks (ANET). We like Arista's position in the cloud networking solutions space and expect the company to outperform in FY2023, driven by a strong backlog and increased industry transition to 400G. Let's backtrack and discuss what Arista does; the company operates in data-driven, client-to-cloud networking from data centers and campus workspace environments. The company's Extensible Operating System ((EOS)) is the core of its cloud networking solutions for next-generation data centers and cloud networks. Our bullish sentiment is based on our belief that Arista is a growth stock well-positioned to boost revenues as enterprise and cloud customers require high-performance compute, storage, and networking gear, which is where Arista thrives. Despite current macro headwinds pressuring cloud spending and data center demand, Arista is proving to be relatively resilient, growing its bottom and top lines in 4Q22. We believe the company will continue to grow meaningfully, driven by increased adoption of 400G by its two main cloud customers, Meta Platforms (META) and Microsoft (MSFT).
The stock is up 17% over the past year, outperforming the S&P 500, which is down nearly 13% in comparison. We expect Arista stock to continue to outperform toward the end of the year and recommend investors jump into the stock at current levels.
The following graph outlines ANET compared to the S&P 500 index.
YCharts
Snowballing growth drivers
We believe Arista has an expanding TAM as it meets both enterprise and hyperscale cloud customer demand. We expect the next leg of growth to be driven by the company expanding its 400G product portfolio for both enterprise and cloud customers with next-generation 7050X/7060X and 7300X series switches. Arista fills a gap in the demand for high performance at the lowest possible cost and has been well-rewarded for it not only in revenue but also in market share - the company's 10-K reports that Arista "achieved the second largest market share in data center Ethernet switch ports." We expect the company's 400G next-generation cloud infrastructure to experience demand tailwinds as it increases maximum data transfer speed over 100G, with 400G to address growing bandwidth demands placed on network infrastructure providers. We also expect the company's 400G product upgrade cycle to make room for increased ASP driving revenue up in FY2023.
FY2022 & what to expect next
Arista is seemingly comfortable despite a rough macroeconomic backdrop. Arista reported revenue of $4,381.3M for FY2022 , accounting for a 48.6% increase from FY2021, and reported revenue of $1,275M in 4Q22, up 8.4% sequentially and 54.7% Y/Y. In the company's 4Q22 earnings call, CEO Jayshree Ullal highlighted that Arista exceeded the guidance it gave for FY2022 in its November 2021 Analyst Day - the company had guided for 30% growth and instead achieved 48% for the year.
Still, the company is not immune to the weaker spending environment impacting cloud and data center demand - Non-GAAP gross margin was 61% in FY2022, down from 64% a year earlier, mainly due to tightening cloud spending amid market uncertainty. We expect the company to see a mixed-demand environment in the first half of FY2023. We've seen macro headwinds take a toll on two of Arista's largest customers, Meta Platforms and Microsoft, dropping 64% and 29% in 2022, respectively - we currently have a buy-rating on Meta and a sell on Microsoft. Together Meta and Microsoft account for "more than 10% customers at 25.5% and 16% contribution, respectively." We believe the "cloud titans" will continue to spend substantially on Arista's data center switching and routing services and products; in 2022, Microsoft spent an estimated $701M at Arista, accounting for 16% of the company's total sales, while Meta spent a whopping $1.12B. We don't expect Microsoft or Meta to pull back spending on Arista substantially - especially as the industry transitions to 400G. We see Arista experiencing demand tailwinds due to increased demand for networking equipment from cloud customers.
Additionally, we see Arista experiencing demand tailwinds amid the Artificial Intelligence ((AI)) boom, with the AI industry forecasted to grow rapidly at a CAGR of 37.3% between 2023-2030. Microsoft is leading the AI hype with the company's announcement of a multiyear, multibillion-dollar investment in OpenAI's ChatGPT. We expect AI/ML attached switching in data centers to be a more meaningful part of the market going forward and believe Arista is well-positioned to ride the upward growth trend with its new 7800 switches. We see Arista stock outperforming toward the end of the year and recommend investors begin looking for entry points at current levels.
Valuation
Arista is not relatively cheap. On a P/E basis, the stock is trading at 25.1x C2024 EPS $6.48 compared to the peer group average of 20.6x. The stock is trading at 7.9x EV/C2024 Sales versus the peer group average of 5.0x. We believe Arista is a growth stock; the company has grown its EPS by 16% per year over the past three years, and we believe if Arista can sustain the EPS growth, the share price will follow. We recommend investors buy the stock at current levels.
The following table outlines ANET's valuation.
Word on Wall Street
It appears that Wall Street shares our bullish sentiment on the stock. Of the 26 analysts covering the stock, 17 are buy-rated, and the remaining are hold-rated. The stock is currently priced at $163 per share. We see more upside in the mid-to-long term for Arista stock.
The following table outlines ANET's sell-side ratings.
TechStockPros
What to do with the stock
We're bullish on Arista. We see the stock rallying in FY2023 in spite of the weaker spending environment. The stock is trading at $161 per share, 45% higher than its 52-week low of $89. Our bullish sentiment is driven by our belief that Arista will outperform, driven by cloud customers' adoption of 400G allowing for higher ASP. We see favorable entry points at current levels and recommend investors buy the stock.
For further details see:
Arista Networks Could Be Headed For A Bull Run