Summary
- Cloud Titans have contributed significantly to ANET's revenue, but I do have concerns about inventory stockpiling.
- Management has increased its revenue forecast for 1Q23 based on strong results in 4Q22.
- ANET is well-positioned for long-term growth, with increasing demand for AI workloads among cloud users and potential market share gains with enterprise customers.
Thesis
Management increased their revenue forecast for FY23 as Arista Networks ( ANET ) saw sustained growth thanks to increased demand from cloud customers for networking equipment. Exiting 2022, demand was strong, and the results for the 4Q22 were fantastic. ANET's Cloud Titan vertical grew by triple digits for the full year despite supply constraints due to the strength of its customer base. In 2023, I anticipate continued robust growth thanks to strong underlying demand from ANET's customer base.
Management stated that it is still receiving demand visibility from customers for the next 9 months and is seeing minimal demand impact from the weak macro backdrop. While I do believe the company will see revenue growth in 2023, I believe that the effects of the macroeconomy will become more noticeable in 2024. This is because shorter lead times might not be as highly valued by customers once the backlog has returned to its normal levels. I believe the slowdown in growth in FY24 is likely to be driven by a decrease in spending by Cloud customers on new data center builds, while demand trends from Enterprise customers are likely to depend on how the macro environment turns out to be. Even though I am optimistic about the short-term outlook, I am being more cautious about the impact of temporary customer pullbacks by lowering my expectations for the medium term. Looking ahead in the long run, I expect the growing importance of AI workloads among cloud users, faster production upgrades of datacenter switching products, and increased market share with enterprise customers to result in robust growth.
4Q results
Non-GAAP revenue for ANET stock in Q4 was $1.27 billion, and EPS was $1.41. Cloud Titans contributed 46% of revenue in 2022, up triple digits % from the previous quarter. Meta ( META ) contributed 25%, and Microsoft ( MSFT ) contributed 16%. Besides Cloud Titan, Enterprise financials and providers revenue both grew by 20%+ as well. Gross margins were hampered by the combination of the supply chain and mix towards Cloud Titans.
Cloud Titans
Frankly, I believe that 4Q22's primary driver is META's remarkable expansion. To put that into perspective, in 2021, META accounted for less than 10% of revenue, and by 2022, that number had increased to 25.5% (2.5x), and revenue had increased from less than $295 million to more than $1.117 billion. Although this expansion is impressive, I believe it is important to keep in mind that management has already acknowledged that the impressive growth largely came from playing catch-up after several years of under-investment, so I believe it is not likely to see growth on this scale in such a short period of time again. In comparison, MSFT revenue increased from $442 million in 2021 to $701 million in 2022. Clearly, ANET is doing very well with these clients, but I do have concerns regarding inventory stockpiling (both ANET and customer level). Given how fast ANET has grown, this is certainly worthy of a thought. However, I emphasize that any inventory correction may not occur for some time, as it is unlikely that customers want to face a long wait time again. That being said, this is something to monitor.
Guidance
Management reiterated their forecast for FY23 based on strong FY22, which suggests that demand momentum is continuing. The new guided 1Q revenue ranges between $1.275 billion and $1.325 billion. On the other hand, given the ongoing supply headwinds and the high Cloud mix, gross margin is expected to face some headwinds (management guides to 60.0%). More importantly, despite a strong FY22, management still expects revenue growth of 25% in FY23. All in all, while there is some pressure on margins, I believe the guidance was very positive, suggesting that growth will continue.
Valuation
While growth has been strong in FY22 and possibly FY23 (due to guidance), I have baked in some slowdown in revenue to reflect my concerns. Margin should continue to expand as ANET faces lesser headwinds at the gross margin level and more OPEX discipline. The last assumption made was the forward PE, which I think is reasonable at 24x (7x below the 10-year average). Should ANET beat FY23 guidance, I am guessing it could lead to possible multiples upside.
Author's estimates
Conclusion
Overall, ANET has had a fantastic year in 2022, with sustained growth driven by increased demand from cloud customers for networking equipment. Despite some supply constraints, ANET's Cloud Titan vertical grew by triple digits for the full year, demonstrating the strong underlying demand. Looking ahead in the long run, I believe ANET is well-positioned for robust growth, thanks to the increasing relevance of AI workloads among cloud users and the company's market share gains with enterprise customers.
For further details see:
Arista Networks: Strong Growth Momentum Going Into FY23