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Strong AI Tailwinds to Persist for Nvidia and SMCI

The rise of Artificial Intelligence over the past year, and the resulting race for AI infrastructure across the world have led to a stunning rally in stocks that were even tangentially related to the mania. The biggest beneficiaries of course were semiconductors giant,Nvidia (NVDA: $902) and server management and storage systems provider Super Micro Computer (SMCI: $783) posting rallies of 240% and 250%, respectively in 2023, showing no signs of slowing.

Nvidia is up another 84% so far this year, and Super Micro Computers by an incredible 175% in just 4 1/2 short months. With the former’s valuations at $2.2 trillion, it seems only rational to question the rationale behind this run-up, but this is because most analysts and industry watchers fail to grasp the sheer scale and magnitude of what lies ahead and the role of these two companies in this exploding business.

From tech giants such as Google and Amazon to automotive companies such as Tesla, everyone is going all out to gain the upper hand with AI, and Nvidia’s graphic cards are perfect for parallel processing power that is essential for large language models (LLMs). The company currently has a 90% share in the burgeoning AI chip market, with a robust product roadmap aimed at maintaining this sizable lead.

To put this in perspective, Nvidia’s 2023 data center revenues stood at $48 billion, more than triple that of its prior year, with the potential to multiply by nearly three times more over the coming years. At the same time, its closest competitors in this segment, AMD and Intel have forecasted 2024 revenues from AI graphics cards and accelerators at $4 billion and $500 million, respectively, leaving them eons behind.

Coming to Super Micro Computers, while the company does not make AI chips, it does manufacture crucial server products and components on which the AI infrastructure is built on. It makes the metaphorical shovel that is fueling this AI gold rush. Just like Nvidia, Super Micro’s sales have grown at an unprecedented rate in recent years, 46% in 2022 and 37% in 2023 riding the same tailwinds. The company currently controls half of the $12 billion AI server market, which is expected to hit $50 billion by 2029. Its biggest competitive edge is its deepening partnership with Nvidia, whose products come mounted in Super Micro’s racks. With this, the company is all set to double its revenues in 2024, to $15 billion, making its current valuation of 4 times sales and 22 times earnings compelling.

Prominent analysts from firms such as Goldman Sachs and others have raised their Price Targets for the stock, to the $1,100 range. The same goes for Super Micro, with an average Price Target of $1,130, an upside of 40% from current levels. When dealing with forces set to have a $7 trillion impact, the age-old tried-and-tested rules of value investing no longer apply. We do not believe we are in a bubble, which some on Wall Street are espousing. We believe it is just the beginning of a massive change in computing that is changing the world that we live in, at home, at work, and at play.

Our Target for Nvidia is $900 with a Sell Price of $700. We are hereby raising our Target to $1,200 and leaving the Sell Price at $700, although if the stock drops to that level, we would more than likely be looking to add more at that price. For SMCI, our Target is $1,300 and our Sell Price is also $700. We had set the Target at $1,300 during the months of February and March when it rallied from the $800 level to $1229. We fully expect new highs to be reached in both stocks this year.

Note that Super Micro is still a puppy compared to Nvidia, clocking in at $45 billion in market cap but still a sizable firm. We believe both are split candidates and the stocks will surge when management makes the announcements.

Shopify Stumbles. Walk Away

Shopify (SHOP: $63, down $15 yesterday) reported mixed results for Q1 2024 Tuesday evening. Revenue grew 23% year-over-year, exceeding analyst expectations. However, the company posted a net loss due to increased expenses, a shift from the previous year's profit.

Highlights:

  • Revenue: $1.86 billion (up from $1.51 billion)
  • Gross merchandise volume (GMV): $61 billion (up 23%)
  • Monthly recurring revenue: $151 million (up 32%)
  • Gross margin: 51.4% (up from 47.5%)
  • Strong cash flow position: $5.2 billion cash, $1.1 billion debt

Concerns:

  • Net loss: $270 million (vs. $60 million profit in Q1 2023)
  • Management transparency: We have concerns about the company's communication during the earnings call.
  • Increased competition: The e-commerce landscape is competitive, and Shopify faces pressure to maintain its market share.

BMR Take:

Shopify's core business remains healthy, with strong growth in revenue, GMV, and recurring revenue. The company's focus on AI solutions holds promise for the future. However, the net loss and questions about management transparency are causes for concern. We are removing Shopify from our portfolio, but the long-term potential remains. We are generally displeased with the company. We loved this company and they have let us down. The comments from management are in many cases hyperbole and we don’t believe many of them. Once you start to disbelieve a company’s management, you lose trust in the company. It is hard to get trust back.

We thought we had a company for the ages, like Microsoft or Google. But they have let us down. We added the stock at $73 in 2017 and it rose to $1,763 in 2021, a 24-bagger, but the stock has faded to its current level of $620. Of course, after the 10-1 split in 2022, you can divide all these numbers by 10. We still have an 8-bagger, which is not bad in the whole scheme of things. But the company has let us down, so we are removing the stock today.

Where will the stock be in a year or two? Perhaps right where it is now; perhaps higher, as the platform they have built is second to none. But competition is heating up and if management can screw up like they have in the past year, then the whole franchise could be in trouble. We’d rather have our money in Amazon.

Berkshire Hathaway Produces a Strong Q1 Performance

Stocks for Success Portfolio

Diversified conglomerate, Berkshire Hathaway, (BRK.B, $407, BRK.A, $611,000 per share!!) released its first quarter results last week, reporting $90 billion in revenue, up 5% YoY, compared to $85 billion a year ago. It posted a profit of $12.7 billion, or $5.20 per share, compared to $8.8 billion, or $3.69, with a beat on consensus estimates on the top and bottom lines, driven by a strong performance across its insurance underwriting and energy divisions.
Note that this isn’t the net profit, which would include the company’s investment gains and losses, which Warren Buffett has asked investors time and time again to ignore, given that these gains or losses are unrealized. When it comes to the pure operating performance of its subsidiaries, Berkshire’s insurance underwriting earnings swelled to $2.6 billion, up almost triple YoY, compared to $910 million.

The energy division similarly saw earnings double during the quarter to $720 million, up from $410 million a year ago. The company’s railroad business witnessed a slight decline in revenue, at $5.6 billion, down from $6.0 billion a year ago, owing to strikes and staffing issues that have plagued the industry for over a year. Other segments, however, point towards resilience and a resurgence in the broader US economy.

The spotlight during the quarter was Berkshire’s ever-rising cash hoard, which hit a fresh high of $190 billion, up from $168 billion the prior quarter. What an amazing number. This was the result of the company dumping $20 billion worth of stocks, and redeploying just $3 billion in fresh investments. Much of the disposal comprised of Apple stock, which has long been the conglomerate’s prized holding. The company trimmed its Apple holdings up to 13% during the quarter, and while the consumer tech giant is still its largest stock holding, this marks a major shift in strategy. This comes as Apple itself unveiled a record $110 billion stock buyback program.

By being a net seller of stock for 6 consecutive quarters and hoarding an ever-increasing pile of cash, the Oracle of Omaha has quietly hinted at his disapproval of present equity valuations. Hence, Berkshire is focused on delivering value to investors via its repurchase program, with $2.6 billion in buybacks during the quarter, made possible by its $190 billion in cash, $120 billion in debt, and $51 billion in cash flow. We expect these buybacks to increase dramatically this year.”

We believe Warren Buffett will announce a big purchase in the coming quarters. He has a legacy that will stand for all time, but one more big deal would be the way to go, as he leaves this world. Almost $200 billion in cash is burning a hole in his pocket, of that there is no doubt. Hold tight and watch. We added the stock at $208 in 2019; we have almost a double. The all-time high is listed at $430, but we can’t verify that in our research. We see it as $424 on April 4th. We aren’t going to quibble over $6. Our Target is $450 and our Sell Price is “We would not sell Berkshire Hathaway.”

Eli Lilly - The Pharmaceutial Company for the Future

Pharmaceuticals giant Eli Lilly (LLY: $730) blew past estimates during its fourth quarter results Monday night after the close, posting $9.4 billion in revenues, up 28% YoY, compared to $7.3 billion a year ago. Profit was $2.2 billion, or $2.49 per share, against $1.9 billion, or $2.09, driven by the strong response to its new anti-obesity drug, Zepbound, coupled with price increases for its blockbuster diabetes treatment, Mounjaro.

For the full year, the company produced $34.1 billion in revenues, up 20% YoY, from $28.5 billion during the same period last year. Profits for the year, however, took a dip, dropping from $7.2 billion, or $7.94 per share, to $5.7 billion, or $6.32. This was largely the result of various in-process research and development charges, most of which were acquired by the company over the past few quarters.

During the quarter, the company’s incretins, or drugs that work by mimicking hormones led the way in terms of growth, with Mounjaro posting sales of $2.2 billion during the quarter, up 700% YoY, followed by its GLP-1 candidate, Zepbound, at $176 million which was just introduced in the quarter. Other key growth drivers include Verzenio, Jardiance, and Tyvyt*, up 42%, 30%, and 98%, respectively. Please re-read the first sentence of this paragraph.

* a medication used to treat Hodgkin's disease

A few detractors included the likes of Trulicity, Humalog, and Alimta, down 14%, 33%, and 81% YoY, respectively. This was largely owing to lower realized prices, coupled with persistent supply constraints in recent months. The lower prices weren’t that surprising, with the company announcing last year that it would be cutting the prices of Humalog, and its other insulin products by as much as 70% going forward

The big story about the company, however, is its new obesity play, Zepbound, which has gained strong momentum within just a few months after its launch, and is already threatening Novo Nordisk’s dominance in this space. Lilly expects demand for this drug to far outstrip supply for 2024, as it grapples to build capacity with a fresh $3 billion commitment to expand manufacturing.

Given the pace at which incretins are expanding within the US and internationally, with the entire market expected to hit $50 billion in 2030, the drug now has 90% insurance coverage and Medicare Part D. Sales are only going to heat up from here, with Morgan Stanley projecting sales for Zepbound for 2024 to be $2.2 billion. As noted above, Zepbound did just $176 million last quarter. Barclays forecasts $7.3 billion in 2024 sales for Wegovy, which as you know is made by Novo Nordisk (NVO).

In addition, Eli Lilly is working to unveil its oral weight loss drug, Orforglipron. This could be very important as all of the weight-loss drugs on the market are injectables. When you can just take a pill, this market will explode.*

* https://www.nejm.org/doi/full/10.1056/NEJMoa2302392    Read this report from September 2023. If this doesn’t get you excited about owning Eli Lilly, there is nothing we can ever say that will do so.

Following a 60% rally in 2023, the stock is already up 20% so far this year, starting at $592 on January 2nd, and is showing no signs of cooling down. The new all-time highs hit by the stock this week and all of this year, are perfectly justified. How can I buy this stock at such a high price, you are asking yourself? Very easy. Think 2025, 2028, 2030. Then sit down at your computer and buy the stock!

In addition to investing in R&D and expanding its productive capacity, Eli Lilly is increasingly generous in returning capital, with its sixth consecutive yearly dividend increase, doubling it since 2018. It ended the quarter with $2.6 billion in cash and $20 billion in debt. Our Target is $665 and we would not sell Eli Lilly. Whoops. We have to raise our Target again. It hit $742 during the day yesterday, and closed at $705, up $37 for the day. If the stock market continues its bull market run this month and on into the spring and summer, we wouldn’t be surprised to see the stock with a 9 in front of it. Our new Target is $825.

Apple Reports Earnings. Market Not Thrilled

Consumer tech giant Apple (AAPL: $182) released its first quarter results last night, posting $120 billion in revenue, up 2% YoY, compared to $117 billion a year ago. The company posted a profit of $34 billion, or $2.18 per share, against $30 billion, or $1.88, beating consensus estimates on the top and bottom lines. The YoY growth during the quarter marks an end to four consecutive quarters of declining sales for the company, and it produced a beat on sales estimates across most of its product lines.

Apple’s strong showing during the quarter was driven by its flagship iPhone, with $70 billion in sales, up 6% YoY, compared to $66 billion a year ago. This was followed by the Services segment at $23 billion, up 11% YoY, compared to $21 billion, and iPad, Mac, and other product revenues at $7.0 billion, $7.8 billion, and $12.0 billion, down by 25%, 1%, and 11%, on a YoY-basis, respectively. This is largely the result of the company not having launched any new products across these categories in recent months, further aggravated by the fact that it had just 13 weeks of business during this quarter, compared to 14 last year. Apart from this, products such as the Apple Watch were removed from store shelves for a few days owing to a patent dispute with medical devices company, Masimo.

It was bound to get tough extracting more growth, and continually innovating with its long-running range of products. Fortunately, Apple has found another winner in its Vision Pro headset, with the $3,500 spatial computing device already hitting 200,000 units in presales, weeks before it was set to arrive in stores, giving rise to another major product line with a multi-billion dollar sales potential. We are a little bit skeptical about how successful this product will be. One of our favorite podcasters, Scott Galloway, a brilliant mind, believes it will never sell.

Apple’s eye-popping $2.9 trillion valuation might seem excessive to some, but the company still trades at just 7 times sales and 28 times earnings. While it seeks newer avenues to monetize its brand and drive growth, investors are well taken care of with $24 billion being returned in the form of buybacks and dividends, made possible by its massive $62 billion in cash reserves, $124 billion in debt, and $110 billion in cash flow. The debt is quite high in our opinion, but most of it is at sub-5% interest rate levels.

Our Target is $225 and our Sell Price is that we would not sell Apple. We’re a little concerned about the stock, though. Not the company, but the stock. It is SO BIG, that for it to get back to 10-15% growth levels, is not easy. To add 10% to revenues it would have to produce $28 billion in new business, an astounding number. The company could conceivably do it with major acquisitions, which it is not prone to do, or by moving into new areas, like the Apple Car. But these things are a long way off and meanwhile, revenues stagnate. Wall Street doesn’t like stagnation. The stock hasn’t participated in the strong market this year, peaking on December 14th at $200, and is off 10% in the last six weeks – losing $300 billion in market cap. It’s lost its leadership as Microsoft has passed it by in the market cap race.

So what to do? As always, it’s a tough call. We are big believers in letting the market tell us what to do. It’s down $6 (3%) after earnings early Friday morning as we write this, and the market looks strong starting out today. We would suggest setting a stop and if the market goes there, taking your cash and looking for other places for it. There are certainly a lot of great choices out there. We are going to lower our Target to $200 and are setting a Sell Price of $174. We added the stock at $24 in $2016, so we are happy for all of you who did the same. Perhaps the growth game is over now for Apple for a while. Will the company go away? Of course not. But it may stagnate here in the $170-$200 range for the next year or so…. and "stagnation" is a word Wall Street doesn’t like.

Netflix Rules The Streaming Landscape

Streaming giant Netflix (indicated at $538, up 9% overnight)  had a spectacular fourth quarter, hitting $8.8 billion in revenues, up 12% YoY, compared to $7.8 billion a year ago. The company posted a profit of $940 million, or $2.11 per share, up from just $60 million, or $0.12 a year ago, with a beat on consensus estimates on the top and bottom lines, coupled with healthy core metrics lifting the stock as high as $50, following the results, in the post and pre-market trading.

The company’s full-year figures were just as impressive, with $33.7 billion in revenues, up 7% YoY, compared to $31.6 billion, with a profit of $5.4 billion, or $12.03 per share, against $4.5 billion, or $9.95 during the same period a year ago. In the midst of all this, Netflix’s guidance for the upcoming first quarter of 2024 stole the spotlight, with $9.2 billion in revenues, up 13% YoY, and profits expected to more than double.

Netflix unveiled a slew of changes to its platform in 2023, starting with the crackdown on password sharing, followed by lower-tiered pricing, and ad-supported accounts. These initiatives have exceeded all expectations, with 13 million new subscriber additions during the fourth quarter alone, bringing its total headcount to a record 260 million, well ahead of estimates.

These changes were complemented by a strong slate of new releases during the quarter, such as the final season of its long-running royal drama, The Crown, among many others. This is amidst the sea of other content that keeps viewers around the world hooked, leading many observers and analysts to conclude once and for all that Netflix has won the online streaming game.

Despite rising competition from all over the world, Netflix is the only company in this space that has consistently posted growth, while remaining profitable. This year it plans to invest $17 billion in fresh content, and just signed a $5 billion deal to livestream the World Wrestling Entertainment’s RAW, along with other exclusive programming and content on the platform by 2025.

The stock has rallied over 35% during the past year, and 48% if you include today’s big jump, and shows no signs of slowing down as the company goes on the offensive to unlock more value across its platform. We love the fact that the company is buying back its stock. During the fourth quarter alone, Netflix repurchased $2.4 billion worth, made possible by its strong and growing balance sheet position with $7.1 billion in cash, $15 billion in debt, and a massive $7.3 billion in free cash flow. Our Target has been a big $590 because we believe so much in this company. We would not sell Netflix. Would you like to know why? Take a peek at this chart and YOU decide:

Year Number of Subscribers (Millions)
2014 57
2015 69
2016 82
2017 94
2018 137
2019 158
2020 195
2021 209
2022 221
2023 (Q3) 247