Arista Networks (NYSE: ANET), a leading cloud-based networking hardware vendor, has experienced significant growth over the past year, driven by strong execution and favorable industry tailwinds. The company’s stock has more than doubled in value as it successfully navigated challenges such as supply chain constraints and declining margins. Looking ahead to FY24, analysts continue to see substantial potential for Arista, thanks to its position as a cloud networking technology leader and the growing demand for AI-related infrastructure.
Leader in cloud-based networking technology
Arista Networks has consistently been recognized as a top vendor in cloud-oriented networking hardware technology. The company’s ability to capture market share from established players like Cisco is evident in its continued growth. Major tech giants such as Meta have chosen Arista’s products for their networking needs, highlighting the company’s appeal to large internet titans. This sustained recognition positions Arista as a key player in the cloud networking industry.
AI Tailwinds driving growth
As businesses invest in AI technologies, they must expand their datacenters to accommodate the increasing demands for data storage and processing. This expansion naturally leads to a higher demand for networking hardware, providing Arista with a substantial growth opportunity. The integration of AI into various industries further strengthens Arista’s growth trajectory, as companies seek reliable and efficient networking solutions to support their AI initiatives.
Improved enterprise IT budgets
The economic outlook for 2024 indicates a potential normalization of enterprise buying patterns, which bodes well for Arista. Large enterprises represent a significant portion of the company’s revenue, and an improvement in their IT budgets can drive further growth. After cost-cutting measures and project delays in the first half of 2023, the prospect of renewed investment in IT infrastructure is a positive sign for Arista’s financial prospects.
Enhanced supply chain position
Arista’s efforts to reduce lead times for customers and optimize component procurement have strengthened its supply chain position. This improvement not only benefits the company’s operational efficiency but also reduces the risk associated with incorrect product mix and excessive inventory. However, it’s worth noting that shorter customer-facing lead times may impact revenue visibility in the short term, potentially flattening growth in 2024.
Robust gross margin profile
Despite being a hardware vendor, Arista’s financials resemble those of a software company due to the value-add of its software features. The company boasts pro forma gross margins exceeding 60%, providing scalability to its overall earnings. This strong gross margin profile contributes to Arista’s competitive edge in the industry.
Risk factors and valuation
While Arista has several strengths, it is essential to acknowledge the associated risks. One significant risk is the company’s reliance on a small number of large customers, often referred to as “cloud titans.” These customers, including Meta and Microsoft, account for a substantial portion of Arista’s revenue. Buying patterns in this segment can be unpredictable, leading to periods of contraction and lower growth rates. Additionally, Arista’s current impressive revenue growth may represent a pull-forward of demand, potentially impacting future growth in 2024.
Valuation is another consideration, with Arista trading at a P/E ratio of 34x based on Wall Street analysts’ expectations for FY24. However, the company’s strong growth profile, driven by gross margin expansion and operational efficiency, should not be overlooked. Arista recently achieved a remarkable 46% earnings growth in its most recent quarter, and its PEG ratio of 0.7x, based on current EPS growth rates, suggests an attractive investment opportunity. Furthermore, the company’s significant net cash balance of $4.5 billion, representing approximately 6% of its market capitalization, further enhances its valuation.
Recent trends highlight growth potential
Recent financial releases from Arista reinforce its growth momentum. The company’s gross margins increased by 190 basis points year-over-year, reaching 63.1%. This improvement can be attributed to higher enterprise shipments and optimized supply chain costs, reflecting Arista’s ongoing efforts to normalize its supply chain after pandemic-related constraints. Furthermore, Arista achieved a remarkable 430 basis points year-over-year expansion in pro forma operating margins, reaching 46.1%, one of the highest in the industry. These margin gains were driven by lower product introduction and demonstration costs, as well as operating leverage in sales, marketing, and general administrative expenses.
Arista’s outlook for the coming quarter remains positive, with a revenue projection of $1.50-$1.55 billion, representing 20% year-over-year growth. The company also aims to sustain a gross margin of 63% from the previous quarter.
Arista Networks has demonstrated impressive performance and resilience in overcoming previous challenges. Its leadership in cloud-based networking technology, coupled with the growing demand for AI infrastructure, positions the company for continued success. While risks and valuation should be considered, Arista’s recent financial trends indicate strong growth potential, making it a compelling investment opportunity in the technology sector.
