Arista Networks (ANET 0.41%) is booming this year. The data center equipment and networking design specialist is benefiting from a resurgence in spending from its "cloud titan" customers, Meta Platforms (META 3.77%) and Microsoft (MSFT 1.57%), in particular. The metaverse, a three-dimensional rendition of web-based applications and services already in use today, is being built in earnest right now.
Though you may not have heard of Arista Networks, it's an instrumental player in building future technology infrastructure. Share prices are down 14% so far in 2022, handily beating both the S&P 500 and the Nasdaq Composite indices. After an incredible third-quarter 2022 earnings update, this stock looks like a great buy right now.
NYSE: ANET
Key Data Points
2022 has been an incredible year for Arista Networks
Arista Networks' revenue and profits exploded higher in Q3 thanks to spending from its cloud titan clients (Meta and Microsoft, but also Amazon's cloud segment AWS and Alphabet's Google and Google Cloud). Data traveling across the internet is on the rise, especially with video and now 3D applications being pushed, so big purchases to upgrade data centers are needed. Ahead of Arista's own earnings report, the cloud titans gave a preview of what was coming.
Meta spent $9.4 billion on property and equipment (or capex) in Q3 2022, more than double the $4.4 billion last year. And Microsoft reported an 8% year-over-year increase in capex to $6.28 billion in its fiscal 2023 first quarter (for the three months ended September). Meanwhile, Alphabet's capex rose nearly 7% in its last quarter to $7.28 billion. And Amazon AWS operating expenses (it doesn't categorize AWS-specific capex) were up 35% year over year, uncharacteristically outpacing the cloud segment's revenue growth of 27% by a wide margin.
It was no surprise, then, that Arista reported a huge 57% year-over-year increase in revenue to $1.18 billion in Q3 2022. Though gross profit margins were lowered by supply chain issues and inflation, the company still benefitted from its growing scale and tight cost controls in its operations. Net income rose 58% to $354 million (or up 65% year over year on an adjusted basis). Earnings per share got a boost from share repurchases (now $667 million worth through the first nine months of 2022), increasing 61% year over year to $1.13 (or up 69% to $1.25 on an adjusted basis).
How long will this boom last?
Headed into 2022, Arista Networks anticipated about 30% revenue growth and a balance of revenue from cloud titans, smaller "specialty cloud" companies, and other non-tech businesses that are updating their infrastructure with new data centers. But now the company forecasts 45% revenue growth at the midpoint of Q4 guidance, with nearly half of all revenue coming from the spending spree from Meta, Microsoft, and the other tech giants.
That leads to an important question: How long can Arista keep this up? Infrastructure spending is, after all, a cyclical business model. Boom times are often followed by periods of slower growth or even contraction, like in the period from late 2018 to 2021.
Data by YCharts.
CEO Jayshree Ullal was candid about this concern on the earnings call. She said:
So as you think about the numbers getting larger, it's going to be difficult to sustain 45% growth every year. I'd love to have it. But -- as you know, Arista is a volatile business, and you have to think of us across a 3- to 5-year [compound annual growth], not just on an annual basis. So I still think we have a large [total addressable market]. We're going to do very well. But with the looming uncertainty of recession and capex spend, et cetera, it's definitely difficult to predict beyond a year.
Nevertheless, in spite of the stellar spate of expansion enjoyed this year, Ullal expressed confidence Arista will do well in 2023 as well. To her point, while 45% annual growth isn't a realistic expectation going forward, building next-gen internet infrastructure for the metaverse and supporting an explosion in cloud data won't be completed in a year. COO Anshul Sadana also added on the call that Microsoft and Meta are only just beginning with their data center migrations to 400-gig technology (the latest, greatest, and fastest information "freeway" equipment).
Ullal and the top team will be giving a more in-depth look at their long-term expectations later in November, so stay tuned. But as of this writing, Arista Networks' stock trades for just under 35 times trailing 12-month earnings per share. Given how rapidly this best-in-class "metaverse" company is growing sales and profits right now, I remain a buyer of the stock, with the intent of holding for the very long term.
