With generative AI (like ChatGPT) optimism going strong, it should come as no surprise that data center companies are doing well. There's only one catch: AI infrastructure construction is booming, but a bit at the expense of more traditional data center architecture, as reported by top chip designers Intel and AMD.
It makes no difference to Arista Networks (ANET -0.02%), though. The company sailed past financial expectations in the second quarter of 2023 and offered investors a peek at what is sure to be a great second half of 2023. This is an "expensive" stock, but for good reason.
Arista's position as an "AI specialist"
Arista Networks designs hardware called routers and switches for the data center and network communications industry. Think of routers and switches as the pieces of infrastructure that make up the information highway system for the internet and the cloud (data centers are the computing unit of both). Arista also provides engineering services and software management solutions for network operators.
AI training and inference, not to mention non-AI cloud computing, requires some wide and fast lanes, so Arista's customers have been busy in recent years. The company's resulting revenue of $1.46 billion in Q2 was up nearly 39% year over year, and earnings per share (EPS) were up 65% (or up 46% on an adjusted basis) -- setting new records for Arista's sales and EPS after a hot few years.
Data by YCharts.
The run isn't over yet, as data center operators are in need of Arista's engineering expertise to build out new factories to make more AI services. Management says third-quarter revenue is expected to be upwards of $1.5 billion, implying as much as a 27% increase over the same period in 2022. Full-year revenue growth is trending toward 30% or more versus 2022.
When will the current boom fade?
What's really incredible about Arista's results and outlook is that the cloud market is in flux this year. Many businesses have been looking for ways to conserve cash in what was, up until recently anyway, going to be considered an ugly 2023 for the economy. This includes Arista's customers, cloud titans like Microsoft (NASDAQ: MSFT) and Meta Platforms included.
But Arista's enduring growth illustrates how important it is to its customers. Cloud infrastructure -- both of the "older" variety as well as infrastructure for new generative AI systems like ChatGPT, which Microsoft invested heavily into -- is still very much a secular growth trend. Arista is still working on older cloud and non-cloud data center hardware and gearing up for a new iteration of infrastructure driven by generative AI. But rather than view the two as separate things, Arista management sees the current AI hype really as an extension of what the cloud computing industry has already built.
In other words, this data center company still has a long ramp ahead of it as it helps companies of all sizes update their operations for the cloud and AI era, both of which are expected to be double-digit percentage growth trends through the end of the 2020s. Paired with Arista's wide profit margins, squeaky-clean balance sheet, and ongoing cash return to shareholders via stock repurchases, this could be a high-growth compounding investment for a long time still.
Shares trade for 33 times trailing-12-month EPS, or 27 times EPS based on Wall Street analysts' 2024 estimates. It's a premium price, but this has been the case for Arista for years. If you think data center buildout will continue for years to come, Arista Networks is still a top pick.
