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Bull Of The Day: Synopsys (SNPS)

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The global chip shortage has had a rippling impact across the economy, creating a massive opportunity for semiconductor stocks. Lawmakers are now considering a $52 billion bill to attack the chip shortage head-on in the US, providing funding to help chipmakers increase their capacity to meet the unending demand. Now is the time to jump into this momentum-building segment, and Synopsys SNPS is an under-the-radar chip player that is poised to take off.

Synopsys is the backbone of innovation for global electronics. SNPS is a prudent way to invest in the semiconductor and electronics space while still profiting off the current chip shortage going into the grand 4th Industrial Revolution. This company is the global market leader in chip-making software and intellectual property (IP) related to semiconductors. Synopsys has exceeded expectations consistently and has progressively risen guidance, driving analysts' estimates and price targets higher, propelling the stock into a Zacks Rank #1 (Strong Buy).

The world of semiconductors is proliferating with Moore's Law, which was established 50 years ago by the co-founder of Intel (Gordon Moore), still holding today. The 'law' hypothesizes that every two years, the number of transistors on a microchip doubles, and the cost halves. Today, integrated circuits or computer chips can hold billions of transistors on a chip the size of your fingernail.

The demand for the newest and fastest technology is always there, and we are on the brink of the next tidal wave of tech. Artificial intelligence (AI), cloud computing, the internet of things (IoT), autonomous driving, and 5G are driving the next wave of technological advancement. Synopsys is at the foundation of new technology and will ride this demand wave.

The Business

Synopsys is a global leader in electronic design automation (EDA) and semiconductor IP. Its EDA software serves chip and hardware designers every step of the way, from initial design to verification for quick and efficient turnarounds. The EDA market was worth over $10 billion in 2019 and is expected to grow by 8% annually for the next 6 years (over $20 billion by 2027), according to Global Market Insight.

Its duopoly with Cadence CDNS and high entry barriers gives the firm robust pricing power. This high-margin business is going to continue to drive healthy profitability. Analysts are expecting these margins to expand as the company enjoys economies of scale.

Its IP products provide customers with ready-to-use chip designs that are proven and save customers time. It is the largest global player in this rapidly growing space which is expected to reach $8.8 billion by 2026 (assuming a compounded annual growth rate of 7.5%), according to Business Wire. Synopsys's massive IP portfolio and over 15 years of investments give it a firm grip on this market.

Synopsys also offers products that improve software developers' code, ensuring there are no code defects and verifying that the code is secure. Its software integration revenue only makes up 10% of the topline, but it is the fastest-growing segment at healthy double-digit growth levels.

The Financials

The pandemic created the perfect storm for the future of this business, with digital adaptation accelerating 10 years in just 10 months. The company and its stock show no signs of slowing down as the economy reopens and chip demand proliferates as the transformation to 5G connectivity takes off.

Synopsys's growing annual free-cash-flows of roughly $770 million (in the past 4 quarters), $856 million in cash, and minimal amounts of debt on the balance sheet give this business an enormous amount of financial flexibility to continue acquiring/investing in IP and advancing software in these fragmented markets.

SNPS is trading at a discount to its biggest competitor, CDNS, and these shares show strong signs of renewed momentum as optimism about the space drives chip stocks back towards fresh highs.

The Opportunity

Investors continue to pour money into this innovation machine, despite the pandemic. SNPS is up nearly 70% above its pre-pandemic highs but remains 8% below its mid-February highs. These shares now have legs to run and are sitting materially below analysts' price targets. I see no reason to wait to purchase these shares but be prepared for short-term volatility as the market consolidates during this Q2 earnings season.

I am confident they have more room to rally, with 8 of 9 analysts calling these shares a buy right now (0 sell ratings).

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