Cadence Design Systems CDNS stock has gained 10% year to date. However, the stock has underperformed its industry and the broader technology sector. Within the same time frame, the sub-industry and the Zacks Computer and Technology sector have gained 22.5% and 35.3%, respectively. It has also lagged the S&P 500’s growth of 27.9%.

Price Performance

Image Source: Zacks Investment Research

This considerable underperformance in its stock price has caught the attention of investors, prompting questions about whether to maintain their positions or cut their losses.

What Ails CDNS Stock?

Weakness prevailing over global macroeconomic conditions and substantial exposure to the semiconductor vertical is concerning. Any reduction in R&D spending for companies within the semiconductor sector could affect CDNS' performance.

Image Source: Zacks Investment Research

Higher operating costs and stiff competition in the EDA space from peers like Keysight Technologies KEYS, Synopsys SNPS and ANSYS ANSS are additional headwinds. The pending acquisition of ANSYS by Synopsys is likely to intensify competition in the EDA space for all players.

Moreover, it generates a significant portion of its revenues from the international market. Revenues from international operations as a percentage of overall revenues have historically exceeded 50%. In 2023, the company derived 41.4% of its revenues from the United States, while the remaining 58.6% came from its international operations.

Acquisitions have affected its balance sheet, as a high level of goodwill and intangible assets adds to the risk of investing in the company. Its goodwill and intangible assets totaled $3.156 billion or 34.4% of total assets as of Sept. 30, 2024.

Increasing debt load is concerning for investors. As of Sept. 30, 2024, it had cash and cash equivalents of $2.786 billion compared with long-term debt of $2.475 billion. The company issued $2.5 billion of senior notes at a weighted average interest rate of 4.44% in September 2024. The increasing debt load may jeopardize its ability to pursue accretive acquisitions and other growth endeavors. The company is required to constantly generate adequate cash flows to meet debt requirements.

CDNS' Premium Valuation

Cadence’s stock is trading at a premium with a forward 12-month Price/Earnings of 44.27X compared with the industry’s 33.95X. Though the lofty valuation reflects high expectations for future growth, the near-term prospects of the company remain somewhat muddled.

Image Source: Zacks Investment Research

Declining Estimates for CDNS

Analysts are bearish about the stock, which is evident from the downward revision in earnings estimates.

Image Source: Zacks Investment Research

In the past 60 days, analysts have decreased their earnings estimates for the current quarter and next quarter by 8.5% and 0.6% to $1.82 and $1.57 per share, respectively. The same for the current year has been revised upward by 0.5% to $5.91 per share.

CDNS’ Robust Portfolio

Expanding product portfolio, as well as frequent product launches, is a key catalyst. The company is focusing on providing end-to-end solutions, which rapidly reduces the time required to introduce a semiconductor product in the market. It is experiencing strong demand for its software, particularly verification and digital design products, from customers providing datacenter servers, networking products and smartphones that continue to invest in new design concepts and projects.

Going ahead, the company is likely to benefit from customers increasing their R&D spending in artificial intelligence (AI) driven automation. Cadence remains focused on embedding cutting-edge AI capabilities across its SDA, EDA and digital biology offerings. Secular trends like 5G, increasing usage of hyperscale computing and autonomous driving are influencing design activity across semiconductor and systems companies. This is likely to open up opportunities for its end-to-end EDA, IP and systems solutions.

In the last reported quarter, CDNS noted that sales of its Cadence.AI portfolio (powered by GenAI, AI-driven optimization and JedAI platform) nearly tripled year over year. 

Uptake of CDNS’ New Hardware Systems Bodes Well

Cadence continues to invest heavily in verification and digital design products, which is helping it to launch products that address the ever-growing needs of electronics and semiconductor companies. The company’s verification business is gaining traction due to the rising complexity of system verification and software bring-up.

In April 2024, the company unveiled the latest Palladium Z3 Emulation and Protium X3 FPGA Prototyping systems. This is an advanced digital twin platform that is aimed at addressing the growing complexity of system and semiconductor design. The latest systems offer more than double the capacity and a significant performance increase compared with Palladium Z2 and Protium X2 systems.

Management added that palladium systems have already been deployed by a few customers and were endorsed by NVIDIA, Arm and AMD. Cadence noted that its latest hardware solutions are likely to witness solid demand, especially from AI, hyperscale and automotive companies.

Should Investors Invest in CDNS?

Strong end-market demand trends and opportunities presented by the rapid proliferation of AI applications are positives for Cadence, but the external risks warrant caution in the near term. The company’s falling estimates and expensive valuation are concerning.

Consequently, it may not be a prudent investment decision to bet on the stock, which carries a Zacks Rank #3 (Hold) at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

However, stakeholders and investors already owning the stock could stay put as long-term prospects for CDNS appear promising amid increasing design activity in the semiconductor space.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

Synopsys, Inc. (SNPS) : Free Stock Analysis Report

Cadence Design Systems, Inc. (CDNS) : Free Stock Analysis Report

ANSYS, Inc. (ANSS) : Free Stock Analysis Report

Keysight Technologies Inc. (KEYS) : Free Stock Analysis Report

To read this article on Zacks.com click here.

Zacks Investment Research