Rating Update: Stock Rating B-Positive (9/5/19)-Cadence Design Systems Inc (CDNS).

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BUSINESS

Cadence Design Systems, Inc. provides electronic design automation software, emulation and prototyping hardware, system interconnect, and analysis worldwide. The company offers functional verification services, including emulation and prototyping hardware. Its functional verification offering consists of JasperGold, a formal verification platform; Xcelium, a parallel simulation platform; Palladium Z1, a verification computing platform; and Protium S1 field-programmable gate array prototyping platform.
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INVESTMENT RATING

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CDNS’ future returns on capital are forecasted to exceed the cost of capital. Accordingly, the company is expected to continue to be a major Value Builder.

Cadence Design Sys has a current Value Trend Rating of B (Positive).
This rating combines very contradictory signals from two proprietary PTR measures of a stock’s attractiveness. Cadence Design Sys has a slightly negative Appreciation Score of 32 but a very high Power Rating of 97, leading to the Positive Value Trend Rating.

Cadence Design Sys’ stock is selling well above targeted value. The current stock price of $70.61 compares to targeted value 12 months forward of $56.
This moderately low appreciation potential results in an appreciation score of 32 (68% of the universe has greater appreciation potential.)
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Cadence Design Sys has a Power Rating of 97. (This very high Power Rating indicates that CDNS has a better chance of achieving attractive investment performance over the near to intermediate term than all but 3% of companies in the universe.)
Factors contributing to this very high Power Rating include: recent price action has been extremely favorable; the recent trend in CDNS’ earnings estimates has been favorable; and is currently in a modestly favorable positi.

INVESTMENT PROFILE

CDNS’ financial strength is high. Financial strength rating is 89.
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Relative to the S&P 500 Composite, Cadence Design Systems Inc has significant Growth characteristics; its appeal is likely to be to Capital Gain-oriented investors; the perception is that CDNS is lower risk. All factors are relative strengths. CDNS’ valuation is high: low dividend yield, high P/E ratio, and high price/book ratio. CDNS has normal market capitalization.

CURRENT SIGNALS

Cadence Design Sys’ current operations are strong. Return on equity is rising, reflecting: improving asset utilization; widening pretax margins; rising tax keep rate; and rising leverage.

Cadence Design Sys’ current technical position is very strong. The stock price is in a 15.9 month up move. The stock has appreciated 111.4% from its prior low. The stock price is above its 200 day moving average which is in an uptrend.

ALERTS

Slight positive changes in fundamentals have recently occurred for Cadence Design Systems Inc (NASDAQ: CDNS): significant quarterly sales acceleration occurred.
The stock is currently rated B.
Cadence Design Systems Inc (NASDAQ: CDNS) stock enjoyed a major increase of 36.7% on 9/5/19. The shares closed at $0.28. However, below average trading volume at 81% of normal accompanied the advance. The stock has risen 5.2% during the last week and has been exceptionally strong relative to the market over the last nine months.

CASH FLOW

In 2018, Cadence Design Sys experienced a significant decline in cash of -$159.2 million (-23%). Sources of cash were lower than uses. Cash generated from 2018 EBITDA totalled +$540.9 million. Non-operating uses consumed -$27.6 million (-5% of EBITDA). Cash taxes consumed -$30.5 million (-6% of EBITDA). Re-investment in the business amounted to -$288.2 million (-53% of EBITDA). On a net basis, debt investors withdrew -$307.2 million (-57% of EBITDA) while equity investors pulled out -$46.6 million (-9% of EBITDA).
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Cadence Design Sys’ Non-operating Income, %EBITDA has suffered a very strong overall downtrend over the period. This downtrend was accompanied by stability for the Cadence Design Systems Inc Peer Group. In most years, Cadence Design Sys was in the top quartile and lower quartile. Currently, Cadence Design Sys is below median at -5% of EBITDA (-$27.6 million).

Cadence Design Sys’ Cash Taxes, %EBITDA experienced a volatile overall downtrend over the period. This downtrend was accompanied by stability for the Cadence Design Systems Inc Peer Group. In most years, Cadence Design Sys was in the top quartile. Currently, Cadence Design Sys is upper quartile at -6% of EBITDA (-$30.5 million).

Cadence Design Sys’ Business Re-investment, %EBITDA has suffered a volatile overall downtrend over the period. This downtrend was accompanied by stability for the Cadence Design Systems Inc Peer Group. (Since 2016 Business Re-investment, %EBITDA has decelerated very sharply.) In most years, Cadence Design Sys was in the lower quartile and second quartile. Currently, Cadence Design Sys is lower quartile at -53% of EBITDA (-$288.2 million).

Cadence Design Sys’ Debt Investors, %EBITDA has experienced a very strong overall downtrend over the period. This downtrend was accompanied by an opposite trend for the Cadence Design Systems Inc Peer Group. (Since 2016 Debt Investors, %EBITDA has accelerated very sharply.) In most years, Cadence Design Sys was in the top quartile and lower quartile. Currently, Cadence Design Sys is lower quartile at -57% of EBITDA (-$307.2 million).

Cadence Design Sys’ Equity Investors, %EBITDA has enjoyed a very strong overall uptrend over the period. This improvement was accompanied by an opposite trend for the Cadence Design Systems Inc Peer Group. In most years, Cadence Design Sys was in the top quartile. Currently, Cadence Design Sys is upper quartile at -9% of EBITDA (-$46.6 million).

Cadence Design Sys’ Change in Cash, %EBITDA has experienced a volatile overall downtrend over the period. This downtrend was accompanied by a similar trend for the Cadence Design Systems Inc Peer Group. In most years, Cadence Design Sys was in the top quartile and lower quartile. Currently, Cadence Design Sys is lower quartile at -29% of EBITDA (-$159.2 million).
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Cadence Design Sys’ Cash, %Revenue has suffered a very strong overall downtrend over the period. This downtrend was accompanied by stability for the Cadence Design Systems Inc Peer Group. In most years, Cadence Design Sys was in the top quartile. Currently, Cadence Design Sys is upper quartile at +25%.

PROFITABILITY

CDNS’ return on equity reached a new post-2010 low in 2019.
CDNS’ very strong positive trend in pretax operating return significantly offset by a very strong negative trend in non-operating factors is a major performance consideration.
The productivity of CDNS’ assets rose over the full period 2009-2019: asset turnover has enjoyed a very strong overall uptrend that accelerated after the 2014 level.
Non-operating factors (income taxes and financial leverage) had a significant negative influence on return on equity.
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CDNS’ return on equity is at the upper quartile (29.7%) for the four quarters ended June, 2019.
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Operating performance (pretax return on assets) is upper quartile (17.8%) reflecting asset turnover that is upper quartile (0.86X) and upper quartile pretax margin (20.6%).
Tax “keep” rate (income tax management) is upper quartile (91.5%) resulting in after tax return on assets that is upper quartile.
Financial leverage (leverage) is lower quartile (1.83X).

GROWTH RATES

Overall, Cadence Design Systems’ growth rate has slowed considerably in recent years.
Cadence Design Systems’ historical income statement growth and balance sheet growth have diverged. Revenue growth has paralleled asset growth; earnings growth has fallen short of equity growth.

Annual revenue growth has been 9.5% per year.

Total asset growth has been 4.3% per year.

Annual E.P.S. growth has been 13.7% per year. (More recently it has been 47.0%.)

Equity growth has been 20.9% per year. (More recently it has been 1.7%.)

Cadence Design Systems’ consensus growth rate forecast (average of Wall Street analysts) is 10.0% — in line with the average of the historical growth measures.
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Relative to the Cadence Design Systems Inc Peer Group, Cadence Design Sys’ historical growth measures are erratic. Equity growth (20.9%) has been upper quartile. Revenue growth (9.5%) has been above median. E.P.S. growth (13.7%) has been above median. Total asset growth (4.3%) has been substantially below median.

Consensus growth forecast (10.0%) is at median.
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PRICE HISTORY

Over the full time period, Cadence Design Systems’ stock price performance has been exceptional. Between November, 2008 and September, 2019, Cadence Design Systems’ stock price rose +1729%; relative to the market, this was a +451% gain. Significant price moves during the period: 1) June, 2010 – January, 2018: +675%; and 2) December, 2008 – September, 2009: +101%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of 67.6% is upper quartile relative to the S&P 500 Composite.
In addition to being upper quartile relative to S&P 500 Composite, current annual total return performance through July, 2019 of 67.6% is upper quartile relative to Cadence Design Systems Inc Peer Group.

Current 5-year total return performance of 34.4% is upper quartile relative to the S&P 500 Composite.
Through July, 2019, with upper quartile current 5-year total return of 34.4% relative to S&P 500 Composite, Cadence Design Sys’ total return performance is at the upper quartile relative to Cadence Design Systems Inc Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, CDNS’ overall valuation is exceptionally high. All five factors are lower quartile. The highest factor is the ratio of enterprise value/assets, followed by the price/equity ratio, then by the ratio of enterprise value/revenue, then by the ratio of enterprise value/earnings before interest and taxes. The lowest factor is the price/earnings ratio.

Relative to Cadence Design Systems Inc Peer Group, CDNS’ overall valuation is quite high. The highest factor, the ratio of enterprise value/assets, is upper quartile. Price/equity ratio is at the upper quartile. Ratio of enterprise value/revenue is upper quartile. Ratio of enterprise value/earnings before interest and taxes is upper quartile. The lowest factor, the price/earnings ratio, is near the upper quartile.
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Cadence Design Sys has a major value gap compared to the median valuation. For CDNS to achieve median valuation, its current ratio of enterprise value/revenue would have to fall from the current level of 8.68X to 5.27X. If CDNS’ ratio of enterprise value/revenue were to fall to 5.27X, its stock price would be lower by $-28 to $43.
For CDNS to fall to lower quartile valuation relative to the Cadence Design Systems Inc Peer Group, its current ratio of enterprise value/revenue would have to fall from the current level of 8.68X to 3.52X. If CDNS’ ratio of enterprise value/revenue were to fall to 3.52X, its stock price would decline by $-42 from the current level of $71.

VALUE TARGETS

CDNS’ future returns on capital are forecasted to exceed the cost of capital. Accordingly, the company is expected to continue to be a major Value Builder.
Cadence Design Systems’ current Price Target of $63 represents a -11% change from the current price of $70.61.
This moderately low appreciation potential results in an appreciation score of 32 (68% of the universe has greater appreciation potential.)
Notwithstanding this moderately low Appreciation Score of 32, the high Power Rating of 97 results in an Value Trend Rating of B.
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Cadence Design Systems’ current Price Target is $63 (+135% from the 2018 Target of $27 but -11% from the 09/05/19 price of $70.61). This dramatic rise in the Target is the result of a +6% increase in the equity base and a +122% increase in the price/equity multiple. The forecasted increase in growth has a very large positive impact on the price/equity multiple and the forecasted increase in return on equity has a large positive impact as well. Partially offsetting these Drivers, the forecasted increase in cost of equity has a slight negative impact.
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PTR’s return on equity forecast is 45.7% — in line with our recent forecasts. Forecasted return on equity enjoyed a dramatic, erratic increase between 2010 and 2018. The current forecast is significantly above the 2014 low of 20%.

PTR’s growth forecast is 12.0% — substantially above our recent forecasts. Forecasted growth suffered a dramatic, erratic decline between 2012 and 2018. The current forecast is well above the 2012 low of 5%.

PTR’s cost of equity forecast is 9.8% — in line with recent levels. Forecasted cost of equity exhibited a modest, erratic increase between 2010 and 2018. The current forecast is above the 2010 low of 7.7%.
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At Cadence Design Systems’ current price of $70.61, investors are placing a positive value of $43 on its future investments. This view is consistent with the company’s most recent performance that reflected a growth rate of 2.0% per year, and a return on equity of 38.7% versus a cost of equity of 9.1%.
PTR’s 2020 Price Target of $63 is based on these forecasts and reflects an estimated value of existing assets of $25 and a value of future investments of $38.

About John Lafferty 80532 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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