Arm's stock dips after earnings, but here's the case for optimism

By Emily Bary

Analysts are encouraged about future royalty potential, judging by the performance of company's licensing business

Arm Holdings PLC shares pared intraday losses Thursday, but still ended the session in the red after a report that failed to live up to Wall Street's high expectations for the chip-design name.

Heading into the report, Arm (ARM) faced a setup "as challenging as any in our coverage universe," according to Evercore ISI analyst Mark Lipacis.

Read: Arm crushes earnings expectations, but stock falls as forecast lacks wow factor

"We continue to like the stock over the next 12 months, but near-term believe the stock consolidates as momentum investors look to the second derivative of revenue growth as a signal to lock in profits," he wrote, while sticking with his outperform rating but cutting his price target to $145 from $156.

Big picture, though, he saw an encouraging sign in Arm's outlook, as he noted that Arm's royalty forecast trailed the consensus view, while licensing guidance exceeded it. Since the licensing business leads the royalty business by one to three years, upbeat licensing trends now signal upside potential for the future, according to Lipacis.

Guggenheim's John DiFucci took that view as well. "While royalty revenue guidance was below consensus, it was offset by better growth expectations in license revenue, which bodes well for future royalties," he said.

The royalty outlook also "appropriately takes into account the current macro environment," according to DiFucci.

"Note that royalty revenue is recognized upon shipment of products that include Arm-based chips, which could be tied to an array of end markets, and makes the company somewhat susceptible to conditions in those markets," he wrote. "For instance, Arm called out softness in automotive, industrial IoT and networking, which we believe are cyclical in nature as opposed to structural issues."

At the same time, Arm still anticipates strong growth in the mobile and cloud arenas, DiFucci noted. He rates the stock a buy and lifted his price target to $100 from $93 in his latest note.

BofA Global Research analyst Vivek Arya cheered the company's free cash flow, which was 32% of revenue last fiscal year. He sees the prospect of that rising to 36% this fiscal year and topping 40% in fiscal 2026.

"As reference, this FCF margin is higher than nearly every software and most semiconductor companies in the S&P 500 index," he wrote.

Arya rates the stock a buy with a $150 price objective. Still, he acknowledged the stock's risks. "We expect the stock to remain volatile given its premium [price-to-earnings] multiple, small trading float and concentrated ownership structure," he noted.

The stock fell 2.3% in Thursday trading. Arm shares have slipped 21% over the past month, but are still up 38% year to date.

-Emily Bary

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05-09-24 1607ET

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