Arista Earnings: Great Results and Higher 2023 Guidance Drive Up Our Valuation

We raise our fair value estimate for shares of wide-moat Arista Networks ANET to $150 from $140, after it beat our second-quarter expectations and raised its full-year outlook. Arista is benefiting from a year of strong networking spending, particularly at its large cloud and data center customers. Data center spending is Arista’s largest revenue driver, and despite a lowered capital spending outlook at Meta, we believe Microsoft and its other large customers are supporting strong results in 2023. We continue to view Arista as the leader in high-speed data center switching, with a wide moat driven by its marquee EOS software. We believe artificial intelligence is incremental to Arista’s existing growth opportunity, and will contribute to results in coming years. However, we still see shares out of reach, and recommend investors wait for a pullback.

Second-quarter sales rose 39% year over year and 8% sequentially to $1.46 billion. Sales eclipsed the top end of company guidance driven by strong spending across Arista’s user base. Arista’s push into enterprise customers is progressing, but cloud spending continues to be the driver of results. We’re pleased to hear that lead times for Arista’s orders are normalizing (though still well above the eventual target of six months) as an improved supply environment should see sales better reflect real demand.

Non-GAAP gross margin improved 100 basis points sequentially to 61.3% underpinned by lower supply-constraint-related costs. Gross margins still sit below levels from a year ago and in our view are healthy for Arista, but management called for improvement through 2023 to a higher level in 2024. Non-GAAP operating margin improved 40 basis points sequentially to 41.6%, as Arista’s higher investments to pursue enterprise market share gains can’t keep up with torrid volume growth.