Arista Earnings: Selloff Uncalled for After Strong Quarter; We Raise Our Fair Value to $140

We raise our fair value estimate for wide-moat Arista Networks ANET to $140 per share, from $130. Arista reported first-quarter sales and operating margin ahead of management guidance, but our valuation bump comes primarily from upward revisions to our longer-term growth assumptions. Despite a strong quarter, Arista shares sold off as much as 8% after the print, in our view likely due to concerns over cloud digestion. We don’t share these concerns in the short term and don’t interpret any of management’s commentary as worrisome. In fact, Arista modestly raised its full-year sales guidance, and we continue to expect it to eclipse this figure. Despite our contrarian fair value upgrade following the quarter, we see shares as fully valued.

First-quarter sales rose 54% year over year and 6% sequentially to $1.35 billion behind continued demand strength at cloud customers. Arista cited improved supply availability for the guidance beat, a positive forward-looking sign in our view. Though the year-over-year growth number may be eye-popping, we expect growth to moderate in coming quarters as results lap tough comparisons from last year.

A high cloud mix weighed again on non-GAAP gross margin, which came in at a relatively low 60.3% for Arista. We were pleased to hear management reaffirm their belief in sequentially improving gross margin levels through the rest of 2023 due to increasing supply. Non-GAAP operating margin of 41.2% was very strong for Arista and benefitted from higher-than-expected volumes.

Second-quarter guidance implies sequential sales growth (midpoint of $1.375 billion), sequential gross margin improvement, and sequential operating margin compression. We actually view operating margin compression positively in the short term, as we look for Arista to invest more heavily in its go-to-market approach to take share in the campus market. We see any level above 38% positively for non-GAAP operating margin, and levels above 40% potentially indicating low investment.