HSBC cuts Arm stock price target on royalty weakness despite licensing beat

HSBC has reduced its price target for Arm Holdings (NASDAQ:ARM) stock to $215 from $230, while keeping a Hold rating. Even with the lowered target, the company's stock is trading at $191.80, marking a 16% drop over the past week due to general market uncertainty. Despite Arm's impressive licensing performance, HSBC believes the stock may be priced too high, noting the company is overvalued at present levels.

The fiscal 2027 licensing sales of the UK-based tech firm hit $773 million, surpassing HSBC's expectations by 15% and consensus by 16%, which helped balance out the decline in royalty revenues. Licensing sales are expected to continue growing significantly in the third quarter of fiscal 2027, with more than 50% YoY growth compared to the low single-digit growth in royalties.

However, Arm attributes the weaker royalty revenue momentum to a higher exposure to the smartphone market, as overall demand is affected by rising memory costs. The company remains optimistic about the potential of AGI CPU revenue, aiming for a $2 billion revenue stream in fiscal 2027 and 2028 with its first merchant CPU chip entering the market in the fourth quarter of fiscal 2027.

Despite ongoing uncertainties about execution, Arm has not raised its AGI CPU revenue guidance beyond $1 billion. HSBC sees server royalties as the primary earnings driver, projecting significant growth in this area due to increasing server CPU market size, increased market share, and higher CPU core counts, which will raise royalty ASP per chip.

Arm's gross profit margin of 97.5% and a market capitalization of $205 billion highlight its financial strength, but analysts point out the stock's high valuation, as it trades at a P/E ratio of 195. Investors can find more detailed information in Arm's Pro Research Report. Arm is scheduled to release earnings on November 4, 2023, and options data suggests a potential 8.9% stock movement.

Analyst opinions on Arm's future performance vary, with Goldman Sachs maintaining a Sell rating and a price target of $160, while Piper Sandler has initiated coverage with an Overweight rating and a $320 price target. StoneX has held a Hold rating, noting Arm's strong position in the data center CPU market and potential for growth in automotive and PC markets.

Susquehanna analysts expect a modest upside in semiconductor earnings, driven by advancements in artificial intelligence.