ARM Holdings (ARM) considered an attractive entry point because strong Q2 licensing and royalties will offset rising operational expenses, supporting the long-term potential of custom chip development, Morgan Stanley said Thursday in a report.

The firm projects Arm's Q2 sales to rise 28% year-over-year, driven by strong licensing revenue of $470 million and strong royalties supported by Apple's (AAPL) iPhone cycle.

Morgan Stanley sees operating expenses rising to $949 million in Q2 as headcount expansion to 12,000 by 2027 to 2028 pressures near-term margins, according to the report.

The analyst has lowered its projected three-year earnings per share compound annual growth rate for 2024 to 2027 to around 28%, down from an earlier estimate of 32% to 34%, the report said.

Despite Morgan Stanley reduced its 2027 EPS forecast to $2.64 from $2.68, it remains positive on the company's long-term growth, citing prospects in custom chip development and a broadening licensing portfolio. Analysts surveyed by FactSet expect $2.25.

Analysts see Arm's discount to Nvidia (NVDA) and Advanced Micro Devices (AMD) as a buying opportunity, with long-term potential in CPU leadership and future ASIC development over 3 to 5 years, it added.

The firm maintained its rating on Arm Holdings to overweight, but reduced its price target to $171 from $180.

Shares of the company were down 0.8% in recent trading.

Price: 168.15, Change: +1.38, Percent Change: +0.82