When a company reports record revenue, record gross margins, and initiates a dividend, it would be expected that shares would rise. For NVIDIA (NVDA), shares peaked at around $13 when the company reported quarterly earnings in early-November 2012, only to drop below $11.50 later that month. NVIDIA closed recently at $12.17.
Strong demand for Kepler GPUs and Tegra 3 failed to offset ongoing concerns of a weak PC sector. Two things are weighing on shares. First, there is expectation that a weak PC sector will continue to hurt NVIDIA. Second, investors worry about the lack of modem integration with chips will make it difficult to more effectively compete with Qualcomm (QCOM).
Investors are punishing NVIDIA shares because of its reliance on the PC gaming market. The Kepler platform gives PC gamers an upgrade path, enabling them to play top game releases. Strong game sales ensure that NVIDIA will report strong holiday sales from the PC channel, when earnings are released on February 14, 2013.
Over the past few years, NVIDIA reduced its reliance on the PC segment. 3 years ago, non-PC revenues were 7% of total revenues. In its most recently reported quarter, non-PC revenues grew to 30%. Demand for notebooks remains steady, and NVIDIA is ensuring that its chip is used in a growing percentage of all notebooks.
NVIDIA's Tegra 3 is used in many Android tablets. This includes the Google Nexus 7. The chip is also used in Microsoft's (MSFT) RT tablet, along with Lenovo's Yoga 11 tablet.
Financial Health Remains Strong
Gross margin was 52.9% in NVIDIA's most recent quarter. Revenue grew 10.7% in the GPU segment, 12.4% in the professional business segment, and 35.7% on the consumer side.
Integrated Mobile Processor: Tegra 4
The main difficulty NVIDIA previously faced was integrating a 4G LTE modem in its next-generation mobile application processors. It is a new market for NVIDIA, and is the main source of uncertainty for investors. Announced at CES 2012, the Tegra 4 is reportedly 45% more efficient in power management compared to the Tegra 3. An i500 Soft Modem with Tegra 4 also means NVIDIA will support LTE. The company will now offer something closer to that offered by Qualcomm's latest Snapdragon.
Tegra 4 will also have 72 graphics cores, compared to the 12 that were found in the previous version.
Not to be outdone, Qualcomm said its new Snapdragon 800 would support 4K video playback and recording, similar to the Tegra 4. Qualcomm's Snapdragon will also have a faster LTE and Wi-Fi.
Despite the huge improvements by Qualcomm and NVIDIA, these chips may not compete directly with each other. In a performance review, it was suggested that the Tegra 4 will target tablets, while the Snapdragon 800 will target smartphones.
A permanent shift in the growth of tablets as a consumption device will benefit NVIDIA, but there are risks. "Project Shield" illustrates the importance of Android gaming for Tegra chip sales. An NVIDIA-based handheld console is not likely the answer. Investors recognize this risk, and sold off shares accordingly.
The roll-out of Tegra 4 in Android and Nexus devices should get investors interested in NVIDIA. The company is valued at a P/E of 15, while Qualcomm is valued at a P/E of 21. Both companies have roughly the same forward P/E of around 13. This implies that investors do not expect Tegra 4 will compete effectively against Qualcomm. The odds are good that NVIDIA's first-generation integrated chip will exceed investor expectations. If not, and Project Shield clouds consumer interest in Tegra 4-based devices, investors will still get paid a dividend of nearly 2.5% annually. Investors also benefit with the upside of more manufacturers planning to use Tegra 4 chips in their products.