Nvidia (NVDA) reported earnings after the bell on 2/13. The company did $1.1B in sales, earned $0.28/share (ahead of estimates thanks to a tax benefit), and in general had a strong quarter. Year-over-year, the graphics business managed to grow 8% for FY2013, gross margins were up 0.6% from FY2012, but these were offset by higher OpEx from the "Tegra" business and ultimately led to a 3.2% decline in net income for the year.
The ugly part of the report and guide was the guidance for Q1 that was given. While Q1 is typically seasonally down for the majority of semiconductor players, and while Nvidia's guidance still calls for a Y/Y increase in sales (from $924M to $940M or ~2%), it is clear that the gap period between the ramping down of the Tegra 3 and the ramping up of Tegra 4 will materially impact Q1, but should begin to rebound in Q2 as Tegra 4 begins to ship to customers.
Further, OpEx, mostly up due to new hires for Tegra/Icera division (coupled with raises and 401K matching program that was just added) is likely to be a sore spot for investors as the company will need to both maintain its historically high gross margins (52.9%), grow its revenue considerably in GPUs (GeForce, Quadro, and Tesla), and ramp Tegra 4 sales significantly if it is to simply maintain the level of profitability that was seen in FY2013, let alone see any real EPS growth.
Estimates For FY2014 Will Likely Be Cut
In the near term, I would expect earnings estimates for FY2014 to be cut. As they stand, analysts are expecting $0.95/share for the year, up $0.05 from FY2013. Q1 will not exactly have the best start, since at $940M in sales, 52.9% GM, and $430M in OpEx against a tax rate of 16% and depreciation of ~$60M, the company barely turns a profit for the quarter.
The company refused to give a full year guide, so in light of the uninspiring guide, analysts are likely to take a pessimistic view and assume the worst. EPS estimates will be cut, revenue estimates will probably vary wildly depending on how optimistic/pessimistic the analysts are about GeForce/Quadro/Tesla growth offsetting a potentially weak year for Tegra.
The OpEx: Necessary, But Won't Sit Well With Investors
While PC graphics cards are a good, modestly growing business, and while the professional/HPC cards are also a good way to leverage gaming card R&D, the company absolutely needs another source of revenue if it is to be a viable long-term growth story. I believe that Nvidia's increased R&D for the Tegra/Icera division mirrors the intense spending that Intel (INTC), another PC chip vendor that needs additional growth avenues, has put in place for its Atom division. This is a move that needs to happen, and the company needs to invest in this area (modem + apps processor) while it still has a shot at emerging as a market leader, but until the results from those investments are out there, it will be a tough battle for the company.
The Cash Balance Only Limits Downside
Nvidia has a tremendous amount of valuation support as it now sports over $6/share in cash. This implies that, at the current after-hours levels, the company trades at an EV of ~ $3.8B, or less than 1x sales. While this valuation support is certainly nice, and it is encouraging that the company bought back $100M of shares and is paying a $0.30/yr dividend, this only limits downside rather than helping to create any potential upside from here.
I would advise management of Nvidia to not pursue the buyback aggressively at this time. The shares are likely to go lower, and given that this cash reserve will be necessary in the event that the core business starts to face headwinds, it seems unwise to engage in transactions that ultimately destroy shareholder value. Returning the cash as a dividend would be a slightly better idea, but this comes with the obvious tax implications for taxable accounts.
Weighing The Positives And Negatives
I am overall positive on Nvidia's long-term strategy, although in the near- to medium-term, shares are likely to be under pressure. First, let me recap the positives I see for the company:
- Jensen noted that the company is gaining share in Tesla/Quadro (professional, high margin GPUs), and further the 10% Q/Q increase in the Quadro business, which had been under pressure over the last several quarters, is encouraging given the high operating margins of this segment (~46%).
- Jensen gave a positive outlook on Nvidia's competitive positioning in the PC gaming market, implying that further share gains are likely ahead for the company's GeForce product line, in line with the trend that we have seen since the Kepler launch.
- The company's cash position is strong and continues to get stronger, which helps to put a valuation floor on shares of the company at around the $10 level assuming $6/share cash + $4/share EV (~$2.4B, which is pessimistic).
- As a technology company competing in a space with players that are rapidly falling off, if Nvidia can actually survive this race (and it can with the GeForce/Quadro business generating a healthy amount of cash), then Tegra will emerge as a healthy, profitable, and growing segment for the company.
- GRID could be a nontrivial medium-term upside driver on the revenue side for the company, although the opportunity is difficult to quantify at the moment.
- Project SHIELD is likely, at the very least, to drive continued share gains in GeForce as it will give customers/gamers yet another incentive to choose an Nvidia card over one from AMD.
- Gross margins remain consistently high.
- Design wins for T4 are more numerous at this point than T3 has had during its lifetime.
- No update on the much hyped "Project Denver" although I suspect that as a part that is designed to be integrated onto a Tesla add-in board, it is unlikely to be worthy of much fanfare as a standalone product.
- It would have been helpful to get a clearer answer on the company's market share goals in GPU for 2013. The answer given was slightly vague, although recent leaks suggest Nvidia's upcoming "Titan" GPU will solidify the high end of the market and create an indisputable "halo" product.
- Dividend increase unlikely during FY2014 as net income will likely continue to be under pressure until the integrated LTE/Tegra 4 product is available and helping to justify elevated R&D expenses seen throughout the year.
- Company's inability to give a full-year guide creates a level on uncertainty that is unhealthy for the stock in the near- to medium-term.
- While company seems squarely focused on PC gaming (its core strength), the notable absence from the upcoming console cycle is likely to strengthen competitor AMD's image, especially as each of these cycles is usually heralded as doom and gloom for the PC gaming market.
- Management, while understandably defending Windows RT, fail to acknowledge that solutions from Intel in the low power SoC space already deliver similar/better power consumption and performance characteristics to all of the ARM-based SoCs available today, including Nvidia's Tegra 3. The situation becomes tougher as Intel leap-frogs the ARM-camp (Nvidia, Qualcomm, Samsung) and releases its ground-up 22nm low power Atom in the back half of the year.
- Profitability under pressure for the April quarter, and if the Tegra 4 ramp does not occur in Q2, profitability could continue to remain under pressure in light of the heightened OpEx.
Nvidia is in a strong position in its core market, but it remains to be seen whether it can successfully steer its Tegra division to profitability. The uplift in professional graphics, HPC, and even gaming will be tailwinds during the year, offset by the uncertainty of the mobile efforts, especially as Tegra 4 may be too late to score the Amazon (AMZN) Kindle Fire and next generation Google (GOOG) Nexus 7 refresh sockets.
The Tegra division will not become exciting until 2014 when it opens up a significant portion of the smartphone TAM with an LTE solution. While I am confident Nvidia will get wins here, it is unclear if the competitive landscape and the ASP/gross margin profile of these products will allow for Nvidia to profitably pursue this business and continue with the investments in both connectivity and SoC design in order to emerge as one of the dominant players in the field.
On valuation, and on future growth prospects, Nvidia is a solid long-term buy at or below the $12 level, but the opportunity cost of holding the stock until the next major catalyst may be too high for many investors. In the near term, shares are dead money, but the reward for the company - if it can pull off a viable LTE + apps processor combo in 2014 - could be quite good. Until then, Nvidia's share price will still be tied to its GPU fortunes.
Additional disclosure: I am short ARMH