Incorporated in 1993, Nvidia (NVDA) is a pioneer in visual computing, ushering a new era of visual computing with its introduction of GPUs, which are currently used in almost every technology driven device with a screen. Nvidia supplies visual computing devices to a number of industries including smartphones, tablets and auto infotainment systems. The company grew rapidly by tapping into the smartphones industry in early 2000s, and is capitalizing on the fast-growing cloud computing segment by introducing virtual GPUs.
Nvidia has diversified aptly by producing a wide array of products to cater for the expanding technology sector. The company has solidified its roots in PC graphics with the introduction of GEFORCE® processors, providing unparalleled visual experience to the ever-growing gaming industry. The invention of QUADRA® in the early 2000s, a programmable processor made Nvidia reach out to the professional visual graphics segments, providing graphical support to cars and planes. TESLA® is another product which has aided researchers in cutting edge technology providing graphical assistance in climate modeling and quantum physics. TEGRA® is another very profitable product tapping into the Smartphone segment with powerful and efficient processor.
Nvidia is a graphic chip manufacturer that provides vital input to the technology industry. The business model is basic but heavily dependent on Nvidia's capacity to foresee emerging/future trends in technology in order to constantly evolve to sustain its business. The company has successfully evolved in the past at the right time of a new emerging (profitable) trend. It is currently focusing on virtual GPU to make its presence felt in an exponentially growing market, cloud computing.
The chip manufacturing industry is highly competitive and is marked by rapid technology change, constantly evolving industry standards and declining average selling prices. A number of competitive factors are simultaneously at play including performance, variety of product offering, access to customers, software support (after sales services), manufacturing capabilities and total processor pricing to highlight a few. Nvidia's competitive advantage would depend immensely on its ability to anticipate future demand trends and customer needs along with sustained supply, quality standards and competitive pricing. The company has been able to stand out amongst its peers in recent years.
A significant source of competition comes from GPU providers and potential manufactures. Current competitors in GPU manufacturing include Intel (INTC), Matrox Electronics Systems and VIA Technologies. Suppliers of system-on-chip products that primarily support smartphones, tablets, automotive navigation and portable media devices include ARM holdings (ARMH), Broadcom (BRCM) and Qualcomm (QCOM) - all these companies are a source of major competition for Nvidia. Nvidia's competitive advantage would depend on its capacity to compete on a number of fronts. Keeping pace with the technology advancement, development of new products and success in major foreign markets, namely China and India are crucial for Nvidia's sustainability.
Nvidia has seen a major turnaround in its financial position over the last five years. Revenue has grown 4.5% annually, but the gross margin has grown at 13.6% (CAGR), implying a solid business model with lower percentage increase in COGS over the same period. The company aggressively spends on R&D ($1.065billion in 2012), which is imperative for sustained growth and constant evolving nature of the business. Year 2010 saw a number of important financial matrices turning green after reporting a loss over the last two years. Operating income and net income reported profits have grown at astronomical rates, more than doubling over the last three years.
The growth is primarily supported by the booming technology sector and Nvidia's diversification strategy. The company currently sustains a gross margin of 52%, which is impressive in absolute terms but even more compelling when compared to the industry margin of 26%. Net profit margin is almost three times the industry, and has grown twice as fast compared to the industry over the last five years.
Nvidia currently commands a dividend yield of 2.24%, which is relatively higher than the industry and a sector yield of 1.7% and 1.66%, respectively. The stock looks even more compelling when the payout ratio is observed; Nvidia has a payout ratio of 8.33%, significantly lower than the industry and sector payout of 43% and 31%, respectively. This also suggests the sustainability of dividend payout and the room to increase given future profitability. In terms of relative valuation, the company is significantly cheaper, currently maintaining P/E ratio of 14.9 while the industry commands a P/E ratio of 34.7.
One interesting point to note is that the company beats its peers in every single management efficiency ratio i.e. ROA, ROI and ROE by a considerable margin. In determining the fair value for the company, it is imperative to remember that Nvidia is in a fast growing and constantly evolving industry. If it can sustain, which it has over two decades, its long-term growth that is significantly higher (analyst estimate: 10.5%) in comparison to 3-4% for other companies in line with the GDP growth rate, then this, coupled with low sustainable payout ratio, high dividend yield and share repurchase program makes a solid case for Nvidia.
Although the outlook for the business is positive there are number of risk factors that could adversely affect the profitability of the business. The company is reliant on foundries to manufacture their products, and the third party risk is present in terms of not meeting manufacturing requirement. The gross profit margins would be adversely impacted in the case of third party foundries' incapability to transit to new technology platforms or successfully implement high quality. Failure to achieve market acceptance and design wins would adversely impact their operations and business viability.
Overall, Nvidia looks a compelling buy at the current levels - the company is growing at an exceptional rate; the product portfolio is strong, and the company has shown enough flexibility to meet the market demands. The growth is not expected to slow down in the near future, and I expect the stock to carry on its recent upward movement.