Nvidia Corporation (NASDAQ:NVDA) is a technology company operating in the industry of specialized semiconductors. The company was founded in 1993 and is headquartered in Santa Clara, California. Nvidia leverages its graphics technologies to create graphic processing units. These graphic chips have applications ranging from mobiles and PCs to high performance computing. Two technologies are the backbone of the company's business, its GPUs and the Tegra processor.
GPUs, as the name suggests, are graphic processors with densely packed transistors for high graphics performance. The company has specific GPU brands for different users; GeForce for gamers, Quadro for designers, Tesla for researchers and Grid for server graphics modules. Essentially, Nvidia's GPU segment serves markets like gaming, enterprise and cloud computing. The primary competitor of the company in this space is Advanced Micro Devices (NYSE:AMD). The company generated around 84% of its revenue from this segment during the fiscal year ended 2014.
Tegra is an SOC (system on a chip) designed to cater the needs of the high growth mobile and portable devices market. Tegra SOCs incorporate CPU, GPU, audio/video and input/output capabilities. These chips can also be integrated with communication modems that enable phone and data communication. Tegra is essentially a complete solution for mobile devices and is featured in several smartphones and tablets. The competitors of Nvidia in this regard include companies such as Qualcomm (NASDAQ:QCOM), MediaTek, Samsung Electronics and Marvell Technologies (NASDAQ:MRVL). The company generated around 10% of its revenue from this segment in the fiscal year 2014.
Shares of Nvidia Corporation are listed on NASDAQ and are currently trading at around $18. Investors are currently paying approximately $25 for $1 of earnings generated by Nvidia. There has been around a 44% appreciation in valuations since the last year or so. The company surpassed analyst EPS estimates by an average 20% in the past four quarters which is one the reasons behind the recent valuation surge.
Figure 1 Source: Yahoo Finance
Announcements regarding the Tegra K1 and the Maxwell architecture have also contributed to the valuation growth in the last month. The power efficiency claims related to Maxwell and the performance claims related to Tegra K1 may have driven the prices upwards. We will analyze these claims later on.
Revenues and EPS
Nvidia posted a revenue figure of $4.13 billion in the fiscal year ended January 2014. The revenue declined by 4% as compared to the previous year. Despite a 7% growth in the core GPU business, the overall revenue went down due to a decrease in the revenues of the Tegra segment. The company stated that the revenue decline in Tegra is a consequence of the transition from Tegra 3 to Tegra 4, but we believe this is not entirely the case. The revenues of Q4 2014 attributed to Tegra 4, declined by 37% as compared to the revenues in the same quarter last year. This indicates that the company is facing stiff competition from other SOC companies like Qualcomm. Tegra has been lagging behind Qualcomm's offerings in terms of performance. Therefore, the product offerings of Nvidia have not been as competitive as others and have caused the revenues to decline. Note that this is not expected to be reflected in future performance, which we will discuss later on. The chart below summarizes the revenue position of the company:
Figure 2 Source: Financial statements
The GPU revenue is showing a year-on-year increase reflecting the constantly improving graphics technology of the company. Revenues from Tegra are volatile amidst stiff competition from Qualcomm and others.
The net income of the company also declined in the fiscal year ended January 2014. This decline was partially attributed to the decline in revenues and partially to the 12% increase in operating expenses during the reporting period. The operating expenses increase was due to an increase in employees and related expenses. As Nvidia is focused on rolling out the Maxwell architecture and K1 processors, the operating expenses are justified. The past EPS trend of the company is as follows:
Figure 3 Source: Company financial statements and Yahoo Finance
The increase in expenses has resulted in a declining EPS as shown above. Revenues were pressured by the slowing PC demand and less competitive Tegra business, but expenses were increased to support the upcoming product rollouts and resulted in the reduced EPS. Note that this trend is also not expected to reflect in the future performance.
Balance Sheet and Cash Flows
The cash and cash equivalent balance of the company is around $4.67 billion which translates to $8 cash per share. The current ratio is 5.95, indicating a very healthy short-term liquidity position as the industry's average current ratio is around 2.57. The enhanced liquidity position is mainly because of recent convertible debt offerings of $1.5 billion. The debt proceeds are expected to be used to repurchase stock and pay quarterly dividends. The company bought back 62 million shares for $887 million in the fiscal year 2014. The debt transaction in Q4 F2014 points toward further buyback plans. Buybacks are normally indicative of the fact that shares are undervalued, and the management is adjusting its capital structure while the shares are trading low. Nonetheless, the restructuring will help in reducing the cost of capital and will result in a high NPV for the company.
As far as OCF is concerned, the company generated $835 million in the fiscal year 2014. FCF was around $580 million for the year. The graph below shows dividends in comparison to the cash flows:
Figure 4 Source: Press release and Yahoo finance
The graph depicts that the company is generating enough cash to support its dividend payments. FCF is also above the dividend yield, indicating that even after fulfilling the CAPEX requirements the company has enough cash to pay dividends. Increments are also expected because dividend yield is lagging behind the cash flow yield. Nvidia can manage to pay yields as high as 4%. However, the current yield of around 1.9% is not very attractive dividend income option.
Business Performance and Catalysts
GPU and Maxwell
Figure 5 Source: Company website
The GPU segment of the company posted a growth in fiscal 2014 thanks to the growth of the consumer oriented high end GeForce and professional Quadro. However, the shrinking PC market capped the growth due to low volume sales of mainstream GPUs. According to JPR research, the total PC graphics and discrete GPU market is expected to show a negative 1.3% CAGR (2013-2017). Based on this it can be assumed that the revenues from consumer PC and gaming graphics are expected to remain flat in the years to come. However, on a positive note Nvidia's market share increased during the current quarter from 16.3% to 16.6%. The market is very competitive because of AMD's discrete and integrated GPU offerings as we have discussed elsewhere. Therefore, it is not possible for either of these two companies to capture substantial market share from each other. Nonetheless, the new Maxwell architecture is going to help Nvidia in gaining some share in the gaming graphics segment. A benchmark reveals that the Maxwell based GTX 750Ti is superior to its counterparts in performance per watts. The TDP of AMD's R9 270 is around 150 watts whereas the GTX 750Ti has a TDP of just 60 watts meaning that no extra connector will be required from the power supply as PCI-e supports up to 75 watts. The card is also priced at $149 as compared to the $180 price tag of R9 270. But then again the R9 270 outperforms GTX 750 Ti in FPS by some margin. See the figure below:
Figure 6 Source: extremetech.com
The graph reveals the better price performance of R9 270 as compared to GTX 750Ti. The full benchmark is available here. We believe that the low power Maxwell is going to hurt AMD in the laptop arena as a 45 watt Maxwell is expected to be featured in that space. However, we believe that there is a pecking order as far as PC graphics are concerned. PC users and gamers rank performance and price over power consumption. Hence, the high price/FPS discrete cards are not expected to capture market share from AMD. The bottom line for Nvidia in the graphics market is that revenues will remain flat or decline, and it is not possible to challenge AMD in discrete graphics but it will gain market share in the shrinking laptop market.
In the mobile SOC arena, Nvidia has been facing strong headwinds in the recent past. The company has been unable to gain substantial market share due to the presence of Qualcomm and other players. However, it is rolling out the Tegra K1 SOC this current year.
The K1 is an ARM Cortex-A15 based quadcore SOC clocked at 2.3 GHz. The graphics core features 192 CUDA cores based on the Kelper architecture. It is based on 28nm process technology and supports 4K displays.
Several benchmarks show K1 to be superior to its counterparts like the Qualcomm Snapdragon 800. See the following results:
Figure 7 Source: Tom's hardware
However, performance is not the only thing that matters. Mobiles and tablets require low power processing units and, therefore, the higher performance of the K1 is irrelevant until the power consumption figures are revealed. There are rumors that the power consumption of Tegra K1 is 40 watts. This is quite high for a smartphone or tablet and the product can never be successful with such a high amount of power draw. The actual TDP of Tegra K1 will be the defining factor for the performance of Nvidia in the mobile and tablet market in the near future. The K1 is based on the Kelper architecture. The next generation Maxwell based Tegra can be very low power consuming processors and have the potential to change the competitive scenario of the mobile and tablet market. For now, it is not possible to predict the success or failure of the K1 because of limited data, but if its power requirement is comparable to its counterparts, Nvidia will gain market share at their expense.
- Standard CAPM assumptions. Note that the volatility of this stock is higher than the industry and hence, the cost of capital is high.
- Growth factor of 9% is assumed for five years. Reuters assumes 3.80% growth in revenues for the coming five years. Tablets are expected to grow at 19%. We used a weighted average because we believe that Maxwell will perform better than the previous architecture.
- 3% growth is assumed in perpetuity. Dividends are expected to grow at 6%
The price target, with somewhat relaxed growth conditions, reveals that, in the current scenario, the stock is a bit overpriced and if the company's SOC mobile segment does not gain traction in the coming years, it will trade at around $17 supported by the graphics business of the company. The Tegra K1 will be the defining factor for investment decisions regarding this stock. Investors are advised to watch out for TDP news related to Tegra because a competitive TDP will render this price target irrelevant. Until any such developments, we advise investors to avoid NVDA as it is overvalued at these price levels.
Note that the company bought back the stock at around $15 which is less than our PT.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Equity Flux is a team of analysts. This article was written by our Technology analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.