Nvidia's Q2 Earnings: Solid Results And Outlook, But Continued Frustration With Cash Deployment

Aug.12.12 | About: NVIDIA Corporation (NVDA)

When the most frustrating part of a company's earnings release is that it once again reminds investors that it has too much cash on its balance sheet, it is the sign of a solid company. NVIDIA's (NASDAQ:NVDA) Q2 2013 (fiscal) earnings did just that, for the company's earnings and outlook once again reinforce the bullish thesis for owning its stock. And this earnings release once again highlighted the company's stubbornness in returning capital to shareholders, or deploying it to further the company's strategic position in the marketplace.


After the markets closed on August 9, NVIDIA posted its Q2 2013 results. The company reported EPS of 19 cents on a GAAP basis and 27 cents on a non-GAAP basis. Revenues came in at $1.04427 billion, and both EPS and revenue beat estimates of 14 cents for EPS and $1.01427 billion for revenues. NVIDIA outlook for the third quarter also topped estimates, with the company expecting revenues of $1.15 to $1.25 billion, ahead of the consensus of $1.09 billion.

NVIDIA provided upbeat commentary, saying that its investments in mobile, cloud and visual computing are paying off. Tegra sales reached a record, and the Kepler line of GPU's allowed NVIDIA to gain market share. As 2012 progresses, those trends should continue. Google's (NASDAQ:GOOG) Nexus 7 tablet has received a warm welcome in the market, and while it may not be a challenger to the iPad, it does not have to dethrone Apple (NASDAQ:AAPL) from the top of the tablet market to succeed. We have argued many times that Android suppliers need volume to drive their profits. The profits of the OEMs that they supply are not that relevant. As long as companies like Acer, Asus, or Samsung continue to release new tablets to challenge the iPad, NVIDIA will thrive. And as Tegra becomes more prevalent in smartphones, the company's sales will expand further. On the conference call, CEO Jen-Hsun Huang spoke at length about his new Nexus 7 tablet and how it fits into his life. While this may seem like a bit of frivolity, we believe it provided great insight into how NVIDIA will profit from the tablet market. Huang stated that in his view, this isn't about Android vs. iPad. He does not seem like the kind of CEO who would delude himself into thinking that the iPad can be dethroned. Rather, he spoke about his belief that Android tablets, especially 7-inch models like the Nexus 7, have a place in the lives of users, especially those who own Android smartphones. The smartphone and tablet markets are becoming more and more about ecosystems as opposed to devices, and NVIDIA sees a strong showing for Android tablets as a part of that transition. We will look for more color on this trend in November when NVIDIA reports Q3 2013 results and provides its outlook for Q4 2013, which will capture holiday sales.

A Deeper Look at the Numbers

NVIDIA posted record Tegra sales in the quarter, growing them by 35.5% to $179.7 million. Tegra sales accounted for 17.21% of overall sales in Q2 2013, as opposed to 14.34% in Q1. NVIDIA is continuing to make progress in its mission to diversify away from discrete GPU's and prove to the market that it can overcome the wall of worry that investors have when it comes the overall GPU market. Gross margin rose by 1.6% sequentially to 52%, while operating expenses dropped by 1.6% sequentially. However, expenses rose year-over-year, as NVIDIA continued to spend record sums on R&D. Spending on R&D rose by over 13% to reach $281.193 million. NVIDIA's outlook for Q3 calls for GAAP operating expenses of $390 million, down sequentially from this quarter's $401.096 million in total GAAP operating expenses. Gross margin in Q3 should be down just slightly, to 51.8%.

While EPS did drop year-over-year, from 25 cents to 19 cents, revenues rose by 2.73%. Fiscal 2013 is a transition year for NVIDIA. The company is ramping up spending and sales of Tegra chips, which will transform the company in fiscal 2014 and the years to come. We do not see this fiscal year as meaningful for the company's long-term trajectory. NVIDIA is investing for the future, and based on almost every measure, the future should be bright for NVIDIA.

Analyst Reactions: Looking to the Future

Investors have fretted about NVIDIA's position in the PC market for some time, as almost everyone sees it as a market in decline. And that is why shares of NVIDIA closed lower on August 10, even though its earnings were solid. And so were the reactions of analysts. Most analysts that provided updates to their models and estimates had something positive to ay about NVIDIA. We break down their reactions below.

  1. FBR: The firm maintained its outperform rating but raised its price target to $20 from $17. FBR notes that NVIDIA has opportunity in the second half of 2012 as Tegra sales accelerate, and that with over $5 per share in cash, valuations remain attractive. FBR raised its 2013 (fiscal) estimates substantially, to $1 in EPS on revenues of $4.42 billion, from a prior estimate of 65 cents in EPS on revenues of $3.98 billion.
  2. Merrill Lynch: The firm raised its price target to $16.50 from $14, but maintained its neutral rating. Merrill Lynch is a skeptic, and says that it remains on the sidelines until it can see more evidence of momentum in the non-iPad tablet market. In addition, the firm is worried about Tegra sales in the smartphone market until an LTE modem is integrated. Merrill Lynch notes that at 11.5x its 2013 estimates, NVIDIA is not expensive, but that now is not the time to be chasing the stock.
  3. Raymond James: The firm maintained its strong buy rating and raised its price target from $20 to $24. Raymond James was impressed by what it called "remarkable" momentum for NVIDIA's Kepler GPU line. The firm believes that investor sentiment (a key issue) will become more positive over the next several months, as NVIDIA shows strength across multiple segments, including Ivy Bridge, strength at Apple, and the launch of Windows RT. That, in the firm's view, will lead to an increase in confidence regarding NVIDIA's future earnings power. Estimates for 2013 (fiscal) were raised to 91 cents in EPS on revenues of $4.42 billion, up from 71 cents in EPS on revenues of $4.09 billion.
  4. Morningstar: The firm maintained its hold rating and $15 fair value estimate. Morningstar is worried about the sustainability of NVIDIA's standalone GPU business. The firm is worried that Advanced Micro Devices (NYSE:AMD) and Intel (NASDAQ:INTC) will render discrete GPU's obsolete as they become more and more powerful. Morningstar says that it is impressed with Tegra's growth trajectory, but that the issues with discrete graphics keep the firm on the sidelines.
  5. MKM Partners: The firm maintained its neutral rating and $14 price target. MKM sees a possibility that it could become more constructive on NVIDIA, given its strengths relative to AMD and the opportunities that the company has in cloud computing. But, MKM is worried about the long-term picture for discrete graphics, and notes that NVIDIA will need to invest even more into its growth platforms. The firm did raise its estimates for 2013 (fiscal) to 97 cents in EPS on revenues of $4.4 billion from 84 cents in EPS on revenues of $4.2 billion.

We remain bullish on NVIDIA and think that the right time to buy shares is not after sentiment shifts, but before. NVIDIA is not receiving enough credit for its growth and diversification initiatives, and we think that once the market sees that Tegra and cloud computing will allow NVIDIA to post accelerating growth in both revenues and profits, shares will rally. That being said, we do have one issue when it comes to NVIDIA: the company's intransigence regarding its cash position.

NVIDIA and its Cash: How Much is too Much?

Analysts regularly press NVIDIA regarding its cash position and what it plans to do with it. On the company's Q1 conference call, analysts asked NVIDIA about its plans, noting that the company's cash distorts its valuation, and whether or not the company plans on a buyback or dividend. CEO Jen-Hsun Huang said that while that is a topic of regular discussion with the board of directors, the company had nothing to announce. When the same question was raised on the company's latest earnings call, CEO Jen-Hsun Huang simply stated that the company's only plans for its cash are to continue to generate more cash. Readers unfamiliar with NVIDIA may wonder why this is an issue. Simply put, it is an issue because NVIDIA has more cash relative to its market capitalization than almost every other major technology company. NVIDA ended Q2 2013 with $3.2781 billion in cash & investments, and no debt. That works out to $5.25 per share in cash, or 35.91% of its share price, based on the company's August 10 closing price of $14.62. We break down NVIDIA's cash position, as well as dividend yield, relative to other technology companies below [IBM (NYSE:IBM), Hewlett-Packard (NYSE:HPQ), and AMD are absent from this list because their debt exceeds their cash and investments].

Net Cash per Share of Technology Companies
Company Ticker Net Cash Shares Outstanding Net Cash/Share % of Share Price Dividend Yield
NVIDIA NVDA $3,278,100,000 623,397,000 $5.25 35.91% 0%
Dell DELL $8,217,000,000 1,749,010,893 $4.69 37.79% 2.58%
NetApp NTAP $4,196,200,000 366,999,792 $11.43 35.08% 0%
Qualcomm QCOM $25,579,000,000 1,703,349,039 $15.01 24.22% 1.61%
Microsoft MSFT $60,872,000,000 8,506,000,000 $7.15 23.50% 2.63%
Apple AAPL $117,221,000,000 937,406,000 $125.04 20.27% 1.71%
Google GOOG $41,212,000,000 327,033,324 $126.01 19.63% 0%
EMC EMC $9,195,832,000 2,098,719,769 $4.38 16.23% 0%
Oracle ORCL $14,202,000,000 4,882,506,000 $2.90 9.17% 0.76%
Intel INTC $7,630,000,000 5,003,000,000 $1.52 5.65% 3.35%
Click to enlarge

As the table above shows, NVIDIA has more cash as a percentage of its share price than almost every other major technology company, except for Dell. And in our view, that is not a fair comparison, for Dell has bowed to pressure and initiated a dividend. At 8 cents per quarter, Dell yields over 2.5%, which is a solid starting dividend yield. With the exception of NVIDIA, every company on this list is deploying cash in some fashion, and we highlight their uses of cash below.

  1. Dell: Dell has initiated a dividend, and is on an acquisition spree to diversify away even faster from PC's. Quest Software is the latest company to be taken over by Dell, for a total cost of $2.4 billion (that price tag is not included in Dell's net cash calculations).
  2. NetApp: NetApp has been buying back stock and with the slump in its share price, those buybacks may accelerate.
  3. Qualcomm: Qualcomm has been steadily raising its dividend, is buying back stock, and has publicly stated that it stands ready to write "big checks" to its suppliers to ensure the stability of its supply chain.
  4. Microsoft: Microsoft, like Qualcomm, is raising its dividend and buying back stock, while also acquiring companies, such as Skype.
  5. Apple: Apple has reinstated its dividend, which was suspended in 1995, and has announced that it will be buying back $10 billion of stock. Apple also deploys its cash regularly into its supply chain; a favorite Apple tactic is to subsidize the building of new factories for its suppliers in exchange for exclusive access to the new technologies that they produce for a set period of time.
  6. Google: Google has bought Motorola Mobility (an investment that is more about patents than hardware), and the company regularly acquires companies. While the company's acquisitions don't truly make a dent in the company's cash pile, it still shows that Google is ready and willing to deploy its cash when needed.
  7. EMC: EMC has been aggressively buying back stock, and is set to spend $700 million in 2012 alone on buybacks.
  8. Oracle: CEO Larry Ellison has been on an acquisition binge for years. Oracle is obsessed with buying companies to strengthen its position in cloud computing and head off any chatter that its market position will be eroded by cloud computing. Oracle also pays out a dividend (albeit a small one) and increased the amount of stock it plans to repurchase by $10 billion when it reported Q4 2012 results.
  9. Intel: The company pays out a dividend of over 3%, which is large for a technology company, and is set to spend over $4 billion on an investment in ASML (NASDAQ:ASML), and bought back over $1 billion in stock in Q2 2012 alone.

Each of the 9 companies above are deploying cash in some manner. NVIDIA, however, is not. The company pays no dividend, does not buy back stock, and its last major deal was the $367 million takeover of British semiconductor company Icera, which occurred in May 2011. NVIDIA's cash pile keeps growing, even as the company spends record sums on research & development. In our view, NVIDIA does not need so much cash to run its business or ensure future success. We think that NVIDIA can spark a rally in it shares by simply articulating a strategy for its cash, be it dividends, buybacks, or acquisitions. We think that NVIDIA could find any number of companies to acquire. NVIDIA is frequently named as a potential suitor for ST-Ericsson, alongside AMD and Intel, and we think that NVIDIA should snap up the company before its chief rivals do.


In our view, investors should either add to or initiate positions in NVIDIA at these levels. The company is firing on all cylinders, and it has a clear growth trajectory. NVIDIA's best days are ahead of it, and fiscal 2013 is not representative of the company's full potential. Though Tegra revenue reached a record this quarter, it is only the beginning. NVIDIA is diversifying away from discrete graphics, and the company's future lies in mobile and cloud computing, not desktops and laptops. The pessimism surrounding NVIDIA is unwarranted in our view, and investors agree with us about the company's long-term prospects should be rewarded for their convictions.

Disclosure: I am long NVDA, AAPL, QCOM, EMC, GOOG, MSFT, IBM.