Nvidia: Whatever It Takes (NASDAQ:NVDA)

4.12K Followers

Summary

NVDA shares continue to rip higher, with the chip stock's market cap surpassing $200 billion.
I am reasonably constructive on NVDA fundamentally. My problem mostly lies in the valuation of the stock. The valuation is getting a little ridiculous on both revenue and EPS.
NVDA's launch of the Ampere-based A100 accelerators will likely keep its reaccelerating datacenter business strong. These accelerators have a large performance lead over the previous generation V100 and T4 accelerators.
Gaming could come in a little light, at least until CQ3, when NVDA is likely to launch its Ampere-based gaming offerings (RTX 30 Series cards). And when the next gen gaming consoles release, Nintendo Switch could suffer, hurting NVDA.
Reiterating HOLD. PT raised from $270 to $300.

Datacenter Trends Accelerating at Nvidia

The vast majority of positivity I notice in the sell-side community on Nvidia (NASDAQ:NVDA) has to do with the company's ever-improving footing in the datacenter market. The datacenter was a reason for me being negative on the stock a few years ago, as some of their hyper scale clients as well as other smaller startups began developing competitive ASICs (application specific integrated circuits). At the time, we didn't have much data on the performance differentiation between Nvidia's GPU accelerators and these new ASICs, except really for the TPU. All three generations of Google's (GOOG) (GOOGL) TPU processor were faster and more efficient than even Nvidia's top-of-the-line GPU offerings.

Since then, however, my mind has been changed by two things: Understanding Nvidia's deep software ecosystem and the launch of the A100 accelerator. First of all, Nvidia's CUDA ecosystem is an advantage that no other competing silicon manufacturer can replicate. Nvidia has millions of developers working in the CUDA software ecosystem, an ecosystem that is very difficult to leave. It will take time and resources for other competitors to attempt to match the size of the CUDA software ecosystem.

With regards to the A100 accelerator, Nvidia is clearly not only ahead of the competition but has also been leapfrogging from generation to generation.

(Source: Nvidia)

In high-performance computing, inference, and training tasks, Nvidia's latest A100 offering is a generational leap. Remember last year when Nvidia saw an extremely weak datacenter business? The datacenter Capex cycle is a build-and-digest cycle. With the release of the A100 accelerator and A100-based systems, we are likely to see a spurt of growth as datacenters begin adopting these extremely high performance accelerators. So, I believe Nvidia's datacenter business, which has been experiencing rapid growth in recent quarters, will continue to grow quickly in the quarters to come. As workloads move to the cloud (think programmable communications, Telehealth, online learning, etc.), more computational performance is necessary. So, it will likely be a while before hyperscalers digest, and datacenter revenue growth (temporarily) stagnates.

Temporary Gaming Weakness

While gaming drove revenues over the last few years, I would expect weakness from the segment in the near term. In CQ2, we could see digestion in gaming, as consumers loaded up on notebooks in Q1 (as work from home trends played out), and buying could be slowed down temporarily. While notebook is a much smaller fraction of Nvidia's overall gaming revenue stream compared to discrete GPUs, Nvidia will likely be negatively affected by notebooks declines nonetheless.

However, as we saw with Nvidia's enterprise-centric 7nm Ampere-based offerings, Nvidia has seen astonishing technological performance improvements. Right now, the general anticipation is for a CQ3 release of Nvidia's Ampere gaming cards (I'm going to call them RTX 30 Series). Nvidia's RTX 20 Series of gaming discrete GPUs already lead the market in terms of performance, at least in most scenarios. While ray-tracing was established as a technology in the first generation RTX GPUs, it was not compatible with many AAA gaming titles. When Nvidia launches RTX 30 Series, they will likely reassert their dominance in the GPU market. Until then, notebooks could be temporarily weak.

In addition, Nvidia's gaming segment could be a little light this holiday season in terms of Nintendo Switch. With the launch of competing consoles like the PlayStation 5 and Xbox Series X, an older Nintendo Switch could lose market share and sales volume, thus negatively impacting its suppliers, Nvidia being one of them.

While gaming is likely a stable strong business long term, there is certainly a chance that we see short-term problems with the gaming business.

Datacenter Competition

In the datacenter market, Nvidia is likely to face some fairly fierce competition in the coming years, and not just in GPU accelerators. ASICs, FPGAs, GPUs, and CPUs are all vying to be the most relevant technology in the datacenter and AI markets. If Nvidia can keep executing on its software stack, and generation-to-generation hardware performance upgrades, they will likely be able to keep competition at bay.

Autonomy

Another interesting front that Nvidia is pursuing is the autonomous driving business. Nvidia's latest Orin system continues to help Nvidia make strides in the autonomous driving business. That being said, growth has been stalling for quite a while now on this business. Management even guided to a 40% sequential drop-off in revenue from their automotive business.

And even then, Nvidia faces stiff competition in the space. Companies like Intel's Mobileye (INTC) have interesting offerings, and automotive OEMs like Tesla (TSLA) have even resorted to designing their own custom hardware. So, Nvidia's leading the autonomous hardware market is not a sure bet.

Valuation

The biggest problem I have with Nvidia is the stock's valuation. I value Nvidia using a multiple analysis, not necessarily a DCF. There are two parts of a P/E multiple-based valuation, the underlying earnings and the valuation multiple. So, let's break down my expectations for Nvidia's earnings for the full year on a segment-by-segment basis. Let's start with Nvidia's gaming business.

We already have Q1 data, but let's break out into management's Q2 commentary:

Revenue of $3.65 billion +/- 2%
- 40% sequential decline in automotive revenue
- Sequential decline in ProViz revenue
- MLNX = low-teens % of total revenue
- Low to mid single digit sequential growth in gaming revenue
Non-GAAP gross margin of 66% +/- 50bps
Non-GAAP OpEx of $1.04 billion
- Full-year non-GAAP OpEx of $4.1 billion
$45 million in non-GAAP OI&E
9% tax rate

Let's break out my expectations for Nvidia's business with this guidance in mind.

Gaming Revenue	FQ1A'21	FQ2E'21	FQ3E'21	FQ4E'21	FY'21E
Revenue	$1.339B	$1.392B	$1.74B	$1.595B	$6.066B
Y/Y	+26.9%	+6.0%	+4.9%	+7%	+9.9%

I likely will not be on the money with these calculations. If anything, I could actually see a much greater Y/Y acceleration in Q4 as consumers buy Nvidia's RTX 30 Series discrete cards and Nvidia powered laptops in the holiday season. That being said, because of increased holiday competition from competing consoles, I believe Nintendo Switch sales could suffer, negatively impacting Nvidia's gaming revenues.

Now, let's move on to my projections for Nvidia's datacenter segment.

Datacenter Revenue	FQ1A'21	FQ2E'21	FQ3E'21	FQ4E'21	FY'21E
Revenue	$1.141B	$1.709B	$1.846B	$1.883B	$6.579B
Y/Y	+80%	+160%	+154%	+94.5%	+120.5%

The real acceleration in top-line growth will be driven from two main areas: the inorganic growth driver of the Mellanox acquisition and A100 hyperscale deployment. The reason the Y/Y comparable looks so strong is because Nvidia was in the digest phase of the build and digest cycle in the datacenter market. This meant the organic comp is weak especially as hyperscalers begin ramping budgets up again. Second of all, you have the inorganic inflation of Nvidia's numbers by the acquisition of Mellanox, which will begin reporting into Nvidia's datacenter segment.

ProViz Revenue	FQ1A'21	FQ2E'21	FQ3E'21	FQ4E'21	FY'21E
Revenue	$307M	$300M	$345M	$347M	$1.299B
Y/Y	+15.4%	+3.0%	+6.5%	+5%	+7.2%

I see ProViz revenues being stable until Q3 when Nvidia likely launches their Ampere-based workstation cards. When that happens, I can see a spurt of demand into the back half of the year that brings the ProViz business segment higher for the full year.

Auto Revenue	FQ1A'21	FQ2E'21	FQ3E'21	FQ4E'21	FY'21E
Revenue	$155M	$93M	$110M	$113M	$471M
Y/Y	-6.6%	-55.5%	-32.1%	-30.7%	-32.7%

Nvidia called for a 40% sequential drop in auto revenue in Q2. From there, I would anticipate some level of recovery as Nvidia's Orin platform gains more widespread adoption in the industry.

OEM&IP	FQ1A'21	FQ2E'21	FQ3'21	FQ4E'21	FY'21E
Revenue	$138M	$140M	$146M	$150M	$574M
Y/Y	+39.4%	+26.1%	+2.1%	-1.3%	+13.7%

So, let's combine my expectations into one clear vision for Nvidia's financial execution.

Total Revenue	FQ1A'21	FQ2E'21	FQ3E'21	FQ4E'21	FY'21
Revenue	$3.08B	$3.634B	$4.187B	$4.088B	$14.989B
Y/Y	+38.7%	+40.9%	+38.9%	+31.6%	+37.3%

This revenue expectation is slightly north of consensus expectations. So, by no means is this a bearish expectation.

Assuming full-year gross margins of 66% (consensus is at ~65.7%), a non-GAAP OpEx of $4.1 billion, and a 9% tax rate, net income comes out at $5.271 billion. On 615 million shares outstanding, EPS comes out to at ~$8.57.

So, now that we have the earnings number, what is the appropriate multiple on this business? Considering the large and quickly growing addressable market in the datacenter, this is a company that could conceivably grow for many years to come. Even while ProViz and gaming will likely begin to see slowdowns, datacenter and auto are likely to drive the growth story over the years to come. Because of this long-term growth profile, I believe a more premium valuation multiple is warranted. I am going to stick with 35X earnings. This gets me to a valuation of $299.95/share. Thus, my target on the stock is $300.

Conclusion

Right now, my valuation sees ~15% downside in Nvidia. While this isn't enough downside for me to recommend a short position or a sell rating, it is definitely not a buy at this point in time. I would wait until the name is well south of $300 before buying in.

This article was written by

MangoTree Analysis

4.12K Followers

(10/1/23): MTA is focused on L/S ideas primarily in the TMT space. MTA's investment process is environment agnostic, and views each opportunity through the lens of generating alpha against whatever timetable is appropriate for the idea. MTA employs a mock sell-side coverage process, utilizing valuation methodologies, ratings and price objectives, and takes advantage of alternative data.

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