Nvidia had its start by producing Graphic Processing Unit (GPU) for laptop manufacturers to render perfect images in 1993 mainly for the gaming market. As a first mover equipped with a founding team of top notch engineers, Nvidia (NVDA) dominated the market. Today, the application of Nvidia chips had expanded from mere graphics to cloud computing, artificial intelligence, autonomous vehicles, data centre, visualization, among others.
Chip design and manufacturing is a capital-intensive job by its very nature and Nvidia competes with the likes of Intel (INTC) and AMD (AMD) in this crowded field. Despite that competition, Nvidia continues to generate strong free cash flow for its shareholders as tech giants such as Microsoft (MSFT) are buying Nvidia’s chip for their data centre and Alibaba (BABA) continues to use Nvidia for its cloud computing.
Let’s take a deeper look into Nvidia to understand why analysts are upgrading this stock despite its 921% run up from $19.20 in January 2015 to $196 today. They are now looking Nvidia to hit $230 over the next 18 to 24 months.
Understanding the Source of Nvidia Financial Strength
Nvidia started out its corporate life as the manufacturer of gaming chips and gaming continues to account for the lion share of its revenue at 53.2%. Data centre accounts for 18.7% of its revenue and it is experiencing strong growth, followed by OEM & IP at 10.5% and automotive at 6.4% of sales.
Nvidia also has $1.99 billion in cash and it is planning to return $1.25 billion through cash dividends and share repurchase for the full year. Its capital expenditure is expected to range between $65 million to $75 million. Therefore, it can return funds back to investors without having to seek refinancing from the banks. Its current asset is at $8.07 billion and its current liability is low at $1.03 billion.
Embedded in these different segments, we have the common drive for artificial intelligence which is set for steep growth in the years ahead. Nvidia AI enabled GPU are used as the backbone for various AI applications from cloud to data centres to autonomous vehicles. It is clear from the above results that Nvidia is firing on all cylinders which is impressive for any tech company.
Morningstar expects Nvidia to dominate 66% of this AI market by 2021. The basis of this expectation would be Nvidia’s superior GPU, Volta, which allows for 100 times increase in deep learning for their clients. The superior performance of Nvidia’s Volta has been confirmed and endorsed by independent tests which was a vast improvement from its previous version and AMD’s alternative.
Impact of Cryptocurrency Ban
One area of concern is that ban of cryptocurrency whose graphic boards account for 10% of Nvidia’s revenue. China had banned cryptocurrencies while South Korea had been Initial Coin Offering (ICO). Bitcoin had its biggest drop in a month recently over such concerns.
Governments have an incentive to regulate bitcoins given its opaque nature which allows for money laundering and the need for tax revenue. Both Europe and Russia are considering plans to regulate bitcoin which would dampen demand for Bitcoin in the near term.
Nvidia had announced strong growth of 15% over 3 months and 56% over 1 year in its revenue. Impressively, its earnings per share had shot up to 124% over 1 year. At the current price of $197, we are at about 57 times earnings which is rich compared to Intel’s 16 times, TSM’s (TSM) 19 times and Qualcomm’s (QCOM) 21 times.
Fully Priced In
In other words, the market had priced its over-performance firmly and any weakness in the coming quarter can result in a sharp correction for this stock with $118 billion capitalization. CEO Jensen Huang and team would have to execute both the research and marketing of its chip perfectly to please the market. It is tough to be the champion.