Nvidia Initial Coverage (NVDA)
Nvidia Business Case and Valuation
Nvidia, a company that now boasts a $1.2 trillion market capitalization has been all over the news in regards to artificial intelligence, and sells a variety of products that aren’t easy to decipher for the layperson. It’s been almost a week since Nvidia released its Q3 2023 earnings and I will try to break down its various lines of business and the future growth for each of them. Then I will take a look at Nvidia’s historical valuation up to this point. Finally I will make a recommendation on an appropriate valuation given macroeconomic factors along with the rise of potential competitors and other risks. It’s been a few days since Nvidia released its 3rd quarter earnings and I will try to break down its various lines of business and the future growth for each of them.
Nvidia’s business segments in detail show rapid growth specifically in Data Center’s and even gaming as well.
Nvidia blew past earnings estimates and ended up producing $18.12 billion in revenue for its 2023 3rd quarter earnings. Most of this $18.12 billion came from its data center market platform which provided $14.514 Billion and thus accounted for around 80% of Nvidia’s revenue. The other market segments can be seen on the graphic below. The Compute and networking segment also accounted for $14.645 of the $18.120 billion.
It’s important to understand exactly what services/products Nvidia provides in that segment and the others in order to make predictions about what the future revenues and cash flows will look like. Nvidia, ultimately sells GPUs (Graphic Processing Units) to various companies including some of the largest in the world. The main use that has driven revenue is for the AI applications that the companies are seeking to take advantage of and need Nvidia’s chips to power those processes. Now Nvidia has multiple products on both the software and hardware side that are able to help companies with artificial intelligence opportunities. These include the HGX platform which is being used by cloud service providers, consumer internet companies and enterprises. The HGX platform is effectively a supercomputer that is a complete software stack of GPUS, networking and other products to allow for fully optimized AI and high performance computing.The GPU’s were initially used for high quality graphics but now are used for any purpose that requires high intensity and complex calculations. These chips are the main reason for the $14 billion in revenue in that segment and some of the biggest customers include Amazon, Microsoft, Google, Meta and Tesla, thus some of the world's biggest and most powerful companies. This understanding of why companies are purchasing Nvidia’s chips and AI tailored products will help illustrate the future opportunities and risks the companies will face. After explaining the current valuation of the company I will delve further into the potential opportunities and risks that will help narrow the potential future price of the stock.
One opportunity for Nvidia to grow their revenues lies in the automotive segment. This segment accounted for $261 million this quarter and is one of the smallest segments in terms of revenue for Nvidia. With this being said Tesla has said they will continue to purchase Nvidia’s chips for their Dojo Supercomputer. Most of the major automakers are also listed as partners with Nvidia as their chips are needed for the fast and complex calculations needed for autonomous self driving. The addressable market for this segment could be far more than the $261 million a quarter that Nvidia currently brought in. Market research firm Precedence research came out with a report that indicates that the autonomous driving market was $121 billion in 2022 and will grow at a compounded annual growth rate of 35% leading to a $2.353 trillion market in 2032. In my opinion it’s clear that rideshare companies would love to have autonomous driving and have fleets of robotaxis. While that may take a very long time to come to fruition, Nvidia in the meantime will continue to benefit from the growth in this segment by selling their software and platforms catered to AI and autonomous driving.
Valuation:
At the start of January 3rd Nvidia shares listed at $143, and now are trading at $487 illustrating a 233% an unheard of year-to-date return. Last week, the company reported earnings of $4.02 per share flying past the expected earnings per share of $3.37. This was approximately a revenue beat of $2 billion dollars as well. In my opinion, most of the positive information that came out has already been priced into the stock. Currently the stock is trading at a P/E (TTM) of 117.00. The lowest P/E ratio the stock has traded at this year was $97.83 on October 31st. That valuation equates to around $404.68 per share. Thus, I think somewhere above $404 around $430 a share is a reasonable price to buy the stock. What one should consider in the coming months is the macro variables that could affect Nvidia’s business. If there are more interest rate cuts in 2024 this could be an economic boon for Nvidia. Nvidia’s price drop in 2022 largely could be attributed to the rapid interest rate hikes that caused businesses to rein in excess spending. With a looser economic environment, companies will be more willing to spend on opportunities for innovation that in many cases will involve some of Nvidia’s solutions. Companies that are cyclical that have been hit hard by interest rates include the large automotive firms that I previously mentioned as a revenue opportunity for Nvidia. On the other hand higher interest rates for a longer period of time could put a damper on growth for Nvidia’s business segments. Another potential risk for Nvidia is the rise of competitors in the GPU space including companies such as Tesla, Amazon and Microsoft making chips in house and thus replacing part of their need for Nvidia’s chips. This may be easier said than done however for many of those companies given the immense costs and research required for chip creation. Another geopolitical risk is tensions between the US, China, and Taiwan. The Taiwan Semiconductor manufacturing company still provides raw materials to Nvidia and thus any flaring of tensions over the Taiwan issue could put Nvidia’s business at risk. US regulations on semiconductor sales to China also could have a financial impact in the short and long term on Nvidia’s business as well.
Disclosure: Dim Andrahennady holds a long position in NVDA whether this is through holding equity and or options