Stock of the week - Nvidia (22.11.2023)

• Nvidia reported fiscal-Q3 2024 earnings yesterday
• Company smashed sales and earnings expectations
• Almost 280% YoY growth in Datacenter segment sales
• Datacenter revenue accounted for 80% of total revenue
• Company expects new license requirements to significantly impact China revenue
• A look at valuation
• Shares trade flat in premarket today

Nvidia (NVDA.US) reported another solid quarterly report yesterday after close of US markets. Company beat expectations in all key metrics. However, warning on sales to China is making investors cautious, with company's stock trading flat in premarket today. Let's take a closer look at recent earnings release from the company, how it reacted to previous releases and how its valuation looks like!

Another solid quarterly report

Nvidia (NVDA.US) reported quarterly earnings report for fiscal-Q3 2024 yesterday after close of the Wall Street session. Company reported an over-200% YoY jump in total revenue, to $18.12 billion. Total revenue came in over $2 billion higher than expected by analysts, with strong growth being reported in two of the company's key segments - Data Center and Gaming. Margin improved greatly compared to a year ago quarter and were also better than expected. An over 600% YoY jump in operating income further highlights a massive, positive impact a boost in AI demand has on company's business. While operating increase more than 600%, operating expenses saw a year-over-year jump of just 13% YoY, showing that company is much more efficient than it was a year ago.

Fiscal-Q3 2024 results

• Revenue: $18.12 billion vs $16.09 billion expected (+205.5% YoY)
  • Data Center: $14.51 billion vs $12.82 billion expected (+278.8% YoY)
  • Gaming: $2.86 billion vs $2.70 billion expected (+82% YoY)
  • Professional Visualization: $416 million vs $409.2 million expected (+108% YoY)
  • Automotive: $261 million vs $266.9 million expected (+4% YoY)
• Adjusted gross margin: 75.0% vs 72.5% expected (56.1% YoY a year ago)
• Adjusted operating expenses: $2.03 billion vs $2.00 billion expected (+13% YoY)
• Adjusted operating income: $11.56 billion vs $9.67 billion expected (+650.6% YoY)
• Adjusted operating margin: 63.8% vs 61.0% expected (26% a year ago)
• R&D expenses: $2.29 billion vs $2.21 billion expected (+18% YoY)
• Adjusted EPS: $4.02 vs $3.36 expected (+593.1% YoY)
• Free cash flow: $7.04 billion vs $7.17 billion expected (-$156 million a year ago)

Source: Bloomberg Finance LP, XTB Research

New license requirements expected to impact sales to China

Apart from releasing solid fiscal-Q3 earnings, Nvidia also provided upbeat forecasts for fiscal-Q4 2024. Company expects revenue in the final quarter of fiscal year to reach $20.0 billion, plus or minus 2%. This would mark a year-over-year growth of 224-237%, as well as quarter-over-quarter growth of 8.2-12.6%. However, not everything in the outlook was so rosy. Company noted that new licensing requirements will significantly lower its sales to China in fiscal-Q4 2024 and highlighted that China accounted for around 20-25% of its Date Center revenue in recent quarters. On the bright side, Nvidia said that it expects solid sales in other regions, that will more than offset the drop in sales to China.

Fiscal-Q4 2024 forecasts

• Revenue: $19.6-20.4 billion vs $17.8 billion expected
• Adjusted gross margin: 75.0-76.0% vs 72.6% expected
• Adjusted operating expenses: around $2.2 billion vs $2.13 billion expected

Sales to China accounted for over 20% of Nvidia's total revenue in recent quarters. Importantly, revenue growth in China has been exceeding total revenue growth recently, meaning that the negative impact of new license requirements on this will be a drag on growth outlook. Source: Bloomberg Finance LP, XTB Research

AI demand fuels Datacenter revenue surge

Recent quarterly earnings reports from Nvidia show a significant change in what is driving company's business now. A chart with revenue breakdown by segment below shows that Data Center segment accounted for around 80% of company's total revenue during the most recent quarter! Meteoric rise in AI demand that is fuelling Datacenter segment sales, caused importance of Nvidia's previous money-makers, like Gaming or OEM, to shrink significantly.  Gaming segment accounted for less than 16% of total revenue. This is a massive shift given that Gaming segment accounted for around 50% of total revenue as recently as in 2020/2021.Original Equipment Manufacturer (OEM) segment, which accounted for over 30% in fiscal-2015, saw its share in total revenue drop to below 1% in the first three quarters of fiscal-2024. 

Source: Bloomberg Finance LP, XTB Research

Shares trade slightly lower in premarket

In spite of Nvidia reporting quarterly results that were much better than expected by the market, company's shares are trading flat in premarket today. A warning on drop in sales to China as a result of new licensing requirements may explain investors caution. Also, while $20 billion sales forecast for fiscal-Q4 was higher than the average estimate from analysts, it was lower than the highest estimates that suggested sales of over $21 billion in the November 2023 - January 2024 quarter.

A table below shows how Nvidia's stock responded to previous quarterly earnings releases. A point to note is that while company has a long and solid track record of beating revenue expectations, EPS beats are having been rare prior to emergence of AI craze.

Source: Bloomberg Finance LP, XTB Research

A look at valuation

Let's now try to value Nvidia's shares based on its fundamentals and stock multiples. This is a hard task as the company is at the forefront of AI craze and benefits massively from it. Its revenue is surging, thanks to a massive demand in its Datacenter segment. Having said that, it is hard to make appropriate assumptions for the DCF model.

We decided to base our assumptions more or less on 5-year averages, but with a small twists to revenue and operating margin assumptions. We have assumed a 50% revenue growth and 60% operating margin for the 5 years of forecasts with other assumptions being based on 5-year averages. For the terminal value calculations we have used a 10% revenue growth as well as 13% terminal WACC, down from 15% WACC used for 5 years of forecasts to capture the effect of AI business maturing. Such a set of assumptions provides us with an intrinsic share price of $656.98 - or around 31.5% above yesterday's closing price. However, a note of caution is needed that there is a high uncertainty around revenue and operating margin assumptions, given that Nvidia's dominance in AI is likely to wane over time as more and more companies enter and develop in the field. Also, it should be noted that terminal value forecast accounts for over 92% of the DCF forecasts.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions. 

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Next, let's take a look at how Nvidia compares with peers. We have constructed a peer group consisting of 8 companies, which were mentioned as Nvidia's competitors in recent annual report. Group includes Intel, Advanced Micro Devices, Qualcomm, Broadcom, Cisco Systems, Hewlett Packard Enterprise, Juniper Networks and Marvell Technology. We have taken a look at 6 different valuation multiples - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA.

We have calculated mean, median as well as cap-weighted multiples for the peer group. Three different Nvidia valuations for each of those multiples were later calculated. As one can see in the table below, the vast majority of those suggest that Nvidia shares are highly overvalued at current prices. However, current market price of Nvidia includes a premium for being a leader in a quickly developing AI field, which is hard to quantify in valuation models.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Last but not least, let's take a quick look at Nvidia chart (NVDA.US) at D1 interval. We can see that the stock has been trading sideways in the $403-477 range recently. Stock managed to break above the upper limit of the range and climbed to the $500 area marked with previous all-time highs, which were reached during a previous false upside breakout from the range. Flat performance of the company's shares in premarket shows that investors have second thoughts about growth outlook following recent steep rise in share price. Should we see the stock start to pull back, the upper limit of the earlier-broken trading range in the $477 area will act as the first potential support. On the other hand, should we see bulls regain control and push the stock higher, the first potential target will be $550 area, where the textbook range of the breakout from the sideways move can be found.

Source: xStation5