Stock of the week - Nvidia (29.08.2024)

Nvidia (NVDA.US) released earnings report for fiscal-Q2 2025 (calendar May - July 2024) yesterday after close of the market session. The report was anticipated and closely watched by investors as Nvidia, due to its size and importance for AI sector, has been the main driver of US stock market moves recently. While company reported better-than-expected results, market reaction hints at disappointment. Let's take a closer look at results presented by the company.

Nvidia reports another better-than-expected quarter

Nvidia has reported yet another blockbuster quarter with its fiscal-Q2 earnings release (calendar May - July 2024). Revenue during the quarter grew by 122.4% compared to a year ago quarter and exceeded $30 billion, driven by a 154.5% YoY jump in Data Center revenue. Adjusted gross margin improved from 71.2% in fiscal-Q2 2024 to 75.7% now, paving the way for gross profit to grow faster than sales (136.4% YoY), hinting at further improvement in efficiency. Continued improvement was also spotted in operating margin, pointing to better cost discipline.This has allowed for adjusted net income to jump by over 150% YoY and diluted EPS to surge from $0.27 in fiscal-Q2 2024 to $0.68.

In every case, results were much better than expected by analysts. However, it should be said that scale of sales beat continued to decline with fiscal-Q2 2025 sales being 'just' 4.2% higher than median analysts' estimate. The only measure in which Nvidia turned out to be weaker than expected was operating cash flow, which was driven by changes in non-cash working capital. Big increases in capital expenditures and R&D spending show that company continues to invest heavily in growth.

Nvidia fiscal-Q2 2025 earnings

• Revenue: $30.04 billion vs $28.82 billion expected (+122.4% YoY)
  • Data Center: $26.27 billion vs $25.08 billion expected (+154.5% YoY)
    • Compute: $22.60 billion vs $21.61 billion expected
    • Networking: $3.67 billion vs $3.65 billion expected
  • Gaming: $2.88 billion vs $2.79 billion expected (+15.9% YoY)
  • Professional Visualization: $454 million vs $451.1 million expected (+19.8% YoY)
  • Automotive: $346 million vs $348 million expected (+36.8% YoY)
  • OEM & Other: $88 million vs $78 million expected (+33.3% YoY)
• Adjusted gross profit: $22.73 billion vs $21.59 billion expected (+136.4% YoY)
  • Adjusted gross margin: 75.7% vs 75.5% expected (71.2% a year ago)
• Adjusted operating expenses: $2.79 billion vs $2.81 billion expected (+51.9% YoY)
• Adjusted operating income: $19.94 billion vs $18.85 billion expected (+156.4% YoY)
  • Adjusted operating margin: 66.4% vs 65.8% expected (57.6% a year ago)
• Adjusted EBITDA: $20.37 billion vs $19.00 billion expected (+150.2% YoY)
• Adjusted net income: $16.95 billion vs $15.94 billion expected (+151.5% YoY)
  • Adjusted net margin: 56.4% vs 54.8% expected (49.9% a year ago)
• Diluted EPS: $0.68 vs $0.64 expected ($0.27 a year ago)
• R&D expenses: $3.09 billion vs $3.08 billion expected (+51.5% YoY)
• Operating cash flow: $14.49 billion vs $15.00 billion expected (+128.3% YoY)
• Capital expenditures: $977 million vs $438 million expected (+238% YoY)
• Free cash flow: $13.51 billion vs $13.57 billion expected (+123% YoY)

Nvidia margins on GAAP basis (unadjusted). Source: Bloomberg Finance LP, XTB Research

Fiscal-Q3 forecast disappoints

As Nvidia's fiscal-Q2 earnings turned out to be better-than-expected, one may wonder why did company's stock drop in the after-hours trading. Part of the answer is forecasts. Nvidia said that it expects fiscal-Q3 revenue to reach $32.5 billion+-2%, or $31.85-33.15 billion. While this is still above $31.9 billion median analysts' forecast, some analysts called for fiscal-Q3 revenue to be as high as $37.9 billion. Also, company expects adjusted gross margin to be around 74.5-75.5% in the current quarter. This was also in-line with expectations, but at the same time it suggests that expansion of gross margin will be halted.

Overall, Nvidia's fiscal-Q3 forecast was in-line with analysts' expectations, which by many was seen as a disappointment given that the company has kept surprising positively up to now. On the other hand, it should be said that markets' reaction to the release may have been overdone. After all, a $3 trillion company projecting an over-70% revenue growth is not a reason to be disappointed.

Nvidia fiscal-Q3 2025 forecast

• Revenue: $31.85-33.15 billion vs ($31.9 billion median estimate, $37.9 billion high estimate)
• Adjusted gross margin: 74.5-75.5% vs 75% expected
• Adjusted operating expenses: $3.00 billion vs $2.98 billion expected
• Adjusted other income and expenses: $350 million income
• Adjusted tax rate: 16-18%

Nvidia says it is facing Blackwell production delays

We have said that forecasts are part of the answer as to why Nvidia's stock has reacted negatively to the earnings release. The other part of the answer are non-financial details of the release. Company has acknowledged that it is facing issues and delays with production of Blackwell chips. However, company has said that it is making changes aimed at improving manufacturing rates and that it expects several billions of dollars of revenue from Blackwell chips in fiscal-Q4 2025 (calendar November 2024 - January 2025).

A look at valuation

Now, let's 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, but it is hard to judge how long such a robust growth will last. Having said that, it is hard to make appropriate assumptions for the DCF model.

We decided to base our assumptions on adjusted 5-year averages, with aim of adjustments being to better catch outlook for the company. We have assumed a 50% revenue growth and 60% operating margin for the 5 years of forecasts. Decision to make 5 years of detailed forecasts rather than 10 years was made due to huge uncertainty over whether company's robust growth rates will last. Other assumptions were based on 5-year averages. 

As terminal value tends to account for a significant part of DCF valuation, especially with shorter periods of detailed forecasts, we have decided to take a very conservative approach here. For the terminal value calculations we have used a 5% revenue growth as well as 12% terminal WACC, down from 13% WACC used for 5 years of forecasts to capture the effect of AI business maturing. It should be said that the 5% terminal revenue growth forecast was very conservative and decision to make such a conservative assumption was for it not to distort DCF valuation too much.

Such a set of assumptions provides us with an intrinsic value of $144.12 per share - or around 14.7% above yesterday's pre-earnings closing price. Even as we have decided to use very conservative terminal revenue growth assumption, terminal value still accounts for around 83% of DCF forecast.

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 a number of different trailing and forward multiples.

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 situation on Nvidia chart (NVDA.US). Taking a look the chart at H1 interval, we can see that the stock has been trading sideways in the $124-130 range in recent days amid pre-earnings uncertainty. Current premarket quote suggests an around-3% bearish price gap at the launch of today's trading session. However, given that the earnings report released by the company was not bad at all and that the stock was trading 6-7% lower in the after-hours trading yesterday, there is a chance that this drop will be further trimmed ahead of today's cash session opening.

Nevertheless, current pre-market quote suggests a downside breakout from the aforementioned $124-130 trading range. Textbook target of such breakout suggest a possibility of a drop to around $118. This is where another short-term swing level can be found and may prove to be an important support in near-term should the stock continue to drop. If bulls regain control over the market and the stock opens in or returns to the aforementioned range, the near-term resistance to watch can be found at the upper limit of the range, or in the $130 area.

Source: xStation5