Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Nvidia Corporation – September 2021 IR Presentation

By Callum Turcan

On November 17, Nvidia Corporation (NVDA) reported third quarter earnings for fiscal 2022 (period ended October 31, 2021) that beat both consensus top- and bottom-line estimates, and the firm provided favorable guidance covering the current fiscal quarter.

The company has done a solid job navigating the ongoing shortage of semiconductor components along with other hurdles, such as logistical bottlenecks and inflationary pressures. Nvidia’s growth runway is enormous as it intends to expand into a new market within the semiconductor space, which we will cover in this note.

Shares of NVDA have leapt higher during the past month as the “chip” company’s (Nvidia designs chips that are produced by third parties) fundamental performance has been nothing short of stellar while its outlook continues to get brighter and brighter.

Nvidia completed its 4:1 stock split in July 2021, though please note that the catalyst for Nvidia’s strong stock price performance was not due to the stock split, which had no impact on its intrinsic value. There are a lot of reasons companies split their stock, including to make their shares more appealing to retail investors with less capital. However, such a move does not change the company in question’s future forecasted discounted free cash flows. Read more about stock splits >> 

Revenue and Supply Chain Update

Nvidia posted 50% year-over-year GAAP revenue growth in the fiscal third quarter, hitting $7.1 billion. Its strong sales performance was made possible by 42% growth at its ‘Gaming’ segment, 55% growth at its ‘Data Center’ segment, and 144% growth at its ‘Professional Visualization’ segment. Sales at its ‘Automotive’ segment were up just 8% year-over-year last fiscal quarter, though this segment remains a relatively small source of Nvidia’s company-wide revenues (its Gaming and Data Center segments generated over 85% of its GAAP revenues last fiscal quarter).

When asked about the supply chain situation during the firm’s latest earnings call from an analyst, Nvidia’s management team had this to say (emphasis added):

“So let's first start in terms of supply or our supply purchase agreements. You have noted that we are discussing that we had made payments towards some of those commitments. Not only are we procuring for what we need in the quarter, what we need next year, and again, we are planning for growth next year. So we have been planning that supply purchases. We're also doing long-term supply purchases. These are areas of capacity agreements and or many of our different suppliers.” --- Colette Kress, EVP and CFO of Nvidia

Additionally, Nvidia’s management team noted that “in networking, revenue was impacted as demand outstripped supply,” and its supply chain was a popular topic during the company’s latest earnings call. We appreciate Nvidia’s efforts to shore up its supply chain situation. There is clearly ample demand for the company’s offerings, and Nvidia has the financial capacity to make the kinds of longer term commitments with its suppliers to ensure it can continue scaling up its business going forward.

However, headwinds are likely to remain in the near term as demand for electronics, appliances, automobiles, and other chip-hungry offerings remains robust. The semiconductor manufacturing industry is scaling up its production capabilities, though these expansion efforts will take time to get completed.

Impressive Financial Strength

Nvidia’s apparent pricing power and, according to recent management commentary, the strong performance seen at Nvidia’s suite of software offerings helped enable the firm to overcome various inflationary pressures and grow its GAAP gross margin to 65.2% in the fiscal third quarter, up over 255 basis points year-over-year. This highlights Nvidia’s ability to adeptly navigate the difficult landscape.

Its GAAP operating income climbed higher by 91% year-over-year last fiscal quarter, hitting $2.7 billion. Gross margin expansion and economies of scale (growth in its revenues outpaced operating expense growth during this period) were key, and Nvidia’s GAAP operating margin clocked in at 37.6% last fiscal quarter (up over 800 basis points year-over-year).

During the first three quarters of fiscal 2022, Nvidia generated $5.4 billion in free cash flow while spending $0.3 billion on its dividend obligations (which are not a major capital allocation priority for Nvidia). The firm did not repurchase a significant amount, or any, of its stock during this period as Nvidia is building up capital for its pending ~$40 billion cash-and-stock acquisition of Arm Limited (announced back in September 2020) from SoftBank Group Corp (SFTBY) and SoftBank Vision Fund.

According to the acquisition press release, the deal is structured so SoftBank would continue to own a modest stake in Arm should the acquisition proceed as planned. The deal also includes up to ~$5 billion in earnouts for SoftBank should Arm meet certain financial benchmarks, which can be paid in cash or common stock according to the press release.

However, the pending tie-up that has run into major regulatory roadblocks over antitrust and other concerns from governments around the world (including in the UK, the US, China, and the EU). Though Nvidia’s management team noted during the firm’s latest earnings call that “we continue to believe in the merits and benefits of the Arm acquisition” and reaffirmed Nvidia’s commitment to the acquisition, we caution that a deal may not go through due to the aforementioned regulatory concerns.

Nvidia exited October 2021 with $19.3 billion in cash, cash equivalents, and current marketable securities with no short-term debt and $10.9 billion in long-term debt on the books, equal to a net cash position of $8.4 billion. After suspending its share repurchases, Nvidia has the capacity to fund this deal with its balance sheet strength and impressive free cash flow generating abilities while maintaining its financial strength (the cash component is worth ~$12 billion according to the acquisition press release). We are keeping an eye on the deal, though in any event Nvidia’s growth outlook is still quite bright.

Expanding Addressable Market

Historically, Nvidia’s strength has been in the graphics processing unit (‘GPU’) side of the chip industry. Nvidia designs the GPUs, third-party foundries like Taiwan Semiconductor Manufacturing Company Limited (TSM) produce the chips at scale, and Nvidia sells those products to various end buyers. GPUs are an essential part of the videogaming industry as it concerns supporting the consoles and PCs that enable such activities, and GPUs also play a critical role in data centers as well.

Nvidia is utilizing its sizable R&D investments to push deeper into the realm of AI, a space that’s become more important, as managing vast treasure troves of data and digital functions become much easier when automating large parts of these activities. During the first nine months of fiscal 2022, Nvidia spent $3.8 billion on its R&D expenses (up 37% year-over-year), equal to almost 20% of its revenues during this period.

Looking ahead, Nvidia aims to move into the central processing unit (‘CPU’) space, which if successful, would significantly extend its growth runway. In April 2021, Nvidia put out a press release that “announced its first data center CPU, an Arm-based processor that will deliver 10x the performance of today’s fastest servers on the most complex AI and high performance computing workloads… the NVIDIA Grace CPU is designed to address the computing requirements for the world’s most advanced applications.” That includes activities “that analyze enormous datasets” such as “natural language processing, recommender systems and AI supercomputing” according to the press release.

The press release went on to say that the Swiss National Supercomputing Centre (‘CSCS’) and the US Department of Energy’s (‘DOE’) Los Alamos National Laboratory would bring “supercomputers” powered by its Grace GPU online by 2023, with those supercomputers built by Hewlett Packard Enterprise Company (HPE). By moving into the CPU space, keeping in mind CPUs are a core component in both PCs and data centers, Nvidia is effectively pushing into a new market within the semiconductor industry.

Concluding Thoughts

Nvidia’s desire to expand into the CPU space and the enduring strength of its GPU offerings underpin its bright outlook. Whether or not Nvidia’s purchase of Arm goes forward, the company’s growth runway remains immense. The company has a pristine balance sheet and its free cash flow generating abilities are spectacular, aided by its modest capital expenditure requirements to maintain a given level of revenues. Nvidia is a great company, though we prefer Qualcomm Inc (QCOM) in the semiconductor (design) arena. Shares of QCOM are included as an idea in the Dividend Growth Newsletter portfolio.

We recently updated our cash flow valuation models for the tech industry. The top end of Nvidia’s fair value estimate currently sits at $311 per share, though shares of NVDA are trading above that level as of this writing. Pivoting to Qualcomm, the top end of our fair value estimate range sits at $206 per share, meaningfully above where shares of QCOM are trading at as of this writing. We covered our latest thoughts on Qualcomm in our November 2021 article Shares of Dividend Growth Idea Qualcomm Surge Higher (link here). As of this writing, shares of QCOM yield ~1.5% and shares of NVDA yield less than 0.1%.

Our other favorite semiconductor names include photolithography equipment supplier ASML Holding Inc (ASML) and semiconductor foundry Taiwan Semiconductor Manufacturing, which are both included as ideas in our new ESG Newsletter portfolio (readers can learn more about that product here). We covered our latest thoughts on ASML Holding in our November 2021 article ASML Holding’s Bright Growth Outlook (link here) that we encourage our members to check out.

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Technology Giants Industry - FB, AAPL, GOOG, AMZN, MSFT, CSCO, V, MA, PYPL, INTC, ORCL, QCOM, TWTR, IBM, ADBE, NVDA, CRM, AMD, AVGO, BABA, BKNG, BIDU, TSM, FFIV, TXN, EBAY, ADP, PAYX, MU, KFY, MAN, KLAC, LRCX, AMAT, ADI, SIMO

Tickerized for NVDA, ASML, HPE, SFTBY, TSM, ARMHF, GFS, QQQ, USD, BIBL, SMH, ESPO, SOXQ, BITQ, TECL, SOXL, ROM, IVV, XLK, IWF

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Callum Turcan does not own shares in any of the securities mentioned above. Apple Inc (AAPL), Cisco Systems Inc (CSCO), and Microsoft Corporation (MSFT) are all included in both Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Alphabet Inc (GOOG) Class C shares, Facebook Inc (FB), Korn Ferry (KFY), PayPal Holdings Inc (PYPL) and Visa Inc (V) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation (ORCL) and Qualcomm Inc (QCOM) are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. ASML Holding NV (ASML), Facebook Inc, Oracle Corporation, and Taiwan Semiconductor Manufacturing Company Limited (TSM) are all included in Valuentum’s simulated ESG Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.