Nvidia is a pioneer in accelerated computing which helps to solve the most challenging computational problems. Since their original focus on PC graphics, Nvidia has expanded to several other computationally intensive fields like scientific computing, artificial intelligence, data science, autonomous vehicles, robotics, augmented and virtual reality by leveraging their existing GPU architecture. Nvidia platforms address four large markets: Gaming, Data Center, Professional Visualization, and Automotive.
Operating segments
Business results are reported in two segments:
– Graphics segment includes GPUs for gaming, PCs, enterprise work stations, software for cloud based virtual computing, infotainment systems in automotives and AI enterprise.
– Compute & Networking segment includes data center platforms, systems for AI, HPC, and accelerated computing; Mellanox networking and interconnect solutions; cryptocurrency mining processors, or CMP; Jetson for robotics and other embedded platforms; and NVIDIA AI Enterprise.
Competition
- AMD and Intel – Design discrete & integrated GPUs, custom chips and other accelerated computing solutions.
- Alibaba Group, Alphabet, and Amazon – Large internet services companies with internal teams designing chips that incorporate accelerated computing functionality as part of their internal solutions or platforms.
- Ambarella, AMD, Broadcom, Intel, Qualcomm, Renesas Electronics Corporation and Samsung – SoC products that are embedded into automobiles, autonomous machines, and gaming devices.
- AMD, Applied Optoelectronics, Arista Networks, Broadcom, Cisco, HP, Intel, Juniper Networks, Lumentum Holdings, and Marvell Technology Group – Suppliers of interconnect, switch and cable solutions.
- Alphabet and Amazon – Large internet services companies.
Notable items in Nvidia’s account statement
Concentration of Revenue
Revenue outside of the United States accounts in the range of 80% – 85%. This makes Nvidia very susceptible to revenue loss due dollar strength. However, its also states in the annual reports that the effect from foreign exchange rate risk is minimal due to:
- Sales arrangements with third-party manufacturers to provide for pricing and payment in United States dollars, and, therefore, are not subject to exchange rate fluctuations.
- Use of foreign currency forward contracts to mitigate the impact of foreign currency exchange rate movements on operating expenses.
Dollar impact on revenue
In the wake of strengthening dollar as compared to other major currencies of the world, it is prudent to also understand how strength or weakness of dollar may impact revenue.
In practice, if dollar strengthens, then Nvidia’s products will become pricier and it will be difficult to compete on price which may lead to lower sales revenue. On the other end operating expenses benefit from a stronger dollar. If dollar weakens, Nvidia’s price competitiveness increases but operating expenses will increase because supplies are now more expensive.
Income taxes
Nvidia’s annual effective tax rate is very low: 1.9% and 1.7% for fiscal years 2022 and 2021, respectively.
Take a moment to realize how extremenly low Nvidia’s tax rate is!! For comparison, U.S. federal statutory rate is 21%.
Nvidia’s low tax rate is because of multiple factors:
– Tax benefits from the foreign-derived intangible income deduction.
– Income earned in jurisdictions, including the British Virgin Islands, Hong Kong and Israel, that are subject to taxes lower than the U.S. federal statutory tax rate.
– Tax benefits related to stock-based compensation.
– U.S. federal research tax credit.
Annual highlights
2022
NVIDIA and SoftBank announced the termination of the share purchase agreement of Arm from SoftBank because of significant regulatory challenges. Recorded operating expenses of $1.36 billion charge in the first quarter of fiscal year 2023 reflecting the write-off of the prepayment provided at signing in September 2020.
Revenue for fiscal year 2022 was $26.91 billion, up 61% from a year ago.
Gaming revenue was up 61%, Data Center revenue was up 58%, Professional Visualization revenue was up 100% and Automotive revenue was up 6%.
Announced general availability of NVIDIA Omniverse Enterprise
2021
Revenue for fiscal year 2021 was $16.68 billion, up 53% from a year earlier.
Gaming revenue was up 41%, Professional Visualization revenue was down 13%, Data Center revenue was up 124%, and Automotive revenue was down 23%.
Data Center revenue growth was significantly up due to Mellanox acquisition.
2020
Revenue for fiscal year 2020 was $10.92 billion, down 7% from a year earlier.
GPU business revenue was $9.47 billion, down 7%.
Tegra Processor business revenue – which includes Automotive, SoCs for gaming platforms, and embedded edge AI platforms – was $1.45 billion, down 6% from a year earlier.
From a market platform perspective, Gaming revenue was $5.52 billion, down 12%, Professional Visualization revenue was $1.21 billion, up 7%, Data Center revenue was $2.98 billion, up 2%, and Automotive revenue was $700 million, up 9%.
Entered into an Agreement and plan of merger, or the merger agreement, with Mellanox Technologies Ltd. for enterprise value of approximately $6.9 billion.
Fundamentals
Working Capital Position
| Value | Median | Industry Median | |
| Current ratio | 3.62 | 3.56 | 2.23 |
| Cash ratio | 2.25 | 2.68 | 0.93 |
| Cash-to-Debt | 1.46 | 4.05 | 2.15 |
| Debt-to-Equity | 0.49 | 0.26 | 0.24 |
| Interest Coverage | 36.5 | 46 | 44 |
Nvidia has raised raised around $10 billion of debt in last 4 years.
Management
| 2018 | 2019 | 2020 | 2021 | 2022 | Notes | |
| Operating Margin | 33% | 32% | 26% | 27% | 37% | |
| Days Sales Outstanding | 39 | 42 | 51 | 44.7 | 48 | This is on the higher end of the range for all companies in this industry. Qualcomm and Texas Instruments seems to have the best numbers here at ~30 days. |
| Days Inventory (days) | 74 | 95 | 112 | 81 | 85 |
Above simple tools clue us into general management effectiveness.
Days Inventory – while inventory is considered a current asset, it is expected to be realized in cash within one year. The longer inventory sits around without being sold, the less value it adds to the business, since it could be converted into cash and deployed into more productive uses. High inventory levels also increase the risk obsolescence, require large cash/borrowings to finance, and pose the risk of loss if the market price at which they can sold declines.
Days Inventory indicates the number of days of goods in sales that a company has in the inventory. For comparison, Amazon’s “Days inventory” is 25 days for comparison.
Days Sales Outstanding – measures the average number of days that a company takes to collect revenue after a sale has been made. It is a financial ratio that illustrates how well a company’s receivables are managed. Speedy collection enhances liquidity and can enable its customers to finance its business.
Returns
| 2018 | 2019 | 2020 | 2021 | 2022 | |
| Return on Equity (RoE) | 46% | 49% | 26% | 29.8% | 44.8% |
| Return on Invested Capital (RoIC) | 111% | 104% | 56% | 44.4% | 56.4% |
| Return on Asset (RoA) | 29% | 33.7% | 18.3% | 18.8% | 26.7% |
Nvidia has very high returns which shows that they hold a very strong position (monopoly like) in the market they operate. However, very high returns like this can also signal a warning that this market will attract competitors that can affect Nvidia’s operating performance. However, I think the industry of graphics processors is very tough to break into. A lot of IPs that Nvidia owns are very hard to develop and takes years of research.
ROIC is on a deceasing trend. This means that newer investments have not been producing similar rate of return as previous.
Income analysis
| 2018 | 2019 | 2020 | 2021 | 2022 |
| 1.15 | 0.90 | 1.70 | 1.34 | 0.94 |
Here we are trying to measure the reliability of earning using quality of income*. This value should be greater than 1 which indicates that earnings are not manipulated, is free of one-time adjustments to net income, and earnings are actually generated from sales and not other sources.
In 2022, income quality is <1 due to very high receivables. Nvidia receives a significant amount of revenue from a limited number of customers and any difficulty in collecting accounts receivables would likely harm financial conditions.
In 2019, income quality was <1 due to high investment in increasing inventory.
Valuation
DCF valuation
DCF valuation is based on four basic inputs for a value estimate:
- Cash flow from operating assets after re-investment and taxes
- Expected growth in these cash flows
- The cost of financing the assets
- An estimate of what the assets will be worth at the end of forecast period.
Cash flow from operations is calculated using the following:
- Revenue growth – 26%
- Operating margin – 27%
- Tax rate – 6%
- Reinvestment rate – 39%
Above values based on median of 8 year operating history of Nvidia
Cost of financing (weighted cost of capital, WACC) is 11.87% calculated using risk free rate of 3.88%, market premium of 6% and 2.44% cost of debt.
The forecast of future cash flows is made for 5 years and then terminal value of operating assets is calculated using the following assumptions:
- Perpetual growth rate of 6% assuming industry average.
- Operating margin – 20%
- Tax rate – 6% assuming same as current tax rate.
- Perpetual WACC – 8.65%
- Perpetual reinvestment rate to sustain 6% growth and cover cost of capital – 69%
Expected cash flow to firm – Nvidia
| 2023 | 2024 | 2025 | 2026 | 2027 | Terminal | |
| Revenue | $33,941.24 | $42,803.28 | $ 53,979.21 | $ 68,073.17 | $ 85,847.05 | $ 90,997.87 |
| Income from operations | $ 9,224.69 | $11,633.25 | $ 14,670.69 | $ 18,501.20 | $ 23,331.86 | $ 18,199.57 |
| Net income | $ 8,660.71 | $10,922.01 | $ 13,773.75 | $ 17,370.07 | $ 21,905.39 | $ 17,086.88 |
| Re-investment | $ 3,353.93 | $4,229.64 | $ 5,333.99 | $ 6,726.70 | $ 8,483.04 | $ 11,852.17 |
| Free cash flow | $ 5,306.78 | $ 6,692.38 | $ 8,439.75 | $ 10,643.37 | $ 13,422.35 | $ 5,234.71 |
| Terminal value | $ 197,536.20 | |||||
| Present Value | $ 4,743.70 | $ 5,347.53 | $ 6,028.22 | $ 6,795.55 | $ 7,660.56 | $ 112,740.12 |
| Invested Capital | $21,997.93 | $ 26,227.56 | $ 31,561.56 | $ 38,288.25 | $ 46,771.29 | |
| ROIC | 43% | 45% | 48% | 50% | 52% |
| Present Value of Total CF | $ 143,315.68 |
| Cash, Cash Equivalent, Marketable securities | $ 17,037.00 |
| Long tern Debt and lease obligations | $ 10,443.00 |
| Equity Value | $ 149,909.68 |
| Total shares outstanding | 2495 |
| Equity value per share | $ 60.08 |
Nvidia’s current share price is $127 (as of writing this), so it twice over-valued as per this DCF value.
Conclusion
Nvidia is a financially strong company with high returns on capital. It makes great products and so it’s revenue has been increasing at a very tremendous rate. However, Nvidia at current share price is highly over-valued.
Disclaimer
The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice.
The rate of growth seems too low of an assumption
Amazing read and analysis! Found this insightful! Looking forward to more!
Thanks! I’m glad you enjoyed it!