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NVIDIA Strong on Growing Datacenter, Gaming & AI Demand

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NVIDIA Corp. NVDA has demonstrated impressive price performance over the last three years. In the beginning of 2015, the stock was around $20 and is currently trading close to $263, surging more than thirteen-fold.

Year to date, NVIDIA’s shares have returned approximately 36% compared with S&P 500 index’s and Nasdaq Composite’s rise of 4.3% and 11.6%, respectively. The stock has also outperformed the industry’s rally of 21.2% in the period.

The upside can be primarily attributed to the company’s stellar financial performance. Its annual revenues have almost doubled while earnings have nearly tripled in the last two fiscal years.



Strong Adoption of NVIDIA’s GPUs Drive Revenues

NVIDIA’s graphic processing units (GPUs) are rapidly penetrating the gaming and datacenter markets, which is driving top-line growth.

Better visualization and speed is needed for a thrilling gaming experience, which NVIDIA successfully provides through its portfolio of Pascal architecture-based GPUs. Further, with the emergence of massively multiplayer online games (MMOG) and Gaming-as-a-Service (GaaS) concepts, the demand for GPUs has been surging exponentially.

Notably, gaming segment revenues reached $5.51 billion in fiscal 2018 from $2.82 billion in fiscal 2016, marking a robust growth of almost two-folds.

Moreover, datacenter presents solid growth opportunity for the company. As more and more businesses are shifting to cloud, demand for datacenters is increasing immensely. To meet this huge demand, datacenter operators like Amazon AMZN, Microsoft MSFT and Alphabet GOOGL are expanding their operations across the world, which is boosting demand for GPUs. This bodes well for NVIDIA. Revenues from this segment have increased to $1.93 billion in fiscal 2018 from $317 million in fiscal 2015.

AI Presents Solid Growth Opportunities

NVIDIA GPUs are gaining rapid traction with the proliferation AI. The increasing usage of artificial intelligence (AI) tools in datacenter, automotive, healthcare and manufacturing industries is likely to drive demand for GPUs in the long haul.

Notably, NVIDIA is already a dominant player in the datacenter market. The company enjoys a first-mover advantage in the AI field and its expanding product portfolio is capable enough to leverage the growing adoption of AI in various industries.

NVIDIA is currently the leading AI supercomputing platform provider which will power future autonomous vehicles. In the last earnings conference call, the company revealed that its DRIVE platform is currently used by more than 370 companies and research institution.

Value-Added Platforms Driving Gross Margin

NVIDIA’s strategy of developing single GPU architecture, at a time when Pascal and Tegra are predominant, has been boosting gross margin performance. Furthermore, the company has started building its Volta GPUs on Samsung’s 10-nm (nanometer) node instead of Taiwan Semiconductor Manufacturing’s 12-nm node. This has reduced its cost while enhancing performance of its GPUs.

Notably, in the last three fiscal years, NVIDIA has registered a solid year-over-year improvement in its gross margin. The company’s non-GAAP gross margin reached 60.2% in fiscal 2018 from 56.8% in fiscal 2016. We expect that its platform model and consistent focus on lowering costs will continue to expand gross margin in the long run.

A Look at Operating Expenses

NVIDIA’s operating expenses, as a percentage of revenues, have shown a declining trend in the last three fiscals. NVIDIA’s platform model has helped in reducing overall costs, thereby enhancing its operational efficiency.

NVIDIA’s non-GAAP operating expenses, as a percentage of revenues, declined to 23% in fiscal 2018 from 35% in fiscal 2015.

Improving gross margin and lower operating expenses are expected to drive the company’s operating margins, which will benefit fiscal 2019 earnings. Notably, operating margin has improved to 37.2% in fiscal 2018 from 20.4% in fiscal 2015.

Strong Cash Flow Generation

The company’s accelerated revenue growth along with improving operating efficiency is bringing in higher cash flows. NVIDIA’s operating cash flow in fiscal 2018 reached $3.5 billion from $906 million in fiscal 2015. At the end of fiscal 2018, NVIDIA had cash and cash equivalents and marketable securities worth $7.12 billion.

Moreover, NVIDIA being a fabless company doesn’t have to make huge capital expenditure like its peers. Notably, in fiscal 2018 the company made a total capital expenditure of $593 million, while its main competitor Intel has incurred a massive $12 billion in capital expenditure last year.

All this make NVIDIA a cash-rich company that gives it flexibility to invest in long-term growth opportunities as well as return cash to shareholders in the form of share repurchases and dividend payments. In the last fiscal year, NVIDIA returned approximately $1.25 billion to shareholders through dividend payments and share buybacks.

To Conclude

Many will argue that NVIDIA is a risky bet given its hefty forward P/E valuation of 33.1x compared with the industry average of 19.3x. However, we beg to differ due to its consistent performance and strong growth opportunities in various untapped markets like automotive, healthcare and manufacturing over long term. Further, the stock sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Keeping all these in mind, we believe investing in NVIDIA will yield strong returns for investors.

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