Nvidia: Earnings and Beyond

Graphic chip maker Nvidia (NVDA) has been one of the top performing stocks of 2016 as shares have gained some 125% thus far year to date. But the company is entering an important transition period which could prove challenging. The company set to report earnings Thursday, November 11th; the question is will the company deliver numbers justifying its already lofty valuation, which could also push the stock beyond current levels.

Over the six previous quarters the company has been posting an average 32% top line and 43% bottom line growth. But the growth rate is expected to slow dramatically as a major portion of its revenues starts declining. Namely, royalty payments from Intel (INTC) that have boosted Nvidia earnings since 2011 could sunset next year.

For its fiscal Q2 ended July 31, Nvidia’s revenue jumped 24% to $1.65 billion and EPS ex items jumped 56% to 53 cents from the year ago period. For the upcoming third quarter analysts expect revenue of $1.69 billion and eps of $0.55 per share. A mere 2%-3% increase. Growth projections remain muted for 2018 as analysts are modeling only 3% full-year EPS growth.

That’s where the patent cross-licensing deal signed by Intel and Nvidia in 2011 comes in. Intel agreed to pay Nvidia $1.5 billion over six years, or roughly $264 million annually, to settle a patent dispute. How will NVDA replace that revenue?

Given the high valuation and stock sitting near highs with no apparent technical support any miss or overly conservative guidance could send shares down toward the $55 level.

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From Partners to Rivals

The partnership of NVDA and INTC in the PC arena is ending just as more competition unfolds between them in data centers, self-driving cars and augmented reality. Both Intel and Nvidia stick out as chipmakers hunting for the next killer app. Mobile phone sales are slowing globally, much as the PC market did earlier. Intel and Nvidia aim for leadership in semiconductors used in cars, artificial intelligence and visual processing.

The moves into new markets are panning out, but Nvidia still gets 60% of revenue from PC graphics and gaming.

Intel, which in Q2 derived 54% of its revenue from its PC unit, recently acquired startups in the AI and visual computing fields. Observers wonder what Nvidia might buy, with nearly $5 billion in cash on its balance sheet.

Nvidia continues to improve upon the high-end graphics processing, which made it the leader in gaming along with Advance Micro Devices (AMD). An edge Nvidia has is its powerful graphics processors, thanks to their “parallel-processing” circuitry, can be extended to artificial intelligence software.

AI chips are well-suited for facial or object recognition, a plus for robotics and security applications, as well as spoken-language apps. Much R&D is focused on “deep learning,” an AI tool enabling computers to be trained and to perform actual reasoning. Self-driving cars map their surroundings and detect hazards, for example.

In self-driving, Nvidia has the right product at the right time as Autonomous driving is all about vision and parallel processing.

Intel’s chips still dominate in low-end PC graphics. And its chips are built into most computer servers packed into data centers. Nvidia’s chips are gaining in data center gear as well, with technology well-suited for apps such as credit-card fraud-detection systems.

But where Intel has had four chief executives since Nvidia was founded in 1993, Nvidia has had one CEO: Jen-Hsun Huang, one of Nvidia’s three co-founders. The CEO gets kudos for reinventing Nvidia and for his ability to recruit top engineers to the chipmaker.

“Jen-Hsun has made several gutsy calls in the past decade,” Mark Hung, an analyst at tech research firm Gartner, told IBD. “Some of them worked out very well, a couple not so much. When he sees an opportunity, he’s been able to marshal the company’s full resources

Intel’s chips still dominate in low-end PC graphics. And its chips are built into most computer servers packed into data centers. Nvidia’s chips are gaining in data center gear as well, with technology well-suited for apps such as credit-card fraud-detection systems, says David Kanter, an analyst at Real World Technologies and the Linley Group.

Apple (AAPL) GOOGLE (GOOG) and Facebook (FB) and others are racing to develop AI-based apps that can be delivered to consumers via the internet cloud. There’s another race underway to equip data centers with AI hardware and software.

Intel’s August acquisition of startup Nervana Systems heated up its rivalry with Nvidia. Nervana’s technology processes “deep learning” algorithms. For its part, Intel last month acquired startup Movidius, whose visual processors are used in drones, virtual reality devices and autonomous machines.

Nvidia can make up the Intel loss, says William Stein, a SunTrust Robinson Humphrey analyst. “Nvidia’s margins will be pressured in the near term for the nearly 90%-margin Intel-licensing revenue rolling off in 2017,” said Stein in a research report. “We believe this will be more than offset in the long term by growth in the high-margin data center end-market, plus new products in automotive, lifting margins above the corporate average. Increasing ASPs (average selling prices) in gaming will also help.”

M&A has not been a big part of Nvidia’s DNA, though it bought U.K.-based Icera for around $370 million in 2011. Nvidia had problems melding Icera’s modem technology with its GPUs and wrote down the Icera business in 2015, says Will Strauss, president of market research firm Forward Concepts. While Nvidia has won some design wins in tablets, it’s not a volume player in smartphones.

With nearly $5 billion in cash on its balance sheet, Nvidia could be primed for acquisitions, Nomura analyst Romit Shah speculated in a September research report.

With a market cap over $13.5 billion, Xilinx (XLNX) could be out of Nvidia’s reach, but it’s a potentially potent combo. “Nvidia and Xilinx … now that would change the world as we know it,” said Penn via email. Intel plucked down $16.7 billion in 2015 to buy top Xilinx rival Altera, which like Xilinx has a sizable data center business.

Self-driving cars are one big battleground for Intel and Nvidia. Intel has teamed with autonomous-driving tech company Mobileye (MBLY) and Germany’s BMW with the goal of bringing a self-driving car to market by 2021.

Nvidia’s highest-profile customer and partner might be Tesla Motors (TSLA) and August, Nvidia nabbed another biggie, announcing a partnership with China internet giant Baidu (BIDI) to make an autonomous car platform.

Self-driving cars would be a big leap forward technologically for the chipmaker, says Kanter, but he says it’s far too early to call Nvidia a winner of the race.

For me, I’d look at any sell-off following next weeks’ earnings report as a buying opportunity. I think NVDA is well positioned to navigate the next evolution of chip design and that should take shares back above recent highs.

— Steve Smith

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About the Author: Steve Smith