Nvidia (NASDAQ:NVDA) is a technological behemoth that supplies specialized building pieces for the gaming, data center, and even artificial intelligence industries. Unfortunately, the stock price of the corporation has been slashed. It was currently down 54% from its all-time highs in November 2021. Poor second-quarter earnings results drove its most recent decline. However, it outperformed analyst expectations because they weren’t as bad as expected. In my opinion, Nvidia is experiencing short-term obstacles, but they have little bearing on long-term secular growth prospects. In this piece, I’ll separate the signal from the noise by breaking out Nvidia’s Q2 earnings release and valuation.
Filter the Signal from the Noise
For the second quarter of FY23, Nvidia announced mixed financial performance. Revenue was $6.7 billion, increasing only 3% yearly and down 19% quarter on quarter. This may appear to be a bad thing at first glance, but when we look deeper, we can see why. Gaming revenue was $2.04 billion, a 33% decrease from the previous year. Again, this was due to various issues, including sluggish consumer demand for gaming, which was also reflected in Microsoft’s (MSFT) profitability for the Xbox.
Taking a step back, it’s evident that the gaming sector is cyclical. It had an unexpected boom during the 2020 lockout when the gaming market expanded by 23% in value, the quickest rate in almost a decade. So, while demand is currently being corrected to “normal levels,” the long-term secular tendency remains obvious. The gaming market is expected to increase at a 9% compound annual growth rate [CAGR] between 2021 and 2026, reaching $321 billion by the end of the term, according to a PwC report.
Because of the secular growth tendencies, I believe Nvidia’s gaming revenue to begin growing again in the long run. With a 60% market share, Intel (INTC) dominates the Graphical Processing Unit (GPU) business. However, Nvidia and AMD are the market leaders in “high-performance” GPUs, which are required for gaming. Looking at the figure below, it’s evident that Nvidia [light blue] had just 15% of the global GPU market in Q1,21. Still, by Q1,22, the business had a sizable 21%, while Intel’s market share shrank.
To evaluate Nvidia, I entered the most recent financials into my advanced valuation model, which used the discounted cash flow approach of valuing. As a result, I’ve reduced my sales growth projection from 30% to 40% to a 10% drop in revenue next year, followed by 22% revenue growth compounded over the next 2 to 5 years. This valuation is based on cyclical gaming revenue rebounding and continuing growth in the Data Center and Automotive divisions.
I’ve also projected a 45% operating margin over the following eight years as the firm grows and benefits from increased economies of scale. This includes a correction for the company’s R&D costs, which I capitalized.
Given these considerations, I calculate a fair value of $140 per share; the company is currently trading at $150, implying that it is 7% overpriced. Moreover, Nvidia is now selling at a Price to Sales Ratio [FWD] = 14.23, which is 3% lower than its five-year average. As a result, I believe the stock is “reasonably valued,” as the adverse news for the upcoming quarter has already been factored in.
China’s sales have ceased.
Nvidia has notified the US government that it has imposed a new licensing requirement to halt the sale of its A100 and new H100 integrated circuits in China. This is for national security grounds since the company believes the devices will be used by “military end users” in China and Russia. This makes reasonable from a security standpoint, but it entails a $400 million cut to sales forecast from China in Q3,23.
Reduced IT spending/Recession
A recession is also projected due to rising interest rates and high inflation, which are expected to affect consumer mood further and restrict expenditure.
Nvidia is a technical powerhouse and a market leader in high-performance GPUs. The company’s financials are coming from a tremendous high last year. The cyclical gaming and cryptocurrency industries have taken a significant knock. However, long-term trends remain intact, and Nvidia’s innovation remains robust. Moreover, the majority of the bad news for the coming quarter is already baked into the price, so the current fear is primarily noise for long-term investors.
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