No one would argue with the fact that Nvidia (NASDAQ: NVDA) has had a spectacular 2017. Nvidia beat its fiscal 3Q sales and earnings estimates, and 4Q guidance exceeded consensus. Company revenue has soared more than 36% and the stock more than 90%. At this point, the most common concern is on the NVDA’s seemingly high valuation which may not be justified by its forecast fundamentals. In this article, I just attempt to answer this question. Based on both the product classification and the end users classification, I use the “sum of parts” method to estimate NVDA’s 2018 price targets.
Murphy’s Law Rules
The good news is that NVDA fended off AMD’s recent assault on GPU market shares and be proven to be less affected by the volatility of the Bitcoin market. All segments across the board have delivered growth rates exceeding expectations. Ironically, Nvidia’s only potential bad news may be a result of its own success. Small revenue share segment shows the largest growth potential, Datacenter delivered over 100% year to year revenue growth (Figure 1-A) but only represents the smallest end user, contributing less than 20% of the revenue (Figure 1-B).
(Source: Bloomberg)
While Nvidia’s GPU business represents 84% of the Q3 revenue, it also dictates the company’s 18% year-to-year revenue growth which is significantly lower than the 74% Tegra Processor growth rate. As a result, Nvidia's near-term overall growth rate may be invariably slowing down amid the “growth dilution” from a large revenue base.
(Source: Bloomberg)
Forward-Looking Segment Fundamentals
In the following sections, I will examine the 2018 growth outlook for Nvidia's largest or fastest growing segments.
Gaming
Gaming is still Nvidia’s largest revenue segment. It increased from 41% in 2015 to the most recent 59% (Figure 1-B). On the other hand, Gaming also has the lower growth rate at 26%, halved from 50% just one year ago (Figure 2-A). However, gaming growth is expected to continue due to upgrades to chips that use Nvidia's Pascal and Maxwell GPU architecture and positioning vs. AMD's.
(Source: Bloomberg)
As the popularity of e-sports increases the demand for mid-range and higher GPUs, the 3-5 years GPU refresh cycle, and matching product releases, the company expects that its gaming revenue will grow in a mid-teen rate. While the IDC predicts PC gamers will rise 4% a year through 2020, Nvidia’s desktop GPU market share will reach 80% by then in figure below. Since MAU is highly correlated with the desktop GPU sales, it stands to reason that Nvidia’s long-term GPU’s CAGR will be halved from the most recent 25% to 12%-14%. The company’s gaming sales rose 13% a year during the past five years.
In the meantime, Nvidia fully enjoys the “margin leverage” that operating margin increases with the revenue growth (Figure 8 and 1-C). I can only see that Nvidia’s early investment in Artificial Intelligence (NYSE:AI) will start paying off. With a steadily rising margin at 44%, it is expected that the GPU’s 2018 operating margin will exceed 45%.
(Source: Bloomberg)
Datacenter
As a company, Nvidia can "leverage" its overall margin from its high growth, high margin Datacenter (Figure 8). Datacenter’s "value-based" pricing structure delivers an over 75% gross margin, compared with the company’s 45%-50%. Although Datacenter only contributes to 19% of the total revenue, growing at a triple-digit rate gives Nvidia a significant room for penetration. On the other hand, the concentration of a handful of large cloud corporate customers may pose a serious supply chain risk. More than 57% Datacenter revenue has been driven by the top 17 cloud companies (Table 1-B).
(Source: Bloomberg)
According to Bloomberg’s Anand Srinivasan, Nvidia’s Datacenter revenue visibility to these large firms may be "limited to 1-3 quarters" depending on whether the purchase is for internal or external system chip use. Although the 25% revenue exposure to the high-performance is less volatile, the remaining 15% of its Datacenter sales is for desktop virtualization which is subject to the slowing PC shipment. The cyclical exposure to these large firms’ IT budget makes the Datacenter recent 109% revenue growth unsustainable. With revenue share grows steadily over 20%, the growth rate is also conservatively halved to 50%.
Automobile
Currently, Automobile segment has a revenue share between 5% and 6%. However, this is the segment which its long-term investment in deep learning, system training, inference and high-performance computing will provide Nvidia an $8 billion AI car opportunity by 2025 (Table 1). While advanced driverless car chips are higher-priced and carry higher margins, they're purchased by fewer vendors and make up a small portion of Nvidia's auto sales. Nvidia’s advanced chip content may be in a range of $600-$1,000 per car. Today's cars average about $450 in chip content with a big gap between lower-end cars, which carry more analog value, and high-end luxury cars that have advanced logic chips, the volume is not expected to rise for several years. Most of Nvidia's exposure remains in infotainment which has less than half the Datacenter’s margin.
Sum of Parts Valuation
For 2018, Nvidia's faster-growing auto and datacenter computing segments will be partially offset by slowing PC graphic chip sales. It is clear that each product segment or end user exhibits significantly different revenue growth and profitability. Therefore, one logical way to estimate Nvidia’s stock is to value each component as an independent identity. Each part will be summed up into a total company valuation. Nvidia can be classified by its product lines, GPU and Tegra. It can also be analyzed by its end-users, i.e., Gaming, Datacenter, Professional Visualization, OEM & IP, and Automobile. I will use both alternative frameworks to estimate Nvidia stock values.
The general procedure of the valuation is to use a revenue-based model as follows:
P i = P/S* i x S i
P i is the value of the segment “i” and P/S* i is its “fair” sales multiple and S i is the segment “i” revenue. The total market capitalization, or stock price per share, is the sum of all the individual segment valuations.
Different Segment P/S Multiples
In contrast to the convention of applying a historical or constant P/S to the valuation, there is the fair P/S multiple varies from segment to segment. The fair P/S multiple should reflect the expected long-term revenue growth and incremental margin in that segment. On the same token, historical P/S and margin rarely repeat themselves as most do not have same sales growth and profitability over time. A P/S should be determined by the expected sales growth in that segment in the long-run, I use the sales franchise model (SFV) to convert the forward-looking fundamentals into share values.
SFV computes two parts of the stock value. The first part includes the market value for constant-growth profitability. The second portion is the excess profit growth over shareholders’ expectation. This is a model to produce stock valuation which reflects both future revenue growth and margin changes. Using the SFV, I first compute a fair P/S for each individual segment. The fair segment P/S will be used to find the individual segment’s valuation. (Please click here for details of the model.)
Product versus End-Users Valuations
Using the forecast revenue growth rates and margin estimates in fiscal 2019 (calendar 2018), as outlined in the first section, I am able to value Nvidia’s GPU segment between $205 and $225 a share, the Tegra Processor between $35 and $39 a share. As a result, NVDA is estimated around $252 (Table 2). Note that the range of the valuation reflects the range of the individual growth rate estimated. For the segment revenue growth rate was not explicitly estimated, I used its CAGR for the past five years.
I perform the same procedure for the 5 end users in Table 3. The fair value for Gaming is around $160, Datacenter $55, Professional Visualization around, OEM/IP, and Automobile $46. Based on this classification, Nvidia should be valued around $261. The reason that End-User valuation is higher than the product-based valuation is due to a higher growth rate and margin being used for Datacenter. The closeness of Nvidia valuations from two independent approaches also provides validity and robustness of the valuation process.
Combining both estimates, Nvidia’s 2018 price target is between $252 and $261.
Limitations
Of course, there are numerous limitations in interpreting and using this valuation:
The sum of parts method treats each part independently. There is an obvious interaction among each segment, either positive synergy or negative cannibalization effect which is not captured. For example, Nvidia’s leading AI investment will invariably impact positively on GPU, Gaming, Datacenter, and Automobile simultaneously. If this is the case, the omission of positive synergy in my calculation only makes NVDA price target estimate a more conservative one. I didn’t explicitly include the likely tech sector selloff in 2018. Based on a previous post, the history tells us that for every 1% drop of tech index, NVDA will drop 1.5% in response. Unlike in previous posts, I didn’t include the “zero-sum gain” nature in GPU & CPU market share among Nvidia, AMD, and Intel. As the new AMD and Intel alliance will pose a likely threat to NVDA in the CPU space, there may be some downside for NVDA’s valuation on that account. Of course, I didn’t include the long-term favorable tax-cut impact, or the short-term negative earnings effect from deferred tax assets write down for NVDA. But I think these tax effects will most likely be a wash to the positive side.
Even with all these caveats in my analysis, I still want to wish Nvidia a “Happy New Year.”
Disclosure: I am/we are long NVDA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Happy New Year 2018: Do you have your list of New Year resolutions ready?
Looking up from my phone 30 seconds every day. #MillennialNewYearResolutions - Alan Rhodes (@Protogenes1) December 15, 2017
#MillennialNewYearResolutions Interact with a human in person - Jeff (@JeffHendrix88) December 15, 2017
Only go to work on odd numbered days because they can't even #MillennialNewYearResolutions - Scott Williams (@jswilliams1962) December 15, 2017
Get my parents better jobs to support me. #MillennialNewYearResolutions - craig onetweetwonder (@craigflynn1) December 15, 2017
Stop saying no to offers so much and start saying yasss #MillennialNewYearResolutions - Luke, Deft (@LukeWheeler01) December 15, 2017
#MillennialNewYearResolutions
Create like 6 or 7 start ups and retire - tribetraveler (@tribetraveler) December 15, 2017
Resolve to really try my bestest to adult next year #MillennialNewYearResolutions - MikealaSunshine (@Alohababe2011) December 15, 2017
Drop the fidget spinners and resort to black coffee.#MillennialNewYearResolutions - Daniel Hopkins (@IamDHop) December 15, 2017
I will continue to save my parents from suffering the pain of empty nest syndrome. You're welcome Mom &/or Dad. #MillennialNewYearResolutions - Pat Mac McKenzie (@pat_4291_mac) December 16, 2017
#MillennialNewYearResolutions
Finally find out what Fleek means.- Kerry Waysman (@KerryWaysman) December 15, 2017
With the new year practically upon us, it's no surprise many of us have started to think about New Year's resolutions - those pesky promises we often make to ourselves on January 1 and promptly break come January 2. Whether it's getting fit, eating right or actively trying to tick more items off our bucket lists, New Year's resolutions are the perfect opportunity for all those who have tried but failed to start making the changes that they said they would make next week, next month or... next year.But, Twitter being Twitter took New Year's resolutions and gave them a millennial twist. Using the hashtag #MillennialNewYearResolutions, Twitterati started posting their take on what millennials may resolve to do next year. And, as the kids these days say, oh, was there shade. Netizens joked about everything from millennials' penchant for fidget spinners to their obsession with their smartphones.There were plenty of jokes made about millennials' addiction of sorts to technology.And, of course, millennials' perceived love-hate relationship with all things career-related."Adulting is hard" may just be the most overused phrase in millennial-speak.Fidget spinners trump caffeine?Helicopter parents, you've got us for lifeTo be honest, we have always wanted to know what "fleek" actually meansHave you started thinking of your own New Year's resolutions for 2018? Let us know what they are and how you plan to keep them in the comments section below.Happy New Year!Click for more trending news
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