Price Target: $210.35 – Discount: 8.10% Consensus Outlook
Nvidia (NASDAQ:NVDA) has seen revenue growth of almost 38%. Wall Street expects almost 30% revenue growth in 2018, stemming almost entirely from GPU sales.
Autonomous car producers are rapidly adopting Nvidia’s DRIVE PX AI automotive platform. Here is our forecast for Nvidia automotive sales.
Catalyst – Autonomous Vehicles (Artificial Intelligence)
- By 2025, we estimate that Nvidia will have an $8 billion opportunity as there will be approximately 25 million cars using Nvidia AI technology, 5 million of those being fully autonomous.
- New partnerships for the DRIVE PX AI platform show the advancements of over 225 car and truck makers using the Nvidia system, which will only grow as autonomous driving leads us into the future. Such partnerships include Audi (OTCPK:AUDVF), Mercedes-Benz, Toyota (NYSE:TM), Volvo (OTCPK:VOLAF), Bosch (OTC:BSWQY), Baidu (NASDAQ:BIDU), and many others.
- Autonomous technology falls into four phases (shown in Figure 2), the last phase being fully autonomous vehicles with no driver needed. We are currently in phase 2 of autonomous adoption with limited driver operation. Nvidia is showcasing the 2019 Audi A8 as the first car to use its phase 3 complete autonomous technology.
- Nvidia CEO Jen-Hsun Huang expects phase 4 autonomous cars to begin showing up on roads by 2021. Currently, several cities in the United States beta test self-driving vehicles. By 2019, Huang says these cars will serve commercial purposes (such as Uber services).
- The extensive partnerships that Nvidia has with automakers mitigate the risk of competition. Nvidia works with each automaker to tailor chips to their needs. We believe that Nvidia will become an industry standard in the automotive sector as automakers incorporate Nvidia technology into all of their models, high and low-end.
The figure below shows the growth in automotive revenue for Nvidia 52% from 2016 to 2017. As mentioned above, this figure also shows the growth in the number of automakers using DRIVE PX (currently, over 225 automakers).
Source: Nvidia’s Investor Presentation
The following figure shows the timeline for adoption of autonomous technology and advancement. Separated into four phases. Currently, in phase 2 (2015-2019), drivers must provide some input while driving. Phase 3 technology (2018-2022) requires a human to be present but should not have to interfere with driving. Nvidia is in pursuit of phase 4 technology which requires no human presence.
Discounted Cash Flow Valuation
Our DCF Model uses:
- 2.17% for the 10-year U.S. Treasury risk-free rate of return
- A 9.50% market risk premium
- A forecast of sales growth for the next nine years
- A perpetual growth of 3% in year 15
- A 1.40 Beta for Nvidia Corporation
Given recent demand for Nvidia products, we believe the company can easily attain consensus estimates of 8.94 billion in sales for 2018. Our model presumes 30% growth, or 8.98 billion in sales, for fiscal 2018. The excess growth in our estimate over the consensus stems from an approximate 48 basis point contribution from Nvidia’s automotive segment. We estimate sales growth to remain 30% for 2019, with declining growth rates until 2032.
Management disclosed that it has high hopes for Nvidia’s automotive sales but intends to focus resources on the development of automotive technology until 2019. CEO Jen-Hsun Huang forecasts that autonomous vehicles will start serving commercial purposes in 2019 and will become commonplace by 2021. Until then, Nvidia will be working to make sure these vehicles will come equipped with its technology.
- We forecast automotive sales to grow at an average CAGR of 39.75% for the next 15 years.
- In 2028, we forecast that automotive revenue will contribute 24.83% of Nvidia’s entire sales.
Gross margin expanded almost 20% in the last six years; our model presumes gross margin will expand 80 basis points to 59.6% in 2018. This figure is 50 basis points ahead of management’s estimate. It will expand 50 basis points subsequently until 2022; from then on, it will remain at 61.6%.
We expect operating margin to expand 190 basis points in 2018 to 29.79%. Afterwards, we expect operating margin to expand 50 basis points each year until 2022; from then on, it will remain at 31.79%.
The lower beta reflects how much growth is expected from Nvidia in the future. If you were to run a regression, you may find beta anywhere from 1.7 to 2.2, depending on the time horizon.
Shares of Nvidia trade for $197.75, an 8.10% discount according to our model.
*To see our model, click here to download (this sheet uses the closing price of 9/21/17).
WACC vs. ROIC
Nvidia is generating more return on its capital than the cost of acquiring the capital.
*shares in millions
Porter’s Five Forces
Competition with Nvidia (High Force):
Nvidia faces high pressure on selling price reductions due to foreign companies that can compete at reduced costs. Nvidia heavily relies on its patents and licensing agreements to protect its intellectual property, and product imitation can be found in companies outside the U.S. Intellectual property is not protected in Asia as it may in the U.S, affecting the bottom line of the business.
Threat of New Entrants (Low Force):
The threat of new entrants to Nvidia is low due to the number of patented products by the company. If new entrants introduce new products to the market, this can adversely affect market share for the company, but this will most likely occur with bigger companies already established in the market. Financial resources required to start up poses as a barrier to entry.
Threat of Substitutes (Moderate Force):
Although switching costs are low for the individual final customer of most consumer goods in which Nvidia’s products are embedded, engineering, and technology integration costs (as well as quality and performance risks) might be high for Nvidia’s OEM customers. The company stated in its 10-K, “customers typically introduce new system configurations as often as twice per year, typically based on spring and fall design cycles or in connection with trade shows”. If Nvidia’s OEM, ODM, and AIB products are not up to par with features, configurations, and or functionalities, customers will not purchase Nvidia’s products until the next season.
As most competitors invest in high levels of research and development, a major risk of substitutes might come from product enhancement, new technological advancements protected by patents, and/or service offerings. This is even more impactful with competitors who operate and maintain their own fabrication facilities and have longer operating histories, greater name recognition, larger customer bases, and greater financial, sales, marketing, and distribution resources.
Bargaining Power of Nvidia’s Customers (Moderate Force):
Concentrated large orders from a limited number of clients increase buyers’ bargain power and represent a risk for Nvidia’s revenues due to order cancellations, price pressures, or major customers switching to competitors. Also, revenue from sales to customers outside of the United States and other Americas accounted for 80%, 79%, and 75% of total revenue for fiscal years 2017, 2016, and 2015. If customers outside the U.S decide to leave Nvidia for a foreign competitors’ product, this can dampen company profits.
Bargaining Power of Nvidia’s Suppliers (Moderate Force):
Suppliers of general purpose circuits and components are more susceptible to competition on price and are most likely to have low switching costs and consequently lower bargain power. Nvidia’s distinct product components, though, might be protected by patents held by their suppliers, increasing their bargain power.
Nvidia utilizes industry-leading suppliers, such as Taiwan Semiconductor Manufacturing Company Limited (NYSE:TSM) and Samsung Electronics Co. Ltd. (OTC:SSNLF) to produce its semiconductor wafers. It also utilizes independent subcontractors, such as Advanced Semiconductor Engineering, Inc. (NYSE:ASX), BYD Auto Co. Ltd., Hon Hai Precision Industry Co., Ltd. (OTCPK:HNHAF), JSI Logistics Ltd., King Yuan Electronics Co., Ltd., and Siliconware Precision Industries Company Ltd. (NASDAQ:SPIL) to perform assembly, testing, and packaging of most of its products and platforms.
Nvidia’s P/E ratio is trading at 46.78x, the highest amongst its peers. Investors should be careful as expectations for earnings are steep, risks of Nvidia missing earnings is possible and can result in a price drop.
Nvidia’s market is always evolving, which requires constant innovation. Identifying new products, services, or technologies, in order to successfully compete in target markets is essential. Nvidia’s revenues are extremely sensitive to this matter.
If Nvidia’s products fail to achieve expected manufacturing yields by OEM customers, financial results can be impacted.
The renewal of the Intel’s (NASDAQ:INTC) licensing revenues may adversely affect financial results:
- In January 2011, Nvidia entered into a patent cross-licensing agreement under which Intel agreed to pay Nvidia an aggregate of $1.50 billion over six years. This allowed Intel to use Nvidia’s GPU intellectual property in its own homemade iGPUs. The final $200 million payment under this agreement was received on January 2016. According to Nvidia’s 10-K, it will be “recognizing revenue under this agreement through the first quarter of fiscal year 2018”. Risks lie on the renewal of this licensing agreement, as it could affect income and financial results.
*I co-authored this article with my colleagues at Precision Asset Management (PAM) of Mihaylo College of Business and Economics: Elad Fedida, Cody Swan, Alia Leiyn, and James Dabbah.
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.