NVIDIA Corporation — A Case for Stock Price Decline
Key Points:
COVID lockdowns in China are likely to impact operations considerably for 2Q2022 and FY2022, forcing the company to halt or slow down operations affecting overall guidance.
NVIDIA Corporation’s top-line and bottom-line are likely to be impacted negatively due to geopolitical tensions, increasing regulatory pressure, and a high-interest rate environment to curb inflation.
Competitors of NVIDIA have reported softening the PC market, inventory buildup, and order cancellations, which will likely lead to downward revisions in revenue projection.
In terms of the stock price, this implies around 25% downside risk. Investors should consider selling NVDA stock until market conditions become more favorable.
Investment Thesis
NVIDIA Corporation (NVDA) faces considerable pressure under the current macroeconomic environment to deliver strong growth seen in 2021. Although NVDA has diversified into data centers and reduced its dependence on gaming to generate revenues, it faces tough challenges in 2022 and beyond to deliver such strong performance. Due to the uncertainty, NVDA has around a 25% downside risk. Investors should avoid investment in NVDA due to its high volatility and wait until condition become more favorable.
Background
NVIDIA Corporation announced its a goal to capture $1 trillion in business opportunities, during its investor day in March 2022. The key business segments it plans to go after are: Gaming ($100 billion), NVIDIA enterprise software ($150 billion), Omniverse Enterprise Software ($150 billion), automotive ($300 billion), and chips and systems ($300 billion). Management unveiled a stack of tools and partnerships to drive such growth. NVIDIA plans to leverage its current position as a leading chipset maker for gaming, a key participant in the data center business, a leading participant in the Omniverse 3D virtual reality, a core supplier in bringing essential chipsets to the automotive industry, and a developer of AI-enabled platform to capture 1% of $100 trillion worth of underlying industries.
Key Factors in Business Slowdown
According to CNN, starting March 2022, China has battled the most widespread COVID and implemented stringent lockdown rules, projected to end in June 2023. According to CRN, as early as mid-march, NVIDIA’s key supplier Unimicron had to shut down production in Shenzhen, China exacerbating chip shortages.
A drop in cryptocurrency prices of around 25% in April and May will reduce overall mining profitability. The simultaneous increase in the price of electricity, which, according to the EIA, has risen 3.6% to 14.26 cents per kWh, will force marginal miners to halt operations. Additionally, the increased regulatory crackdowns of cryptocurrency mining using GPUs and the overall environmental impact of mining becoming headline news will likely add more pressure to reduce mining. Although, mining specific GPUs represent around 2 to 6% of annual of NVIDIA revenue, the subsequent drop in price of GPUs will also negatively affect overall revenue.
In terms of data and data processing with AI, there is increased national security and personal privacy risk associated with data processing that may hamper future growth. For example, China has announced rougher rules around data and increased oversight of Big Tech. United Stated congress has been working to pass new laws cracking down on big-tech as well. EU focus has been focussed on fair competition on big-tech platforms, however big-data regulation ranks a close second.
On March 8th, NVIDIA announced that it will cease sales and operation in Russia, which will likely also affect revenue.
According to Barrons, NVIDIA stock was also downgraded due to the slowing GPU demand and increased order cancellations.
Key Factors Driving NVIDIA Growth
The main factor driving growth for NVIDIA is the diversification of its technological footprint. Originally a gaming chipset provider, now over 50% of NVIDIA revenue is not dependent on gaming. Around 38% of the revenue now comes from data center segment, which experienced significant growth in 2021, as discussed below. With a strong pipeline of development ventures, such as, autonomous driving, NVIDIA Omniverse, and a range of new GPU chipsets under development, NVIDIA has strong tailwinds to support its future revenue growth.
4Q21 Earnings Takeaways
Company touted strong performance in 2021 with full year revenue up 61% YoY to $26.9 billion. Key contributors to the revenue were gaming revenue increase up 61% to $12.5 billion, pro-visualization revenue up 100% to $2.1 billion, automotive revenue up 6% to $556 million, and data center revenue up 58% to $10.6 billion. Additionally the company announced the AI enabled DRIVE platform, growth from the A100 GPU, general availability of NVIDIA Omniverse, record revenues from GeForce RTX 3070 Ti, 3080 Ti GPUs, and the announcement of RTX 30 series with new laptop designs. In the future, management also plans to integrate NVIDIA GeForce into cloud gaming, mobile phones, and smart TVs.
NVIDIA was also pursuing the Acquisition of Arm from Softbank, which it decided to terminate due to insurmountable regulatory pressures.
1Q22 Earnings Outlook
With earnings scheduled on May 25, NVIDIA anticipates $8.1 billion revenue and gross margins around 66%.
Management reiterated accelerated growth in data center revenue across the spectrum of hyperscale, public cloud, enterprise core, and enterprise edge, which is now its second largest revenue source.
However, management also cautioned about the supply constraints and that they are making steady improvements every quarter.
Additionally, the key thing to look for during the upcoming earnings call is updated guidance for 2Q22 and and FY22, in light of other macroeconomic environment.
Company Fundamentals
The cash available has fluctuated considerably going from $4.0 billion in 2018 to $1.99 billion in 2021. In 2020, the cash exceeded $10.9 billion. The cash position is likely to weaken due to the Arm write-off by $1.36 billion, which will be booked as an operating expense. Furthermore, management plans to spend $350 to $400 million in CAPEX and $400 million for paying dividends.
The total assets have nearly tripled from $11.2 billion in 2018 to $44.2 billion in 2022. Lastly, to fund its explosive growth, the long-term debts have increased more than five fold from $2 billion to $11 billion.
Competitor Analysis
In this section, we look at 1Q22 results from two main competitors: Advanced Micro Devices, Inc. (AMD) and Intel Corporation (INTC).
AMD reported 1Q22 earnings on May 3rd. Similar to NVIDIA, they reported a strong performance in 2021. AMD shrugged the business impact due to COVID lockdowns and revised their revenue projection upward. They provided their guidance based economic conditions as of March and April 2022. They mentioned a softening PC market, inventories up 600% due to their Xilinx takeover. Following the earnings report, AMD stock price increased around 6.6% the next day, which coincided with the US Federal Reserve’s announcement to hike interest rate and subsequent market rally. The stock price returned to pre-earnings release levels over the next few days, dropping more than 9%. The share price has still not fully recovered above post-earnings release levels.
Intel reported 1Q22 earnings on April 28th. They faced significant disruption to operation due to supplier lock-downs in China due to COVID, shutdowns due to Russia-Ukraine war, and general inflation. Their revenue and gross margins improved slightly compared to guidance. Additionally, they reported that OEMs have lowered inventory levels in response to the anticipated slowdown. The overall slowdown is projected to last throughout first-half of 2022, affecting 2Q22 results. After the earnings announcement, the stock price declined sharply by 6.95% on April 29th, following earnings. The stock price has continued to slide throughout May.
Based on this analysis, we see that NVIDIA’s share price performance is highly sensitive to the earnings results on May 25th. Not only will investors be looking for impact on NVIDIA due to COVID lockdowns in China, war between Russia-Ukraine, but they will also be reflecting their views on whether the slowdown in business conditions will materially affect NVIDIA’s performance in 2022. NVIDIA’s industry peers trade on the trailing PE multiple of 26.2 times and a forward PE multiple of 30.4 times. As NVIDIA trades on a premium to the sector with a trailing PE multiple of 26.2 and a forward PE multiple of 41.3. With a slow down in economic growth, we anticipate a reversion towards the industry median, which represents a 41.6% downside, with a fair value price of $103.5 per share.
Company Valuation
Utilizing management guidance for 1Q22 along with the factors discussed above, we can anticipate NVIDIA revenues to grow to about 25% per year over the next 5 years. This is considerably below the growth rate experienced by the company last year, however it is in line with management guidance for 1Q22. Furthermore, with strong macroeconomic headwinds and a high-interest rate environment to curb inflation, the slowdown in business for FY22 is highly probable. We also assume a gross margin of 66%, when in reality, the gross margins are likely to worsen due to increased product and service diversity. Based on this analysis, modeling NVIDIA using discounted cash flow analysis, NVIDIA has a 17.3% downside risk, with a fair value price of $146.37 per share.
Conclusion
NVIDIA plans to utilize its strong chip sales and data center revenue growth to expand into a diverse array of markets. However, due to the recent economic downturn, geopolitical tensions, and high-interest rate environment, we anticipate higher probability of a downward revision to previously relayed growth projections, which would imply around a 25% downside risk. Investors should avoid an investment into NVDA or look to sell the stock until economic conditions become more favorable.
