Nvidia: DCF Stock Price Valuation Is Even Higher Than P/S – Seeking Alpha

Graphics Chip Maker Nvidia Reports Quarterly Earnings

Justin Sullivan/Getty Images News

Justin Sullivan/Getty Images News
In our previous analysis of Nvidia Corp. (NASDAQ:NVDA), we identified its AI leadership that is fueling the growth of its data centre segment by capitalizing on the high growth of data volumes. We also determined Nvidia’s high-performance GPUs allow for its continuous ASP increase, which in turn supports the high growth of its Gaming segment revenues, which we believe continues to be a key driver of the company. Lastly, we explored the positive impact of the Arm acquisition and the potential synergies the combined company would derive. Despite the deal breaking down, we had indeed highlighted that given the partnership Nvidia has already established with Arm, it would continue to reap the benefits regardless of whether the acquisition completes or not.
Having already established Nvidia’s leadership in AI and its many growth drivers, in this analysis of Nvidia, we delved deeper into the company’s financials. We determined it has the best potential for increasing its margins, by analyzing the various chipmakers in the industry to identify the fundamental drivers of margin growth. We also looked into the company’s financial position in terms of its net cash position to determine the strength of its capital structure. Finally, we examined its past share buybacks to determine the sustainability of its buybacks based on its free cash flow generation. For our valuation, we used a DCF valuation to supplement our previous P/S valuation of Nvidia.

chipmaker revenue vs margins

Company Data, Khaveen Investments

Company Data, Khaveen Investments
We plotted a chart of 23 semiconductor companies across their total revenue and gross margins. The companies we included are specifically chipmakers only and exclude OSATs, Foundries and Semicon Equipment makers. From the chart, we found that large chipmakers with more than $20 bln in revenue have higher gross margins (56.2%) compared to the average of all companies (50.04%).
Large Companies (>$20 bln) Gross Margins
Average Gross Margins
56.2%
50.04%
Source: Khaveen Investments
We believe that this is because larger companies are more likely to enjoy economies of scale, which refers to the cost advantage obtained due to higher output.
In addition, we noticed that despite having more than $20 bln in revenue, the large memory chipmakers, Micron (MU) and SK Hynix have lower gross margins compared to the other large chipmakers, which we believe is so because of the commoditized nature of the memory market. Excluding Micron and SK Hynix from this mix, large companies have an even greater margin advantage with an average of 62.1%
From the chart, we also found that fabless companies also enjoy higher gross margins with a 56.36% average compared to the overall average (50.04%).
Fabless Companies Gross Margins
Average Gross Margins
56.36%
50.04%
Source: Khaveen Investments
Different from integrated device manufacturers (IDMs) like Intel (INTC) who design, fabricate, and assemble their chips in-house, fabless companies have a lean business model where they only design chips and outsource the fabrication process to contract chip makers thus lowering their capex requirements. This gives fabless companies a cost advantage over IDMs in terms of capital investments and labor costs as they do not do fabrication and assembly in-house, which explains their higher margins.
Based on our findings, we believe that large semiconductor companies (> $20 bln revenue), and fabless have the strongest margins growth prospects. The companies that fall between both of these groups are Qualcomm (QCOM), Nvidia and Broadcom (AVGO). Among these 3, we believe Nvidia to be in the best position due to its higher revenue growth compared to Broadcom and Qualcomm as seen in the table below.
Company
Gross Margins
Revenue ($ mln)
Revenue 5-year CAGR
Qualcomm
58.86%
33,566
-0.37%
Nvidia
61.76%
24,274
27.19%
Broadcom
68.62%
27,450
23.52%
Source: Seeking Alpha, Khaveen Investments
Nonetheless, the growth prospects are based on the economies of scale theory where the companies continue to expand their business, which enhances their production capacity, and increases sales, hence producing a lower-cost-per-unit product. Companies at the beginning of the business life cycle spend more to generate growth, which suppresses their margins. As companies achieve scale, they can redirect cost savings to improve their margins. For example, Amazon’s gross margins were stagnant from 2006 to 2012 but started to increase steadily once it reached a certain size.

nvidia cash flows

Nvidia, Khaveen Investments

Nvidia, Khaveen Investments
Due to the nature of fabless companies, Nvidia does not need intensive capital investment for the fabrication process. This is evident when looking at Nvidia’s cash flow chart above. When excluding cash used for marketable securities, their average capex as % of revenue is only 5.2% in the past 10 years. Thus, we assume the capital expenditure of the company to be its depreciation.

Nvidia expense analysis

Nvidia, Khaveen Investments

Nvidia, Khaveen Investments
Moreover, in terms of its cost breakdown, Nvidia has spent 24.91% of revenue on average on R&D, in the past nine years but has declined as the company’s revenue grew. We believe this indicates a fixed cost component of its R&D costs. To forecast its R&D as a % of revenue based on its R&D as a % of revenue change, we obtained the average R&D as a % of revenue change to revenue growth at an average of -42%.
Nvidia R&D Expense Forecast
2019
2020
2021
2022F
2023F
2024F
2025F
2026F
2027F
Revenue ($ mln)
10,918
16,675
26,914
33,021
40,820
50,321
62,372
76,062
91,236
Revenue Growth (‘a’)
-6.8%
52.7%
61.4%
22.7%
23.6%
23.3%
23.9%
21.9%
19.9%
R&D as % of revenue
20.3%
25.9%
23.5%
17.6%
15.9%
14.3%
12.9%
11.6%
10.5%
R&D as % of revenue Change (‘b’)
9.6%
27.8%
-9.2%
-25.18%
-9.61%
-10.00%
-9.90%
-10.18%
-9.34%
R&D as % of revenue Change/Revenue Growth (‘c’)
47%
-408%
-17%
-42%
-42%
-42%
-42%
-42%
-42%
*b = a x c
Source: Nvidia, Khaveen Investments
To conclude, we believe that the company could significantly increase its margins with its fabless business model and growing revenues. As a fabless chipmaker, the company has a lean model, and we believe this could support its solid free cash flow generation. Additionally, we also believe the company’s R&D expenses as a % of revenue could continue to provide an upside to margins.

nvidia debt to equity

Nvidia, Khaveen Investments

Nvidia, Khaveen Investments
The company’s debt to equity ratio has increased in the past 10 years as the company took on more debt. However, it decreased between 2017 to 2020 as the company’s equity grew while it repaid some of its debt but increased in 2021 as it acquired Mellanox. According to WACC theory, debt is cheaper than equity and provides a tax shield benefit to the company. However, based on the static tradeoff theory, there is an optimal capital structure that balances the financial distress and tax shield benefit from debt. Although Nvidia has increased its debt, its credit analysis ratios indicate a healthy financial position. For example, its EBITDA interest coverage was 54.2x in FY2022 compared to -52.9x in 2013. We forecasted Nvidia’s debt to increase steadily based on our projections for its equity through 2027 based on its average debt to equity ratio in the past 10 years.
Nvidia Debt/Equity Forecast
2022
2023F
2024F
2025F
2026F
2027F
Equity (‘a’)
26,612
38,888
55,188
76,600
104,586
140,274
Debt/Equity (‘b’)
0.59x
0.49x
0.49x
0.49x
0.49x
0.49x
Debt (‘c’)
15,792
18,885
26,801
37,199
50,790
68,122
* c = a x b
Source: Nvidia, Khaveen Investments
To analyze how its WACC has changed over the past 10 years, we calculated its historical WACC in the table below.
Nvidia WACC
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Cost of Equity
12.1%
12.1%
12.1%
12.1%
12.1%
12.1%
12.1%
12.1%
12.1%
12.1%
Equity
8,324
8,868
11,035
13,353
30,590
97,210
146,867
109,117
244,498
490,392
Equity Weight
87.1%
78.2%
81.6%
83.7%
89.5%
96.8%
97.7%
96.1%
95.8%
96.9%
Cost of Debt
2.6%
2.6%
2.6%
2.6%
2.6%
2.6%
2.6%
2.6%
2.6%
2.6%
Debt
1,228
2,470
2,490
2,605
3,594
3,174
3,439
4,424
10,749
15,792
Debt Weight
12.9%
21.8%
18.4%
16.3%
10.5%
3.2%
2.3%
3.9%
4.2%
3.1%
Total
9,552
11,338
13,525
15,958
34,184
100,384
150,306
113,541
255,247
506,184
Discount Rate
10.9%
10.0%
10.4%
10.6%
11.1%
11.8%
11.9%
11.8%
11.7%
11.8%
Source: Nvidia, Khaveen Investments
Nvidia’s WACC had been generally stable between 10% to 12% in the past 10 years with an average of 11.2%. Thus, although the company’s corporate structure had not shown a significant improvement over the past 10 years, we believe that the combination of cash from borrowings and its high FCFs, it highlights the company’s strengthening ability to use generate cash for dividends, share buybacks and M&A.

nvidia net debt

Nvidia, Khaveen Investments

Nvidia, Khaveen Investments
On top of its consistent FCF generation abilities, the company’s net cash position has expanded over the years but declined in FY2021 as it increased its debt for its Mellanox acquisition to $ 6.9 bln. In FY2022, its net cash grew to cash to debt ratio of 1.3x. Additionally, based on our forecast, we expect its cash to further increase to $180 bln by 2027 at cash to debt ratio of 2.65x. We believe this provides the company with the ability to return cash to shareholders through buybacks, dividends or fund acquisitions. For example, its proposed acquisition of ARM for $21.5 bln in stock and $12 bln in cash.
Share Buybacks
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
Share repurchase ($ mln)
-100
-887
-814
-653
-915
-1,521
-2,611
-551
-942
-1,904
Share buybacks growth
787.0%
-8.2%
-19.8%
40.1%
66.2%
71.7%
-78.9%
71.0%
102.1%
Market Cap ($ bln)
8.9
11.0
13.4
30.6
97.2
146.9
109.1
244.5
490.4
557.3
Market Cap Growth
6.5%
24.4%
21.0%
129.1%
217.8%
51.1%
-25.7%
124.1%
100.6%
13.6%
Share repurchase/ Market Cap
1.1%
8.0%
6.1%
2.1%
0.9%
1.0%
2.4%
0.2%
0.2%
0.3%
Source: Nvidia
Nvidia’s share repurchases have increased over the past 10 years at an average of 25.27%. In 2022, its share buybacks increased significantly as it more than doubled from the previous year. In comparison, its market cap grew faster than its share buyback growth with an average of 80.29%. As a result, its share repurchase as a % of market cap has declined over the past years. Through share buybacks, the company reduces its shares outstanding which increases the concentration of ownership for shareholders and in turn increases the intrinsic value of the company.

nvidia share buybacks

Yahoo Finance, YCharts, Khaveen Investments

Yahoo Finance, YCharts, Khaveen Investments
From 2017 to 2019, the company conducted more share buybacks when the share price was lower. Specifically, on 1/1/2019, it increased its share buybacks as its share price plunged. Furthermore, we believe share buybacks could provide a floor to a company’s stock price as the company steps in to fill the demand for the shares. Based on the chart, the company continued to buy back its shares when its stock price was around $240 in 2021 and again in 2022 as its share price dropped. Moreover, we calculated the stock price change in the following 2 quarters and 1 year after the period of the stock buyback in the table below.
Quarter
Return (2 Quarters)
Return (1 Year)
1/7/2017
28.3%
70.0%
1/10/2017
8.1%
57.0%
1/4/2018
9.8%
-18.8%
1/1/2019
31.8%
72.7%
1/4/2019
-9.9%
44.6%
1/10/2019
35.2%
211.1%
1/1/2021
1.8%
124.3%
1/5/2021
31.4%
43.3%
1/8/2021
29.5%
7.6%
1/10/2021
41.8%
2.5%
1/1/2022
-9.4%
-29.4%
Average
18.0%
53.2%
Source: Seeking Alpha, Khaveen Investments
On average, Nvidia’s stock price had increased by 18% in the following 2 quarters after the stock buyback period. Additionally, its stock price increased by 53.2% on average 1 year after the period.

nvidia cash flows

Nvidia, Khaveen Investments

Nvidia, Khaveen Investments
Nvidia has strong FCFs with a 10-year average of 9.5%. We believe that the company could continue generating positive FCFs as a fabless chipmaker with low capex requirements as it outsources to TSMC as well as a high pricing power that we believe it has over its strong market positioning in the GPU market as covered in our previous analysis. Thus, due to these factors, we expect the company to be able to support its share buybacks in the future with its cash. According to the company’s CFO, the company has $5.2 bln in remaining share buyback authorization.
Share Buybacks
2020
2021
2022
2023F
2024F
2025F
2026F
Share repurchase ($ mln) (‘a’)
-551
-942
-1,904
-2,079
-2,269
-2,478
-2,705
Share buybacks growth
-78.9%
71.0%
102.1%
9.2%
9.2%
9.2%
9.2%
Market Cap ($ bln) (‘b’)
244.5
490.4
557.3
633.3
719.7
817.9
929.5
Market Cap Growth
124.1%
100.6%
13.6%
13.6%
13.6%
13.6%
13.6%
Share repurchase/Market Cap (‘c’)
0.2%
0.2%
0.3%
0.3%
0.3%
0.3%
0.3%
* a = b x c
Source: Nvidia, Macrotrends, Khaveen Investments
Previously in 2021, Nvidia’s CEO guided demand to continue exceeding supply in 2022. In its latest earnings briefing, the company’s CEO further explained that it expects to be supply-constrained but with improving supply in the coming quarters.
We expect to still be demand constrained, but our supply base is going to increase this quarter, this next quarter and pretty substantially in the second half. – CEO Jensen Huang
According to DigiTimes, GPU supply could improve in the second half of 2022 with greater availability of components such as ABF substrates required for making GPUs. Moreover, according to TechRadar, retail prices of GPUs had been declining since the end of 2021 by 22% and that supply was indicated to have improved. Thus, we believe that the supply shortage could affect its growth outlook but also note the positive signs and expectations of improving supply.
For its valuation, we used a DCF analysis as we expect the company to have robust free cash flows. We based our EV/EBITDA on the terminal value based on the chipmakers average of 23.87x.

industry average ev/ebitda

Seeking Alpha, Khaveen Investments

Seeking Alpha, Khaveen Investments
We projected our revenues based on its segments as covered in our previous analysis of the company excluding any Arm revenue or synergies previously derived.
Nvidia Revenue Forecast ($ mln)
2020
2021
2022F
2023F
2024F
2025F
Gaming
7,759
12,462
15,953
20,421
26,141
33,463
Professional Visualization
1,053
2,111
2,318
2,545
2,794
3,068
Data Center
6,696
10,613
12,898
15,849
19,196
23,425
Automotive
536
566
691
842
1,028
1,254
OEM and Other
631
1,162
1,162
1,162
1,162
1,162
Total
16,675
26,914
33,021
40,820
50,321
62,372
Growth %
53%
61.4%
22.7%
23.6%
23.3%
23.9%
Source: Nvidia, Khaveen Investments
Based on a discount rate of 11.8% (company’s WACC), our model shows an upside of 88%.

Nvidia valuation

Khaveen Investments

Khaveen Investments
Additionally, we also incorporated a P/S comparable valuation based on the average P/S of chipmakers according to their average 3-year revenue CAGR.

industry average P/S

Khaveen Investments

Khaveen Investments
Based on a P/S of 19.06x for the average 3-year revenue CAGR above 20%, we obtained an upside of 107% for Nvidia on our projected revenues in 2024. We then derived a price target for 2022 based on the price target obtained at a 28% upside.
Valuation
2022F
2023F
2024F
Revenue ($ mln)
33,021
40,820
50,321
Growth Rate %
22.7%
23.6%
23.3%
P/S
17.86
18.42
19.06
Valuation ($ mln)
589,759
752,008
958,894
Shares Outstanding (‘mln’)
2,494
2,494
2,494
Price Target
$236.49
$301.56
$384.52
Current Price
$185.47
$185.47
$185.47
Upside
27.5%
62.6%
107.3%
Source: Khaveen Investments
Overall, we obtained an average price target based on DCF and P/S valuation of $292.96 with an average upside of 58%.

industry average P/S

Khaveen Investments

Khaveen Investments
To sum it up, we analyzed Nvidia’s profit margins and cash flows as a fabless chipmaker and believe that its margins have room for growth. Moreover, we analyzed its corporate finance structure and determined its advantage in terms of having a rising net cash position which we believe could provide it with opportunities to use its cash for more acquisitions or return cash to shareholders through buybacks and dividends. Lastly, we also believe that its strong cash flows and cash position could provide the company with the ability to sustain its share buybacks and determined its average share price increase of 53% in a 1-year period following its share buyback. We valued the company with a DCF which resulted in a valuation that was even higher than our previous P/S valuation. Based on the average of both methods, we obtained an upside of 58%. Overall, we rate the company as a Strong Buy with a price target of $292.96.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of NVDA either through stock ownership, options, or other derivatives. 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.
Additional disclosure: No information in this publication is intended as investment, tax, accounting, or legal advice, or as an offer/solicitation to sell or buy. Material provided in this publication is for educational purposes only, and was prepared from sources and data believed to be reliable, but we do not guarantee its accuracy or completeness.

source
Connect with Chris Hood, a digital strategist that can help you with AI.

Leave a Reply

Your email address will not be published.

© 2022 AI Caosuo - Proudly powered by theme Octo