metamorworks
Investment Thesis
I am initiating my coverage of NVIDIA Corporation (NASDAQ:NVDA) in this article. More specifically, I dissect the company’s latest earnings report and argue why it’s not just the AI revolution that’s going to drive the company’s future growth.
A Snapshot of Nvidia’s Q2 Performance
It was yet another blowout quarter from NVDA, in my opinion. Q2 Revenues came in at $30.04 billion, which represents a staggering growth of 122.4% y/y, beating analyst estimates by $1.29 billion. Data center revenues, a closely watched metric, came in at $26.3 billion, up 155% y/y and 16.4% q/q. Gaming revenues bounced back, coming in at $2.88 billion, up 15.7% y/y and 8.8% q/q.
Non-GAAP diluted EPS came in at $0.68, which translates to an even more astounding y/y growth of 152%, and also represents a q/q growth of 11%. The EPS print also beat analyst estimates by $0.04.
Q2 gross margins came in at 75.1%, up 5% y/y but down 3.3% q/q. Operating expenses saw a sharp increase, coming in at $3.9 billion, up 48% y/y and 12% q/q, primarily due to higher compensation-related costs. The company generated $14.5 billion in cash flow from operations.
Management’s Q3 guidance also beat analyst estimates. Q3 revenues are expected to come in at $32.5 billion (+/- 2%), much higher than analysts estimates of $31.7 billion. Q3 gross margins are expected to be between 74.4% and 75% (+/- 0.5%), with full-year gross margins expected to be in the mid-70% range. The Q3 operating expenses are expected to be $3 billion, with full-year operating expenses expected to grow in the mid-to-upper 40% range, primarily due to the company’s efforts in developing the “next generation of products.” The company is expected to generate other income of approximately $350 million, and non-GAAP tax rates are expected to be 17% (+/- 1%). Finally, the company also announced that its board had authorized $50 billion in share buybacks.
Nvidia Stands to be a Major Beneficiary of the Acceleration of “Sovereign AI”
NVDA’s second quarter results, especially the 155% y/y growth seen in the company’s data center division, confirmed what its fellow Sensational Six members (Amazon, Apple, Meta Platforms, Alphabet, and Microsoft) highlighted during their respective earnings calls: the rate of AI spending is not slowing down any soon. The cloud service providers accounted for approximately 45% of NVDA’s data center revenues. Furthermore, even as many of them wait for NVDA’s next-generation architecture, Blackwell, which the company plans to ship only by Q4, for now, its Hopper architecture is more than enough for these CSPs for now. None of them likely want to put off their AI spend until then. And even after the company starts to ship Blackwell, NVDA still expects its Hopper shipments to increase in the second half of FY25, given that the demand for the former is well above what the company can currently produce.
In addition to the usual suspects, one area, in particular, which showed considerable growth during the current quarter was Sovereign AI. As the AI revolution moves up a gear, data privacy and security could be paramount, not just for organizations but for entire nations. It’s a development, which NVDA management is already starting to observe. During the earnings call, management did provide an example of how Japan’s National Institute of Advanced Industrial Science & Technology has partnered with the company to build its AI-driven supercomputer. The company now expects sovereign AI to already hit low-double-digit billions this year. In my opinion, the potential for this segment is massive. As the saying goes, “data is the new oil,” and NVDA’s management is, unsurprisingly, seeing that countries are considering their data to be a “national resource,” and are therefore, building their own infrastructure to have their “own digital intelligence.”
The US Government has also started the process of geofencing the country’s AI tech for strategic purposes and to ensure AI safety. For instance, the US Department of Commerce’s AI Safety Institute has signed agreements with the likes of Anthropic and OpenAI to collaborate on “AI safety research, testing & evaluation.” According to these agreements, the AI Safety Institute will have first access to the major new AI models from these companies before their public release. Based on this development, the idea of nations funding their own AI startups in the future, based on their proprietary data, is not farfetched at all. The enterprise AI wave, as NVDA management calls it, has already started. But Sovereign AI is one area that has the potential to really accelerate the AI revolution. And based on current evidence, NVDA, and its Blackwell architecture, stand to be a major beneficiary of this trend.
Don’t Lose Focus on Company’s Other Divisions, Especially Automotive
Nvidia’s evolution from a gaming company to a data center company may have been complete thanks to the AI revolution, but it does not mean that the company’s other segments, including gaming, should be ignored. One division of the company, which is slowly gaining pace and momentum, is automotive.
The company’s automotive and robotics segment, during the quarter, generated $346 million in revenues, an impressive growth of 37% y/y. It also translates to a q/q growth of 5%. The growth was primarily driven by ramps in self-driving platforms and a surge in demand for AI cockpit solutions. As autonomous vehicles become the next battleground for major automakers, with many of them moving towards building Robotaxis, Nvidia’s automotive business could be a major beneficiary in the coming years. During the earnings call, management touched upon this by confirming that automakers developing AV technology are all using Nvidia in their data centers. Management expects the automotive segment to be a multi-billion dollar business and attributes this to the potential surge in demand for computing power from next-generation AV models.
They are certainly not wrong on that front. In my last article on Uber Technologies, Inc. (UBER), I wrote at length about the future of AVs. I foresee the growth in this market as a major catalyst for UBER and explain why its AV partnership with BYD Company Limited (OTCPK:BYDDF) is only the start. Furthermore, as I mentioned in the same article, according to Fortune Business Insights, the global AV market size is expected to surge to $13.6 trillion by 2030 at a CAGE of 32.3%. And NVDA could be a major beneficiary of this revolution, in my opinion.
NVDA’s advanced driver-assistance platform, DRIVE’s latest version, Thor, which was launched in March of this year, has been widely adopted by major automakers who have AV ambitions. Major Chinese automakers such as BYD, Hyper, XPeng, Nuro, Waabi, and WeRide have all adopted Thor, which integrates the company’s Blackwell Architecture. Li Auto and ZEEKR have also announced that their AV roadmap will also be built on the Thor platform. The AV revolution in China is well ahead of the US, and companies such as BYD are continuing to spend billions towards autonomous driving. The Chinese AV market, according to Research And Markets, is expected to hit $31.6 billion by 2030 at a CAGR of 21.7%. And with the Chinese players also harboring European ambitions, the growth potential for AVs, despite the tariffs, is huge in my opinion. Today, Nvidia may be synonymous with AI, but that does not mean that investors should discount its other divisions, especially automotive, which is primed to be a major catalyst for the company in the future.
Valuation
|
Forward P/E Multiple Approach |
|
|
Price Target |
$138.00 |
|
Projected Forward P/E multiple |
35.6x |
|
Projected FY24 EPS |
$2.96 |
|
Projected Forward PEG Ratio |
1.15 |
|
Projected Earnings Growth Rate |
30.95% |
|
Projected FY26 EPS |
$3.88 |
Source: Company’s Q2FY25 Press Release, LSEG Data (formerly Refinitiv), Seeking Alpha and Author’s Calculations.
The company now expects third quarter revenues to come in at $32.5 billion (+/- 2%). The high-end of this guidance would put Q3 revenues at $33.1 billion, a y/y growth of 83.1% and q/q growth of 10.2%, which would be a deceleration from the previous two quarters (15.3% q/q in Q2 and 17.8% q/q). Q3 gross margins are projected to come in at 75% (+/- 50 bps). I have assumed Q3 gross margins of 75%, which results in Q3 gross profits of $24.8 billion. Non-GAAP operating expenses are projected to come in at $3 billion, and other income is expected to be about $350 million. I have also assumed interest income to be the same as Q2, which is £383 million. The company assumes non-GAAP tax rates for the third quarter to be 17% (+/- 1%). I have assumed Q3 tax rates to be 16%.
Taken things together, we get the projected net income (after taxes) for the third quarter to be $18.93 billion. The weighted average shares used to calculate diluted EPS stands at 24.85 billion, which results in projected diluted EPS of $0.76 for the third quarter.
Since the AI revolution began back in 2023, on average, NVDA has registered q/q growth of 29.43%. If you remove the second quarter of FY23, where NVDA registered a q/q growth of 87.9%, an outlier in my opinion, the average drops to 19.7%. This is a more reasonable estimate for Q4 revenue growth, given that the company expects to ramp up production of Blackwell during the quarter and given that demand for Hopper continues to be strong. At a q/q estimated growth of 19.7%, the company’s Q4 revenues are projected to come in at $39.6 billion.
I have assumed Q4 gross margins to be 74%, a slight decline from Q3 due to the production ramp of Blackwell. This would result in Q4 profits of $29.3 billion.
The company expects full-year operating expenses to grow in the mid-to-upper 40% range. I have assumed the growth rate to be at 45%, which would result in FY24 operating expenses, on a non-GAAP basis, of $11.35 billion. Including Q3 projections, total operating expenses at the end of the third quarter are projected to be $8.3 billion, which implies that Q4 non-operating expenses are projected to come in at $3.05 billion.
I have kept my assumptions for interest and other income for Q4 to be the same as Q3, which are $383 million & 350 million respectively. I have assumed an effective tax rate for Q4 of 16%.
Taken things together, this results in Q4 net income (after taxes) of $22.7 billion. The weighted average shares used to calculate diluted EPS stands at 24.85 billion, which results in projected diluted EPS of $0.91 for the fourth quarter, which would subsequently result in FY24 diluted EPS of $2.96.
The company, according to LSEG data (formerly Refinitiv) currently trades at a forward P/E of 34.2, similar to its 10-year historical median multiple. Given the potential growth, not just in its data center business but also in its other divisions such as automotive, I have assumed a higher multiple of 35.6, which is the company’s 2-year historical median multiple.
The company, according to Seeking Alpha, currently trades at a forward PEG ratio of 1.15, significantly below its 5-year average of 2.09 and even below the sector median of 1.93. However, I do believe that its current ratio of 1.15 is justifiable, given the multitude of catalysts for its earnings growth. As such, I have assumed this multiple for my calculations, and with a forward P/E of 35.6, the projected earnings growth comes to 30.96%. At this earnings growth, the company’s FY26 EPS comes in at $3.88.
A forward P/E multiple of 35.6 and a projected EPS of $3.88 results in a price target of $138, which suggests an upside of approximately 16% from current levels.
Risk Factors
The main risk factor, in my opinion, is the slowing sequential growth in revenues and gross margins. While there were valid reasons, such as inventory provisions for low-yielding Blackwell material, for the decline this quarter, whether the company can reverse its growth trajectory is an area that investors should watch out for. Furthermore, the rise in competition is also a headwind to growth, and at what rate competitors like AMD are grabbing market share will also be key for NVDA’s future growth.
Concluding Thoughts
Nvidia Corporation had yet another impressive quarter, with guidance also nearly beating expectations. The growth expectations for this company have been so stratospheric in recent times, that the magnitude of the guidance beat is what has been driving the stock price. As such, the stock tanked after its earnings release since the magnitude didn’t match investors’ already lofty expectations.
If one digs a little deeper, however, then one would see a company that’s firing on all cylinders. The company’s data center business confirmed what the likes of Microsoft and Alphabet talked about, which is that AI spend is here to stay and that Nvidia Corporation stands to be a major beneficiary of this development. At the same time, the rise of Sovereign AI is an area that investors really need to pay attention to, given that it has the potential to be a substantial growth driver in the coming months.
Lastly, the AI revolution should not distract investors from the company’s other divisions, especially automotive. As automakers pivot towards building autonomous vehicles, the automotive division of NVDA is set for years, if not decades, of growth.
When one really thinks about it, there are two revolutions taking place simultaneously: the much talked about AI revolution and the quiet AV revolution. And NVDA, in my opinion, is one of those rare companies that stand to benefit from both. As such, one can’t ignore this semiconductor giant for too long.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.