Nvidia Has Bright Prospects Though This Quarter Could Be Soft

Despite macro headwinds and a sluggish PC market, fiscal 2013 was a record year for Nvidia (NASDAQ:NVDA) as it reached $4.3 billion in sales (7% annual growth) and increased its gross margin to 52.3% compared to 51.9% in fiscal 2012. While the slowdown in the PC market impacted many of its competitors such as Intel (NASDAQ:INTC), AMD (NASDAQ:AMD) and Texas Instruments (NASDAQ:TXN), we think Nvidia’s growing focus and success in the mobile computing space has cushioned the negative impact of lower PC shipments on the company’s growth rate. Nevertheless, deriving over 80% of its revenue from the PC market, Nvidia remains highly sensitive to any adverse development in the industry.

Nvidia will be announcing its Q1 2014 earnings on May 9, and it could report a slower growth rate this quarter. The company expects lower GPU sales in line with the overall weakness in the PC industry and will not get much support from its mobile processing business. However, we think the slowdown is temporary and continue to believe in Nvidia’s long term growth prospects.

With the increasing revenue contribution from the non-PC business segment and its dominance in the GPU market, we feel that Nvidia has strong fundamentals to support a higher valuation. Additionally, it has a solid balance sheet with a strong cash position and no debt. Last month, the company announced that it will return $1 billion to its shareholders in 2013 via stock buybacks and dividend payments.

See our complete analysis for Nvidia

Nvidia’s GPU Division Continues To Grow Despite A Sluggish PC Market

The slowing enterprise market, consumer softness in mature markets (U.S. and Western Europe), slowing demand from emerging markets, a weak reception for Windows 8 OS and the cannibalization by tablets and smartphones are the main factors leading to the slump in the PC market. PC sales declined marginally in 2012, and research firm IDC estimates the downward trend to continue this year as well. Global PC shipments witnessed the sharpest quarterly decline in almost two decades (13.9% y-o-y), in Q1 2013. ^[1]

Nvidia sells its PC graphics to two key segments – PC Original Equipment Manufacturers (OEMs) and gaming enthusiasts to generate realistic and interactive graphics on PCs. While the PC shipments have slowed down, the robust PC gaming market led to an increase in Nvidia’s GPU shipments in 2012. Jon Peddie Reasearch valued the PC gaming hardware market at $23.6 billion in 2012, and forecasts the global gaming market to cross $30 billion by 2015. ^[2]

Massively multiplayer games and the growth in cloud gaming continued to drive a robust PC gaming market in 2012. As per market research firm Newzoo, the global massively mutiplayer games revenues grew 21% in 2012, reaching $13 billion. ((Nvidia Corporation’s CEO Discusses F4Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013)) Cloud gaming is a category of online gaming which allows direct and on-demand streaming of games on a computer. Nvidia has around six partners and is in the process of evaluating new middleware partners who provide cloud gaming to various TELCOs around the world. Nvidia’s GeForce is the gamers choice of GPUs by a margin of almost 2:1. ((Nvidia Corporation’s CEO Discusses F4Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013))

While many might argue that the significant improvement in Intel’s integrated graphic chipsets could threaten Nvidia’s dominance in discrete desktop and notebook graphics, we feel the increasing popularity of high performance GPUs for high-end gaming will enable Nvidia to retain its foothold in the GPU market. Nvidia’s overall GPU market share increased from 53% in 2011 to 65% in 2012.

LTE Capability To Increase Nvidia’s Competitiveness In Mobile

Earlier this year, Nvidia announced that its mobile processing business will remain flat in 2013 after growing at a CAGR of approximately 97% in the last two years. Nvidia earned $765 million from Tegra sales in 2012, a near 30% increase compared to 2011. Nvidia-powered tablets were up by almost 100% and remain the most important driver for its progress in the mobile computing space. However, the company’s progress in smartphones remains more or less stable with only a few design wins to its credit. We believe that Tegra is an important revenue driver for Nvidia’s long term growth.

The reason for the flat mobile outlook this year is that Nvidia has decided to delay the launch of its Tegra 4 processor by one quarter in order to pull up the production of its Tegra 4i chips by two quarters. Introduced at the 2013 Consumer Electronic Show in January, Tegra 4 is the world’s first quad-core processor based on Cortex A15, ARM’s most advanced CPU core and consume 45% less power than the Tegra 3 processor. A month later, the company introduced Tegra 4i, its first fully integrated 4G LTE mobile processor to expand its presence in the smartphone market.

Considering that Nvidia has a negligible presence in the smartphone market, we think that speeding up the launch of its LTE compatible chips is a good move. 4G/LTE is the future of wireless connectivity for mobile devices, especially smartphones, and the LTE integrated chipset will better equip Nvidia to challenge Qualcomm’s (NASDAQ:QCOM) growing dominance in smartphones.

We will update our price estimate of $17.50 after the Q1 2014 earnings release.

See our complete analysis for Nvidia’s stock

1. PC Shipments Post The Steepest Decline Ever in a Single Quarter, According to IDC, IDC Press Release, April 10, 2013 [↩]
2. PC Gaming Hardware Market to Hit $23.6 Billion in 2012, Jon Peddie Research, May 3, 2012 [↩]