It wasn’t that long ago that Nvidia Corporation (NASDAQ:NVDA) looked like a disappointing investment. In 2013, NVDA stock spent April hovering in the $12-$13 range. It traded at barely half of an early 2011 peak. In fact, NVDA had only doubled off financial crisis lows, at a time when most tech stocks, in particular, had rebounded much more sharply. Trading volume in Nvidia stock was declining as well, as investors looked to more exciting, more promising opportunities.
Four years later, the story surrounding NVDA stock is very different. It is up about 700% from those 2013 levels. It’s one of the more-covered tech stocks, with volume to match.
Growth opportunities in gaming, automotive and data centers have given Nvidia stock the promise, and excitement, it lacked earlier in the decade. In response, its earnings multiple has expanded steadily, as investors price in future increases in sales and earnings.
But as I continue to have grave concerns about NVDA stock from a valuation standpoint, it’s worth looking at what exactly has changed for Nvidia as a business over those four years. And, looking backward, my core concern remains.
Growth Everywhere — But Mostly in Gaming
With NVDA coming off a fiscal year 2017 (ending Jan. 29) where revenue increased 38% — including 55% in Q4 — it’s easy to forget that sales were declining not that long ago. But Nvidia’s FY 2014 revenue did decline year-over-year, falling 3.5%.
Since then, the trajectory has changed — and notably so. Over the past three years, according to SEC filings, Nvidia has grown revenue 67%, or $2.78 billion. Data center and automotive end markets have grown sharply. Datacenter revenue has more than quadrupled, to $830 million. Automotive market sales have nearly quintupled, jumping from just $99 million in FY 2014 to $487 million last year.
But, perhaps unsurprisingly, most of the growth has coming from the gaming business. Gaming-related GPU revenue has increased 169%, and some $2.58 billion on an absolute basis. In contrast, automotive and data center market sales have added just over $1 billion to Nvidia’s total revenue.
Those gains have been offset by declines in OEM & IP segment revenue. That business represents sales to PC manufacturers like HP Inc (NYSE:HPQ) and Dell Technologies Inc (NYSE:DVMT). Those sales have been declining steadily; per figures from the most recent 10-K, PC OEM revenues have fallen 41% in just the last two years.
Meanwhile, IP revenue is set to tumble, as the cross-licensing agreement with Intel Corporation (NASDAQ:INTC) has expired. That agreement contributed $264 million in revenue in each of the last two fiscal years; after a $44 million recognition in Q1, it will fall off of Nvidia’s P&L.
What the Past Means for the Future of NVDA Stock
A look backwards highlights some of the challenges for Nvidia stock going forward. The notable contribution of gaming — which drove 59% of FY 2017 revenue — represents one significant risk. For all the hype about automotive (and data center to a lesser extent), Nvidia is a gaming GPU-centric company. That’s a great business — at the moment. CEO Jen-Hsun Huang said on Nvidia’s Q4 conference call that “the upgrade cycle is going well, and we have plenty to go.”
But it is a cycle, nevertheless — and it will turn.
The last time it turned, Nvidia’s overall revenue wound up declining. (The company didn’t break out end market revenue earlier this decade.) With NVDA stock still trading at well over 20x FY 2020 EPS estimates, that cycle needs to last longer than the common three-to-four years to even support the current price. And the fact that so much of Nvidia’s recent growth – 70%-plus of the increase, outside of OEM & IP — is reliant on gaming raises the question of whether automotive and data center can offset any cyclical weakness there when (not if) it comes.
The other concern is the OEM & IP business. Nvidia — and NVDA bulls — largely have dismissed the declines in that business. Most notably, OEM revenues are lower-margin. The decline in OEM and the growth of gaming GPUs is a key reason why Nvidia’s non-GAAP gross margin has increased from 52% in FY 2013 to 58.8% last year.
But the benefits of that mix shift are fading. Meanwhile, the $264 million from Intel boosted gross margin significantly, as the royalty payments were recognized likely at close to 100% margin. The fading benefit from mix and the loss of (likely) ~$260 million in gross profit dollars both might pressure Nvidia’s gross margin going forward. So, too, could pricing pressure from rising rival Advanced Micro Devices, Inc. (NASDAQ:AMD).
It’s tough for a large company to leverage earnings significantly without some sort of gross margin expansion. A potential ceiling on gross margin over the next few years could lead Nvidia’s operating margins to come in below expectations. And NVDA stock is not priced for an earnings miss.
Nvidia Stock Still Looks Dangerous
All told, a historical review of Nvidia’s growth only highlights how dependent the company, and Nvidia stock, are on success in automotive and data center. And neither is guaranteed, particularly after Intel’s acquisition of Mobileye NV (NYSE:MBLY).
Meanwhile, the 6%-plus decline in NVDA stock on Tuesday on the back of an analyst downgrade shows a notable lack of confidence in the near-term performance of the stock. Nvidia stock already tumbled in February after two downgrades — and all three of the negative ratings have come from smaller firms.
It’s clear that there’s some nervousness in NVDA shareholders. Truthfully, I think there’s good reason for some concern. The stock looks increasingly reliant on competitive, out-year opportunities. Even if Nvidia has some success, there will be some nervous moments along the way. I’d expect more than a few of those moments in 2017.
As of this writing, Vince Martin had no position in any securities mentioned.
