Nvidia (NASDAQ:NVDA) stock, which has been surging higher since August 2019, might be ripe for some near-term correction. Escalating tension in the Middle East is the key reason for this view than any company-specific factor. However, if NVDA stock does decline by 5% to 10% from current levels, I would recommend fresh exposure. I believe that the uptrend will remain intact in 2020, supported by multiple catalysts.
The U.S.-China trade deal progress is one key trigger for NVDA stock trending higher. China’s policymakers are already optimistic on higher growth as trade tensions ease. Specifically for Nvidia, it is critical that the trade-war deescalates further. The reason is the company’s acquisition of Mellanox Technologies (NASDAQ:MLNX)
The acquisition has been cleared by the United States and the European Union. If Chinese regulators clear the deal in 2020, NVDA stock will surge higher. Nvidia management said yesterday at the J.P. Morgan (NYSE:JPM) Tech/Auto Forum that it still expects to close the $6.9 billion deal in the coming weeks.
The reason: Mellanox is among the leading companies in high-speed interconnects and networking. The acquisition will therefore help Nvidia capitalize on the $60 billion data center market opportunity. Along with artificial intelligence, machine learning and data science, data centers will continue to grow over the next decade.
Furthermore, the acquisition is expected to be accretive to NVDA’s earnings and free cash flow immediately after close. The market will therefore reassess the valuation on acquisition closure and I am optimistic on “re-rating.”
Gaming Strength to Continue
It is worth noting that for Q4 2019, Nvidia reported gaming segment revenue of $954 million. Revenue has trended higher to $1.66 billion in Q3 2020. I believe that the strength in the gaming segment will sustain in 2020.
The first positive is that the ray tracing graphics (RTX) card is gaining traction. The RTX graphics card creates more realistic light effects. With Minecraft, the company has already marketed RTX graphics card on a wide scale. In 2020, Cyberpunk will also be optimized for RTX graphics card.
In Q2 2020, the company mentioned that “RTX adoption is faster than Pascal’s adoption.” This is likely to be positive for the segment growth. Further, RTX cards also have higher margin and should help in EBITDA margin expansion.
Recently, Nvidia also partnered with Tencent Games to bring “PC gaming in the cloud to China.” Tencent is one of the leading game developers and China is one of the biggest games market. The partnership with the Chinese giant will also explore applications for AI in games.
The launch of 5G is also a potential game changer for many industries. In the gaming industry, 5G can bring more multiplayer games, cloud gaming and augmented reality gaming. Nvidia stock stands to benefit from these trends in the gaming segment.
Another area for growth is likely to be e-sports. The market for e-sports is expected to be worth $2.2 billion by 2023. Nvidia, in collaboration with Asus, has unveiled G-SYNC technology. This technology will help game frames to be displayed once in every 2.80 milliseconds. This is six times faster than traditional gaming displays. This should help Nvidia make inroads in the high-growth sub-segment of e-sports.
Last Words on NVDA Stock
Nvidia is likely to emerge as a more diversified company in the next five years. Artificial intelligence will serve as a key growth trigger. R&D expense has increased by 69% in the current financial year as compared to the prior. Investment in innovation will help NVDA stay ahead of the curve.
The company’s key EBITDA drivers will be the gaming and data center. However, Nvidia will benefit from positive trends in autonomous cars, autonomous machines and adoption of AI in sectors like healthcare.
From a financial perspective, Nvidia reported cash & equivalents of $9.8 billion for Q3 2020. In addition, the company reported free cash flow of $2.95 billion for the first nine months of 2020. This implies an annualized FCF of $3.9 billion. NVDA is therefore positioned to create shareholder value through dividends and share repurchases.
In conclusion, investors can wait for a correction before considering fresh exposure to NVDA stock. I believe that NVDA stock is in a long-term uptrend and is worth holding in the core portfolio.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
