Calendar 2018 was a wild year for shares of GPU giant Nvidia (NASDAQ:NVDA). Nvidia stock soared as high as $300, before losing more than half of its value amid slowing global growth concerns. The stock has since rebounded some, but it still remains ~50% off its all time highs.
It is unlikely that Nvidia stock hits $300 highs again any time soon. But, Nvidia stock could rally in 2019. In order for that to happen, these five things need to happen first:
- Revenue growth needs to stabilize after going red hot for several years and turning ice cold this quarter.
- Gross margins need to stabilize as multiple years of expansion appear to be ending now.
- The opex rate needs to normalize amid slowing revenue growth.
- Long term EPS growth estimates must remain robust.
- The long term valuation can’t get ahead of itself.
If those five things happen in 2019, Nvidia stock could stage a nice turnaround. Presently, it looks like all five of those things will happen. Thus, Nvidia stock looks positioned for a rally in 2019.
Revenues Need to Stabilize, and They Will
From the second quarter of fiscal 2017 to the third quarter of fiscal 2019, Nvidia morphed into an “all things AI” company. As it did, the company’s revenues exploded higher. In each quarter during that stretch, revenue growth was in excess of 20%. There were even a few 50%-plus revenue growth quarters.
Some thought that this 20%-plus growth was sustainable forever given tailwinds in AI related markets. It wasn’t. The reality is that even the biggest and brightest growth markets go through normalization periods.
We are currently going through one of those normalization periods in AI end markets due to escalating U.S.-China trade tensions, inventory related issues, and cracks starting to form in the global economy. As a result, Nvidia’s revenues are expected to fall more than 20% year-over-year next quarter.
These are all near term headwinds. Long term, the U.S. and China will resolve trade disputes. Nvidia and the global semiconductor market will work through inventory issues. And the global economy, specifically China, will find its footing again.
In the meantime, demand for AI related technologies and products will not falter. Nor will demand for the building blocks underlying those technologies and products. Nvidia sells the best AI building blocks in the world. So long as this remains true, this company should continue to grow revenues at a pace equivalent to the global semiconductor growth rate.
From 1997 to 2018, the global semiconductor market has grown from $10 billion in sales per month, to $40 billion in sales per month, good enough for a 7.5% compounded annual growth rate. As such, Nvidia seems like a lock for at least 7.5% annualized revenue growth over the next several years.
Gross Margins Need to Keep Expanding, and They Will
Much like revenues, gross margins have consistently marched higher for Nvidia over the past several years. But, the pace of gross margin expansion has slowed recently, and there’s a reasonable chance that gross margins start compressing soon given near term inventory issues.
Nvidia will ultimately work through those inventory issues, and any gross margin pain as a result of these inventory issues will be near term in nature. In the bigger picture, Nvidia is rapidly expanding its reach into higher-end and higher-value markets. These markets require more complex chips, and more complex chips have higher unit prices. Higher unit prices flow into higher margins.
Thus, in a multi-year window, Nvidia’s gross margins will continue to expand towards 65% and up thanks to expansion into higher-value end markets.
Opex Rates Need to Go Lower, and They Will
Another consistent theme of Nvidia over the past several years has been a falling opex rate. Quite simply, opex growth couldn’t keep up with revenue growth, which was running consistently north of 20%.
This falling opex narrative, however, is in the process of changing course. Next quarter’s revenue growth is expected to go sharply negative. Opex is expected to be up big. The net result is that the Q4 opex rate is expected to rise sharply.
This dynamic won’t last forever. Nvidia’s opex growth mirrors its revenue growth. When revenues were rising by 20%, 30%, 40%, and more, operating expenses were rising by 10-30%. By, when revenues rose by less than 10% in fiscal 2016 and 2015, operating expenses rose less than 5%.
Thus, Nvidia will likely moderate opex growth over the next several years as revenue growth normalizes lower. In all likelihood, revenue growth will stabilize around 7.5%, and opex growth will stabilize around 5-7%. That will allow for consistent albeit small opex leverage.
Earnings Growth Needs to Remain Strong, and It Will
If we look at the big picture here, Nvidia sock is supported by stable mid to high single digit revenue growth, continued gross margin expansion, and a falling opex rate. That combination implies strong earnings growth potential in the long run.
In all likelihood, earnings growth over the next several years will likely shake out around 10-15% per year. At that rate, EPS should easily hit $12 by fiscal 2024. That means earnings have the potential to nearly double over the next five years.
Valuation Needs to Remain Reasonable, and It Will
When it comes to Nvidia stock, the valuation is reasonable considering the company’s underlying growth potential.
Nvidia stock currently trades at around 20 forward earnings. That’s about as cheap as this stock has been in recent memory. Granted, growth is slower than it has been in recent memory, so the lower multiple is warranted. But, the long term growth potential is as promising as ever, given long-running tailwinds in AI related end-markets.
The math also adds up here. Growth stocks normally trade around 20 forward earnings. Given Nvidia’s exposure to all things AI, this is definitely a growth company. A 20 forward multiple on fiscal 2024 EPS of $12 implies a 2023 price target of $240. Discounted back by 10% per year, that equates to a 2019 price target of ~$165. That implies healthy upside from here.
Bottom Line on NVDA Stock
Five things need to happen in order for Nvidia stock to continue its rebound in 2019. Right now, it looks like all five of those things will happen, meaning that the current rebound in Nvidia stock has legs.
As of this writing, Luke Lango was long NVDA.
