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Nvidia - gaming and data drives rapid sales growth

Nicholas Hyett, Equity Analyst | 19 November 2020 | A A A
Nvidia - gaming and data drives rapid sales growth

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NVIDIA Corp USD0.001

Sell: 183.35 | Buy: 183.36 | Change -5.44 (-2.88%)
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Third quarter revenues rose 57% year-on-year to $4.7bn. That was driven by the acquisition of Mellanox in the Data Centres division and a good result from Gaming, partially offset by weakness in the more cyclical automotive and professional visualisation businesses.

Operating profits rose 51% to $1.4bn, as a significant increase in operating expenses (particularly stock-based compensation) partially offset revenue growth. Earnings per share rose 46% to $2.12, and the group intends to pay a $0.16 quarterly dividend per share in December.

During the quarter the group agreed to acquire Arm from Softbank for a total of $40bn in cash and shares.

Nvidia shares fell 2% in after-market trading.

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Our view

NVIDIA started out making graphics cards for gamers. Gaming still accounts for a little under half of sales, leaving NVIDIA well placed to capitalise on the growing gaming industry. However, the power of NVIDIA's chips means that as time's gone on they're increasingly in demand outside the world of consoles and joysticks.

The 'Professional Visualisation' division supports digital design and engineering work in architecture, oil & gas and medical imaging. The group's DRIVE platform gives it a stake in the potentially exciting self-driving car market, with a product that can "perceive and understand in real-time what's happening around the vehicle...and plan a safe path forward". The end markets for both divisions have been hit hard by coronavirus, but should recover over the longer term.

However it's the Data Centres business which has been the real engine room. As well as powering some of the world's most powerful supercomputers NVIDIA produces cutting edge hardware for training artificial intelligence (AI) software.

It's this AI expertise, enhanced by the $6.9bn acquisition of Mellanox last year, which are being used as the strategic rationale for the blockbuster Arm deal.

Arm designs chips and licences out its technology, staying well clear of any manufacturing or direct sales processes. This is a very cost effective way of operating, with capital requirements pretty minimal, and means over 180bn Arm technology chips have been shipped since the group was founded. It also means there are millions, if not billions, of devices in use today running on Arm chips.

As well as the fundamentally attractive core business model, it's this global reach that has attracted NVIDIA to Arm. If it can perfect its AI technology and integrate it into devices from smartphones to supercomputers that would place it at the heart of the next technology revolution.

The deal is expensive though, and a lot of the cost is being met by issuing new shares. While the cash component is manageable, if the deal doesn't work out issuing new shares will dilute existing investors.

Looking back at the core NVIDIA business, we generally see coronavirus as a positive for the group - despite disruption in some of the smaller divisions. Increased interest in gaming and cloud computing are both good news for long term demand.

If growing end markets is one attraction, the group's neat business model is another. Like Arm, NVIDIA outsources all of its manufacturing. There has been a little slip up on cash more recently (with working capital climbing), and that's something we'll be keeping an eye on. However, avoiding the costs, capital and risk associated with owning manufacturing facilities has generally helped NVIDIA deliver impressive gross margins and cash flow.

High gross margins help fund the research & development budget, which stood at $2.8bn last year. Recent innovations have included real time ray tracing, which could revolutionise gaming graphics with ultra-realistic imagery.

With net cash on the balance sheet (at least until the Arm deal completes) and hefty operating cash flows, it's difficult to see NVIDIA as anything other than a very high-quality business. Unusually for a US tech company, the group's willing to return surplus cash to shareholders, mostly through share buybacks, although these are on hold at the moment, and there's a very modest dividend on offer.

Overall it's hard not to be impressed by a business at the cutting edge of some pioneering industries. But keep in mind all those strengths come at a price - the shares change hands on a PE ratio almost twice the ten year average.

NVIDIA key facts

  • Price/Earnings ratio: 50.6
  • 10 year average Price/Earnings ratio: 26.5
  • Prospective yield (next 12 months): 0.1%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third Quarter Results

Data Centre revenues rose 162% year-on-year to $1.9bn, with around a third of divisional revenue driven by the acquisition of Mellanox. Particularly notable was the news that Amazon Web Services and Oracle Cloud Infrastructure have announced the general availability of Nvidia based cloud computing options - following similar announcements from Google and Microsoft.

In Gaming the group saw revenues rise 37% to $2.3bn. That follows the launch of the GeForce RTX 30 Series of GPUs, and also reflects strong laptop, desktop and console sales.

Sales in Professional Visualisation fell 27% year-on-year to $236m, with COVID-19 affecting demand for desktop workstations. Automotive sales fell 23% to $125m, as new AI cockpit sales failed to offset declines in legacy infotainment module sales and self-driving agreements.

Free cash flow came in at $806m, compared to $1.5bn a year earlier. That reflects a significant increase in working capital, with receivables, inventories and pre-paid expenses all increasing.

Net cash fell from $8.9bn at the start of the year to $3.2bn at the end of the quarter. That reflects payments relating to the Mellanox and ARM acquisitions.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refnitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.