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NVIDIA - growth still motoring

Nicholas Hyett, Equity Analyst | 27 May 2021 | A A A
NVIDIA - growth still motoring

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NVIDIA Corp USD0.001

Sell: 170.85 | Buy: 170.86 | Change -7.07 (-3.97%)
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Nvidia reported first quarter revenues of $5.7bn, up 84% year-on-year, with very strong growth in Gaming and the benefit of the Mellanox acquisition in Data Centres.

Underlying operating profits more than doubled to $2.6bn, as underlying operating costs rose 45% following the acquisition of Mellanox and the group increased its number of employees.

The shares were broadly flat following the announcement.

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Our view

Gaming has been enjoying a golden era and NVIDIA's chips are right at the heart of it - it's RTX 30 series has been described as "the most revolutionary graphics card in years". With gaming sales more than doubling in the first quarter of the year it's no surprise the bottom line is accelerating like a Mario Karter after a Mega-Mushroom power up. However, the power of NVIDIA's chips means 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 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 in recent times. 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 is 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, issuing new shares will dilute existing investors and that will be particularly painful if the deal doesn't work out. The deal has also run into competition concerns in the UK and EU - so is one to watch. The whole plan could yet be derailed by regulators.

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.

The group's neat business model is another attraction, with NVIDIA outsourcing all of its manufacturing to keep capital requirements low. There has been a little slip up on cash more recently (with inventory increasing), 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 $3.9bn last year. Recent innovations have included real time ray tracing, which could revolutionise gaming graphics with ultra-realistic imagery, and sparked a run on the group's new graphics chips in 2020.

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 59% above the ten-year average. Add to that a real risk that the ARM deal fails to complete and some niggles around cash last year, and there are reasons to be cautious.

NVIDIA key facts

  • Price/Earnings ratio: 44.2
  • 10 year average Price/Earnings ratio: 27.8
  • 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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First Quarter Results

NVIDIA's Gaming business reported sales of $2.8bn, up 106% year-on-year. That reflects increased sales of GeForce GPUs across desktop, laptop and consoles. The division also continues to benefit from demand for the ray-tracing enabled RTX 30 series. The group also believes the division benefited from increased cryptocurrency mining demand, although it is hard to say to what extent.

Data Centre revenues rose 79% year-on-year, to $2.0bn. That reflects the acquisition of Mellanox as well as the ramp up in NVIDIA Ampere GPU architecture products into large commercial customers.

Sales in Professional Visualization rose 21% to $372m, with strong growth in both desktop and notebook workstations. Automotive sales fell 1% to $154m, while OEM & Other benefited from increased crypto demand with sales up 137% to $327m. Cryptocurrency Mining Processors accounted for $155m of revenue.

Free cash flow in the quarter was $1.56bn, up from $754m a year ago as operating cash flows more than offset a near 100% increase in capital expenditure.

Net cash at the end of the quarter stood at $5.7bn, up from $4.6bn at the end of January.

Management expect revenue to be around $6.3bn in the second quarter, with operating expense of $1.76bn and capital expenditure of $300-$325m.

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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.


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