This week I want to evaluate one of AMD’s main competitors in Nvidia. Much like AMD, Nvidia’s stock price has been hit hard over the past year. As of 1/20/23, Nvidia’s stock price is down 26.1% from a year ago. The consumer driven components of Nvidia’s business have been hit especially hard over the last 6 months as the federal reserve continues to raise interest rates to fend off inflation. After we run through the various valuation analyses for Nvidia, I’ll give a brief take on what I think of how Nvidia and AMD stack up to one another moving forward.
Nvidia (NVDA) Overview
Nvidia was founded in 1993 and is headquartered in Santa Clara, California. In fact, Nvidia’s headquarters is only a mile from the headquarters of AMD. Similarly to AMD, Nvidia is also a fabless semiconductor company which means they design and sell proprietary semiconductor chips but outsource the fabrication to contract producers known as foundries. Although Nvidia sells their products across the globe, most of their revenue is concentrated in Taiwan, China, and the United States. Here you can see a breakdown of their revenue by geographic region over the past 5 years.
Nvidia’s is separated into 2 reporting business segments which include Compute & Networking, and Graphics. The Computing and Graphics business segment includes products geared towards data center platforms and systems, Artificial Intelligence, High Performance Computing, and accelerated computing. Whereas Nvidia’s graphics unit is focused on products that are used for gaming, workstation graphics, cloud-based visual computing, automotive infotainment systems, and the Omniverse. Up until 2022, the Graphics business segment generated the majority of Nvidia’s revenue. Compute & Networking consistently gained ground on Graphics from a revenue perspective over the past 5 years before becoming the majority revenue generator this past year. Below is a summary of Nvidia’s reportable segment revenue over the past 5 years.
In addition to the revenue breakdown by reportable business units, Nvidia also provides a revenue breakdown by the end markets they serve. These end markets include Gaming, Data Center, Professional Visualization, Automotive, and OEM & Other. Below is a breakdown of the segmented end market revenue over the past 5 years.
Relative Valuation Analysis
Once again, I started with a relative valuation analysis before diving into the discounted cash flow (DCF) valuation. For the comparable company’s portion of the analysis, I used the same companies that we used in our previous AMD analysis expect Nvidia was swapped out for AMD. Here are all the companies used in the comps analysis:
- Advanced Micro Devices (AMD)
- Broadcom (AVGO)
- Texas Instruments (TXN)
- Analog Devices (ADI)
- Microchip Technology (MCHP)
As of 1/20/2023, Nvidia is trading at a 37.5x EV/EBITDA multiple and a P/E ratio of 46.4x. Both values for Nvidia fall well above both the average and median values calculated for the comparable companies. In fact, both ratios for Nvidia are higher than all 5 of the comparable companies.
Next, we can proceed to the historical P/E portion of the analysis. Once again, I used macrotrends.com for Nvidia’s quarterly historical P/E data. Nvidia has been consistently profitable for a longer time period than AMD. Therefore, I decided to use Nvidia’s P/E ratio dating back to the beginning of 2014. Once all the data was in Excel, I was able to identify the potential upside, middle of road, and downside price scenarios. Below you can see the full relative valuation breakdown. After identifying overly conservative and optimistic scenarios, I calculated a potential upside reward of +$48.97 (+27.2%) and a downside risk of -$100.09 (-55.7%) relative to NVDA’s price per share of $179.75 as of 1/20/22.
DCF Model Assumptions
Now we can move onto the discounted cash flow (DCF) valuation portion of the analysis. Since Nvidia has only reported 3 quarters of their current fiscal year, I decided to use their financial data dating back to the beginning of 2017 for our historical trend analysis. NVDA’s top line revenue has shown significant growth over the last 6 years from $6,010 million in 2016 to an estimated $26,923 million in 2022. This growth equates to a 6-year compound average growth rate (CAGR) of 25.4%. Nvidia has a history of very strong gross margins with their cost of goods consistently coming in at 35-40% of revenue. A gross margin of around 60% demonstrates that Nvidia has pricing power in the marketplace and that they provide a premium product that warrants a premium price tag. Here’s you can see a breakdown of the 5-year averages for most of the factors used in the DCF evaluation.
As we have done with the 3 previous companies that we have evaluated in the semiconductor industry, we will use an 8-year forecast period with 2030 as the terminal year. To start our forward-looking forecast assumptions, I identified the line items that I thought would remain consistent throughout the forecast period based on historical ratios and trends.
- Cost of Goods – 39% of Total Revenue
- R&D – 20% of Total Revenue
- SG&A – 9% of Total Revenue
- Interest Rate – 2.5% of Debt
- Tax Rate – 15% of EBT
- Accounts Payable – 60 days
- Prepaid Expenses – 1.5% of Total Revenue
- Accrued Liabilities – 27% of COGS
- Capital Expenditures – 5% of Total Revenue
- Share-based Compensation – 7.5% of Total Revenue
For the remaining line items below, I felt it was necessary to take some different approaches throughout the forecast period.
- Accounts Receivable – Nvidia’s accounts receivable days has jumped up over the last couple years. I expect this to fall back down to a level more closely aligned with the historical average over the coming years. The forecast period assumes 65 receivable days in 2023 before tapering down to the historical average of 55 days by 2025.
- Inventory – Due to a slowdown in sell through rates over the latter half of 2022, Nvidia’s inventory has spiked relative to previous years. Therefore, I started the forecast period just below Nvidia’s 2022 inventory levels and tapered down to the historical average over the following few years. I assumed 130 inventory days in 2023 before tapering down to 105 days by 2026.
- Total Revenue – I estimated revenue to increase by a modest 10% in 2023 before ramping back up to the average historical growth rate over the middle of the forecast period. I then estimated the revenue growth rate to pull back over the last couple years mainly due to the uncertainty in predicting a high growth industry that far into the future.
My revenue growth rate forecasts for the first couple of years closely resembled the consensus estimates I found on Koyfin.com. After the first 2 forecast years, I simply made my own assumptions based on the historical information and internet research. Nvidia has witnessed weakness in their gaming segment over the last couple quarters but the data center and automotive market segments have shown resilience even through the tough market conditions. Nvidia’s data center revenue has contributed over half of their 2022 revenue through 3 quarters. Therefore, it appears that Nvidia is in a good place to have revenue growth starting to normalize soon. Here you see my table summarizing the annual revenue growth rate for each of the 8 years in my forecast.
DCF Output
Now we can put everything together in the DCF valuation. After performing a weighted average cost of capital (WACC) analysis, I determined a free cash flow discount rate of 11.5%. I settled on a terminal EV/EBITDA multiple of 35.7x based on Nvidia’s historical average EV/EBITDA multiple.
The resulting DCF analysis resulted in a diluted price per share of $201.67 (+12.2% potential upside compared to NVDA’s share price of $179.75 on 1/20/23). Here you can see the full breakdown of my DCF valuation.
After performing the DCF analysis, I analyzed the sensitivity of Nvidia’s DCF share price to see how the price fluctuates under different assumption conditions. Below is a data table showing Nvidia’s DCF share prices under different WACC and EV/EBITDA multiples assumptions.
NVDA Price Target
With the relative and DCF valuations complete, I was able to put together a “football field” chart as shown below that incorporates relative and DCF valuation ranges as well as consensus analyst price targets and the 52-week high and low-price range. All things considered, my current price target for NVDA as of 1/20/22 is $210 (+16.8% potential upside compared to the current price of $179.75). It’s important to note that this price target is based on an 8-year forecast and my personal forecast estimates. With the current economic backdrop with the Federal Reserve raising rates and a predicted recession looming, there is a good chance that Nvidia’s stock price could experience a short term pull back. Also, Nvidia’s current PE ratio is the highest in its class which could mean that any industry wide multiple compression would hit Nvidia’s harder than most. However, Nvidia’s margins are very strong relative to their peers which means they could weather the storm significantly better than the rest of the industry.
AMD Update: Much like Nvidia’s stock price, AMD’s stock price has risen drastically over the past couple weeks from $63.96 to $70.10 (9.6% increase). Therefore, our price target of $80 for AMD now equates to a 14.1% potential upside.
AMD vs NVDA Summary
Based on my estimated price targets for Nvidia and AMD as of 1/22/23, both are currently trading at a slight discount relative to their current share prices. Their share prices have been on a run for the last few weeks AMD and Nvidia are both considered high growth companies which is why they trade at a premium P/E ratio compared to the market average. A downside of trading at a premium P/E ratio is that their share price can get hit harder than most during period of economic uncertainty. Especially when the uncertainty is coupled with rising interest rates. Personally, I would put a hold rating on both companies right now as neither is trading at a steep enough discount to offset the risk. However, things could change if they experience a decent pullback in the coming weeks and months.
If I had to give an edge at this time to either Nvidia or AMD, I would have to lean towards Nvidia as the company to keep an eye on. Nvidia has been consistently profitable for longer than AMD, which I believe is a good quality to have with a rather rocky economic outlook. Also, Nvidia’s 60% gross margins compared to 50% for AMD will them with a larger buffer as their management navigates the next 6-12 months. However, AMD appears to be making strides over the last few years in gaining market share vs its bigger rivals. If AMD can keep up this trend, they could wind up being a bigger winner in the long term.
Disclaimer: These valuations are based on personal assumptions, calculations, and assessment. I am not a financial advisor, nor should my assessment be considered an investment recommendation.
