No Surprises In Nvidia's (NASDAQ:NVDA) Q4 Sales Numbers, Stock Soars

Leading designer of graphics chips Nvidia (NASDAQ:NVDA) reported results in line with analyst expectations in Q4 FY2023 quarter, with revenue down 20.8% year on year to $6.05 billion. Guidance for next quarter's revenue was $6.5 billion at the midpoint, which is 2.8% above the analyst consensus. Nvidia made a GAAP profit of $1.41 billion, down on its profit of $3 billion, in the same quarter last year.

Founded in 1993 by Jensen Huang and two former Sun Microsystems engineers, Nvidia (NASDAQ:NVDA) is a leading fabless designer of chips used in gaming, PCs, data centers, automotive, and a variety of end markets.

Founded with the goal of bringing high end 3D computer graphics processing units (GPUs) to the mainstream PC market, Nvidia ’s business has exploded over the past decade as GPUs’ have changed the computing paradigm by enabling leading edge technologies like artificial intelligence, machine learning, and autonomous driving.

GPUs differ from CPUs (most commonly associated with Intel) in that their multi-core structures are designed to operate in a parallel fashion, which makes them great at performing repeat operations at a fast pace, such as running repeated complex mathematical operations to render 3D graphics for video games. In recent years, technologists began applying GPUs “parallel processing” to new use cases like accelerating computing in data centers, powering artificial intelligence and machine learning, and modeling complex problems like taking in data from car cameras to guide autonomous safety features.

Nvidia’s great differentiation was the introduction of the CUDA programming language back in 2006. Nvidia targeted software developers, giving away CUDA for free to developers, who all used it to code graphics in video games. Importantly, Nvidia kept its CUDA-GPU integration closed, meaning that Cuda could only run on Nvidia’s GPUs, creating a massive barrier to entry for other GPU rivals. In the early to mid 2010s, as developers began using CUDA to program GPUs for the new parallel processing use cases in data centers, Nvidia’s business began expanding dramatically.

The exploding use cases for its GPUs and Nvidia’s proprietary programming language have generated one of the great growth stocks of the 2000s, with Nvidia market cap growing more than 20x. Nvidia now has its eyes on the ARM technology, aiming to pair ARM’s low power low cost CPUs with its GPUs to capture ever greater share in the datacenter from Intel’s x86 architecture CPUs.

Nvidia’s primary competitors are Advanced Micro Devices (NASDAQ:AMD) and Intel (NASDAQ:INTC).

Processors and Graphics Chips

Chips need to keep getting smaller in order to advance on Moore’s law, and that is proving increasingly more complicated and expensive to achieve with time. That has caused most digital chip makers to become “fabless” designers, rather than manufacturers, instead relying on contracted foundries like TSMC to manufacture their designs. This has benefitted the digital chip makers’ free cash flow margins, as exiting the manufacturing business has removed large cash expenses from their business models. Read More The semiconductor industry is broadly divided into analog and digital semiconductors. Digital chips are what most people think of as the brains of almost every electronic device. Their primary purpose is to either store (memory chips) or process (CPUs/GPUs) data. Digital chips derive their processing power from the number of transistors that can be packed on an individual chip. In chip design, nanometers or “nm” refers to the length of a transistor gate – the smaller the gate the more processing power that can be packed into a given space. In 1965, Intel’s founder Gordon Moore famously predicted a doubling of transistors on a chip every two years. The concept, known as Moore’s Law, was based on his belief that the technology used to create semiconductors would improve continuously, allowing chips to become ever smaller and ever more powerful.

Sales Growth

Nvidia's revenue growth over the last three years has been very strong, averaging 39.5% annually. But as you can see below, last year quarterly revenue declined from $7.64 billion to $6.05 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

Despite Nvidia revenues beating analyst estimates, this was still a slow quarter with a 20.8% revenue decline.

Nvidia's revenue growth has slowed for the last three quarters and the company expects growth to turn negative next quarter guiding to a 21.6% year on year decline, but analysts think it will recover next year, as consensus NTM revenues are forecast to grow 11%.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.

This quarter, Nvidia’s inventory days came in at 212, 109 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.

Pricing Power

Nvidia's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 63.3% in Q4, down 2.1 percentage points year on year.

Despite declining over the past year, Nvidia still retains strong gross margins, averaging 56.5%, pointing to a still potent competitive offering, pricing power, and solid inventory management.

Profitability

Nvidia reported an operating margin of 36.8% in Q4, down 11.4 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.

Operating margins have been trending down over the last year, averaging 32.5%. However, Nvidia's margins remain one of the highest in the industry, driven by its strong gross margins and economies of scale generated from its highly efficient operating model.

Earnings & Competitive Moat

Analysts covering the company are expecting earnings per share to grow 51.8% over the next twelve months, although estimates are likely to change post earnings.

Nvidia’s average return on invested capital (ROIC) over the last 5 years of 73.9% implies it has a strong competitive position and is able to invest in profitable growth over the long term.

Key Takeaways from Nvidia's Q4 Results

With a market capitalization of $508 billion, more than $13.3 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

We were impressed by how strongly Nvidia outperformed analysts’ earnings expectations this quarter. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. On the other hand, it was less good to see that the revenue growth was quite weak and operating margin deteriorated. Overall, this quarter's results were good. The company is up 6.92% on the results and currently trades at $222.34 per share.

Is Now The Time?

When considering Nvidia, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. There are a number of reasons why we think Nvidia is a great business. For a start, its revenue growth has been strong, and that growth rate is even expected to increase in the short term. On top of that, its impressive operating margins are indicative of an highly efficient business model, and its high return on invested capital suggests it is well run and in a strong position for profit growth.

The market is certainly expecting long term growth from Nvidia given its price to earnings ratio based on the next twelve months is 48.1x is much higher than other semiconductor companies. But looking at the semiconductors landscape today, Nvidia's qualities as one of the best businesses really stand out and we still like it at this price, despite the higher multiple.

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