Nvidia Is at All-Time Highs, Yet It's Still Too Cheap

Nvidia's strong free cash flows and rapid growth are being underpriced by the market.
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Nvidia  (NVDA) - Get Report is back on firm footing after reporting a strong fourth quarter and guidance

The chipmaker Nvidia continues to ooze free cash flow, and given its rock-solid balance sheet may soon consider increasing its shareholder returns via dividends or repurchases. For now, the stock remains cheaply valued and worth considering. Here’s why:

Faultless Fourth-Quarter Results

Nvidia’s fourth-quarter results were everything shareholders could have a wished for and more.

Revenue was up 41% year over year, which drove gross profit margin expansions of more than 9%, and its adjusted per-share earnings numbers were up 136% year over year to $1.89.

Looking ahead, the good times are showing no signs of slowing down, with the first quarter pointing toward revenue reaching $3 billion and up 35% year over year, while its non-GAAP gross margin expanding more than 5% from a yearearlier. Having said that, for now, the full impact of the coronavirus on its results remains uncertain but is presumed minor.

Two Standout Units

Gaming makes up close to 50% of Nvidia’s total revenue. Therefore, if gaming performs well Nvidia is likely to perform well overall.

Indeed, the fourth quarter saw an impressive performance from Nvidia’s ray tracing RTX GPUs, driven by a strong lineup of gaming titles specifically designed to benefit from Nvidia’s technology. Ultimately, the period saw Nvidia’s gaming unit deliver remarkable performance, up 56% from the same period a year ago.

Next, data center was another impressive unit, which given its strength during the fourth quarter meant that fiscal 2020 saw Nvidia delivering a record $2.98 billion of revenue for the fiscal year. During the earnings call, CEO Jensen Huang argued that there is a new wave of growth within the company's data center business being powered through AI and public cloud demand.

One avenue that has been failing to gather much traction is Nvidia’s auto business unit, which reported a small decline in revenue of 2% year over year. This unit had previously been hailed as having remarkable potential, but for several quarters it remains largely flat at roughly 5% of total revenue. Accordingly, Huang noted that the automotive industry is struggling, but Huang remains optimistic about its long-term prospects.

Valuation - Large Margin of Safety

Nvidia’s fiscal 2020 cash flows from operations reached $4.7 billion. Given that its capex requirements were less than $500 million for the full fiscal year, this implies Nvidia’s free cash flow was slightly more than $4.2 billion for the year.

Put another way, despite being valued at approximately 45 time free cash flow, investors are still being presented with a bargain opportunity. Why? Because this multiple is to free cash flow, and not earnings - free cash flow is worth substantially more than earnings.

Secondly, Nvidia’s free cash flow is evidently growing at a rapid clip. For now, its operations are still expected to grow at north of 25%.

Thirdly, having finished the fourth quarter with about $9 billion in net cash, as well as generating strong free cash flows, investors will no doubt soon turn up the pressure for Nvidia to return to its share repurchase program once it has completed its acquisition of Mellanox, which is expected in the early part of calendar 2020.

The Bottom Line

Nvidia not only put its troubling crypto hangover behind it but it is very well-positioned to benefit from tailwinds in gaming and data center technological demands.

Furthermore, Nvidia's very high margin business allows it to be very free cash flow generative. For now, investors are underpricing this opportunity. This stock will not remain cheaply valued for much longer.