Nvidia Still Has a Very Bright Future Ahead of It

Nvidia delivered strong Q1 2021 results, where its revenue was up 39% compared with the same period a year ago.
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Nvidia  (NVDA) - Get Report delivered strong Q1 2021 results, where its revenue was up 39% compared with the same period a year ago, while its revenue guidance for the next quarter is pointing towards the midpoint of 42% compared with the same period last year.

Thus, given its very strong growth potential, paying up 35 times forward earnings is not as expensive, and in actuality cheaper than it appears on the surface.

Unimpressive Stock Reaction, What Does It Say?

With such strong results, why has the stock not rallied more strongly after hours and into Friday? It could be argued that since the stock had already rallied nearly 80% the past 60 days from its March lows, these results were to some extent already priced in.

Having said that, what matters to investors right now is not the past, but how its future looks over the coming years ahead. Indeed, on this note, one can see huge potential simmering just below the surface.

Data Center Is Its Crown Jewel

As of Q1 2021 Nvidia’s Data Center business unit amounted to 37% of Nvidia’s total revenue was up 80% year-over-year.

Thus, although Nvidia’s Gaming business is a bigger portion of its operations, at 43% of its total revenue, this segment’s growth was slightly more subdued at just 27% year-over-year -- the reason being that supply chains being were disrupted and the closure of retail outlets and China iCafes. However, longer-term intense competition from AMD  (AMD) - Get Report continues to be a very real obstacle to Nvidia prospects.

On the other hand, Nvidia’s Data Center A100 GPU has seen mass adoption by all cloud service providers and system builders, including Alibaba  (BABA) - Get Report Cloud, Amazon’s  (AMZN) - Get Report AWS, Dell Technologies  (DELL) - Get Report, Google Cloud Platform  (GOOGL) - Get Report, and Microsoft’s  (MSFT) - Get Report Azure -- thus, a roaster of all the biggest and most relevant players.

Gross Margins Are Terrific

Nvidia finished Q1 2021 with record GAAP gross margins of 65.1%. Looking ahead to next quarter, its non-GAAP gross margins are expected to reach 66%. On a GAAP-basis, there are some one-off Mellanox acquisition-related costs, which are mostly non-recurring, which will weigh on Nvidia's GAAP gross margins down to 58.6%.

Nonetheless, sequentially, this points to further expansion to its non-GAAP gross margins by approximately 90 basis points. 

When asked on the call as to what were the main drivers for this expansion and whether this would be the new baseline for the company, Nvidia's CFO Colette Kress noted that Mellanox has very high gross margins and that this acquisition is partially responsible for Nvidia’s gross margin expansion. 

Kress further stated that it's too early to say whether this would be a new baseline, but that Nvidia’s data center business carries similarly high gross margins and that this business continues to become a bigger part of Nvidia, leading her to feel optimistic.

Nvidia’s Near-Term Actions Point to Caution

Nvidia had previously stated that it would reconsider repurchasing its stock after closing the acquisition of Mellanox. However, its commentary on the back of reporting its Q1 2021 results was that its market conditions remain uncertain and Nvidia didn’t consider market conditions to be particularly favorable towards employing its strong balance sheet towards repurchasing its shares.

As a reminder, Nvidia’s balance sheet finished Q1 2021 with a solid net cash position of $9 billion. However, subsequent to the end of the quarter, Nvidia had deployed $7 billion towards its Mellanox acquisition. 

Nevertheless, Nvidia still holds $2 billion in net cash, and given its high expected growth combined with its strongly generating huge cash flows, this reinforces that its balance sheet remains flexible.

This is the notable difference between having a founder and CEO leading the company who has significant skin in the game. Jensen Huang holds roughly 3.8% of Nvidia’s total share outstanding and as you can surmise, there is no individual that is more aligned and determined to see Nvidia’s share price rising in time. 

Having said that, you can see this balance of having to manage the short-term, in order to successfully carve out a stronger future for the company.

Valuation - Large Margin of Safety

Looking ahead to next year, Nvidia is minimally likely to grow its revenues in the mid-to-high 20 percent range. When combined with its higher gross margins, this should see its non-GAAP EPS reaching approximately $10 per share by the end of the calendar 2021. 

Objectively, this is not the cheapest bargain opportunity, at least superficially. However, Nvidia's earning power is translated into free cash flow at very high rates.

The Bottom Line

Nvidia's Data Center segment revenue growth rates continue to grow by leaps and bounds and is showing no signs of slowing down. Even if Nvidia's Gaming segment is no longer as attractive as it once was, Nvidia's Data Center segment is likely to be the biggest contributor to its overall growth prospects by this time next year.

Nvidia is a holding in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells NVDA? Learn more now.