Leading graphic processors developer Nvidia (NASDAQ:NVDA) announced its Q1 2014 earnings on May 9. With $955 million in revenues, it witnessed a 13.7% sequential decline but registered 3.2% annual growth. Seasonal factors, declining PC shipments and lower Tegra sales were the key factors responsible for the slow quarter. Nevertheless, the results were better than Nvidia’s expectation as it saw strong sales of its high-end GPUs for PC gaming and increasing acceptance of the Kepler architecture in PCs and beyond. Additionally, on account of a richer mix of higher margin products, increasing strength in GPUs and prudent cost management, Nvidia earned record gross margins of 54.3% in the quarter.
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As mainstream PCs continue to be cannibalized by tablets, Nvidia intends to focus on retaining its lead in visual computing, extending GPUs beyond PCs and leveraging Tegra processors to tap the fast growing market for new computing devices. The company is gaining market share among gamers, strengthening its workstation in super computing segments and extending its lead in GPUs to servers and data centers. With the increasing revenue contribution from the non-PC business segment and its dominance in the GPU market, we feel that Nvidia has strong fundamentals to support a higher valuation.
Confident of generating strong long-term cash flows, Nvidia plans to return $1 billion to its shareholders in 2013 via stock buybacks and dividend payments. It has a solid balance sheet with a strong cash position and no debt.
The Expanding PC Gaming Market To Drive GPU Sales
On account of lower PC shipments, Nvidia marked a 5.6% decline in its Q1 2014 GPU sales, though the figure increased by 8.1% annually. However, driven by the expanding global gaming market, its revenue from the gaming GPUs division was up 24% y-o-y.
Nvidia sells its PC graphics to two key segments – PC Original Equipment Manufacturers (OEMs) and gaming enthusiasts to generate realistic and interactive graphics on PCs. While PC shipments have slowed down, the robust PC gaming market contributed to an increase in its GPU shipments in 2012 and the positive trend continued in Q1 2013.
Jon Peddie Reasearch valued the PC gaming hardware market at $23.6 billion in 2012, and forecasts the global gaming market to cross $30 billion by 2015.  On the other hand, the PC gaming software market is expected to increase from $17 billion in 2012 to over $20 billion by 2015.  Nvidia’s GeForce is the gamers choice of GPUs by a margin of almost 2:1. 
Earlier this year, Nvidia introduced its highest performance single GPU – GeForce GTX Titan. Available for $1,000, the company claims that the GPU is selling at a fast pace. Backed by growing strength in consumer gaming, Nvidia expects to see continued growth momentum in its consumer gaming division this quarter as well.
Extension Of The Kepler Architecture In New Markets To Drive Growth
In March 2012, Nvidia launched its new Kepler graphics processing unit (GPU) architecture, which is the first architecture to include virtualization technology built right into the GPU. The company claims that Kepler is its most efficient GPU architecture to date, and the introduction of the same has translated into higher market share and margins. Despite flat global PC shipments, Nvidia’s GPU revenue grew by 2% in fiscal 2013.
Nvidia transitioned its Kepler architecture across its GPU portfolio and started shipping Kepler into its Quadro products last year. Nvidia claims that the introduction of the Kepler architecture has opened up new markets for the company. The Kepler GPU architecture drove strong GeForce demand for PC gamers. It expects to see higher Quadro and Tesla GPU sales as Kepler-based products drive growth in the professional and high-performance computing segments.
In Q1 2013, Nvidia launched Kepler fully into the enterprise workstation market. Additionally, it recently launched four new Quadro K series professional graphics products that deliver around 50% faster visualization performance and twice the compute horsepower compared to the previous generation Quadro products. With the rapid adoption of Kepler, Nvidia is moving towards a higher market share among gamers, strengthening workstation and supercomputing segments as well as new growth opportunities for its GRID server graphics solutions.
Tegra Remains A Key Long-Term Growth Opportunity
Leveraging its Tegra processors to tap growth in mobile computing is a key long-term growth strategy for Nvidia. Though Tegra revenues increased by nearly 30% in fiscal 2013, the division witnessed a 50.5% sequential and a 22.2% annual decline in Q1 2013. The company expects a flat year for its Tegra business as it made a conscious decision to delay the launch of Tegra 4 by one quarter in order to pull up the production of Tegra 4i chips by two quarters.
Introduced at the 2013 Consumer Electronic Show in January, Tegra 4 is the world’s first quad-core processor based on Cortex A15, ARM’s most advanced CPU core and consumes 45% less power than Tegra 3. A month later, the company introduced Tegra 4i, its first fully integrated 4G LTE mobile processor to expand its presence in the smartphone market. While Tegra 4i is targeted at smartphones, Tegra 4 is meant for tablets, set-top boxes, automotive market, etc.
Considering that Nvidia has a negligible presence in the smartphone market, we think that speeding up the launch of its LTE compatible chips is a good move. 4G/LTE is the future of wireless connectivity for mobile devices, especially smartphones, and the LTE integrated chipset will better equip Nvidia to challenge Qualcomm’s (NASDAQ:QCOM) growing dominance in smartphones. Nvidia claims that Tegra 4i delivers three times higher performance than Qualcomm’s S400 solutions. ((Nvidia’s CEO Discusses F1Q 2014 Results – Earnings Call Transcript, Seeking Alpha, May 9, 2013))
In anticipation of Tegra 4, its customers cut down the production of Tegra 3 based mobile devices in Q1 2012. The trend is likely to continue this quarter as well and Tegra 4 designs are expected to start shipping during the latter part of 2013. With Tegra 4 devices and Tegra 4i certification underway (expected in Q3), we expect growth in Tegra shipments to accelerate in the the second half of 2013.
Q2 2014 Outlook
– Revenue expected to increase by 2% q-o-y.
– Gross margins to remain around 54% driven by an improved mix of high margin products.
– GAAP operating expenses to rise to approximately $448 million due to increasing investments in new products and hiring expenses.
We are in the process of updating our price estimate of $17.50 for Nvidia.Notes:
- PC Shipments Post The Steepest Decline Ever in a Single Quarter, According to IDC, IDC Press Release, April 10, 2013 [↩]
- Nvidia’s CEO Discusses F1Q 2014 Results – Earnings Call Transcript, Seeking Alpha, May 9, 2013 [↩]
- Nvidia Corporation’s CEO Discusses F4Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013 [↩]