At the risk of sounding like a Dos Equis commercial, I don't always write about Nvidia (Nasdaq:NVDA), but when I do, I'm usually pretty bullish on the company's long-term prospects. At the same time, though, I realize that Wall Street is firmly in the “show me” camp on this company and does not believe that it will succeed with its ventures into mobile devices and mobile gaming. This skepticism is why I've held off buying in so far (owning a stock that Wall Street wants to hate is fruitless and frustrating), but it's getting more and more tempting.
Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.
Fiscal First Quarter Results Come In Solid
In a tough market, Nvidia did pretty well. Revenue did rise just 3% from the year-ago quarter and fall 14% sequentially, but that was good for a small beat relative to Street expectations. GPU revenue was up 8% (and down 6% sequentially) in a very tough PC environment, as demand for higher-end systems for gaming stayed strong. Tegra revenue declined 22% and 51% ahead of the new Tegra 4 launch.
Margins were in some ways a mixed bag. Gross margin improved more than four points on a non-GAAP basis, due in very large part to the lower contribution of Tegra revenue. This is why I say “mixed bag” - it's another reminder that Nvidia is absorbing costs in the cause of building its mobile business, and a lot of investors resent that. Operating income (also non-GAAP) rose 11% from last year, but fell by half from the fourth quarter. Nevertheless, despite the heavy investments in Tegra, Nvidia's operating margin was still better than expected.
SEE: Understanding The Income Statement
All Tegra, All The Time
Investors and analysts seem to have made their peace with Nvidia's PC business. Mobile device cannibalization isn't as big of a threat to the high-end PC business, and the company still has strong technology here relative to Intel (Nasdaq:INTC) and AMD (NYSE:AMD). Likewise, while I'd say it's inevitable that Intel gains share in the high performance computing market, I think market growth and Nvidia's strong tech position will cushion the blow.
That leaves the perpetually controversial Tegra business as the main talking point. A decision to focus more attention on the Tegra 4i (which includes an integrated modem as well as strong CPU/GPU technology) has pushed the launch dates back, and that appears to have cost the company some design wins. While I won't argue that Nvidia can ill afford to lose any business to Broadcom (Nasdaq:BRCM), Qualcomm (Nasdaq:QCOM), Intel, or other rivals, management is playing the long game and making sure they get the products out right, instead of right now.
Can Nvidia win here? I think it depends on your definitions and expectations. No, I do not believe that Nvidia can or will unseat Broadcom or Qualcomm. I also do see some risk from the company's focus on high-end devices, as that seems to be where the growth in mobile is weakening most notably. Still, I believe Nvidia will turn this into a profitable, cash flow-generating business that compliments its existing operations. Moreover, I find some irony in all of the complaining about Nvidia's investments in mobile processing, as analysts and investors frequently criticize chip companies for being inadequately diversified and too dependent on one market.
The Bottom Line
We seem to be at a point in the market where investors want to punish companies that invest in their future, as opposed to just playing out the string and funneling all of their cash flow back to shareholders as dividends and buybacks. Frankly, I prefer to invest with management teams that are willing to think long-term and take a few shots to build a bigger, more successful business. Not all of these ventures will succeed (and I have my doubts about the Project Shield gaming device), but I do know what happens when tech companies stagnate.
SEE: A Breakdown Of Stock Buybacks
It would certainly help the stock to see a big design win at a leading mobile device company. That said, I'm not expecting it – I think Nvidia will have to reap what it can from the second and third-tier mobile players. As a result, I think my expectations are modest. I'm looking for long-term revenue growth of 4% and free cash flow growth of about 6% - roughly in line with Broadcom and lower than Qualcomm. That points to a fair value of almost $20 today, and that's more than enough to get my interest. As I think a lot of the Tegra news is priced in, this could be a good time to consider Nvidia shares unless you believe that the summer doldrums will further pound the mobile device market and supply chain.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.