Nvidia: After The Fall

Pronounced Drop And Volatility

After radical swings in the stock price of Nvidia Corp. (NASDAQ:NVDA), which included a rapid 18% drop, investors can examine the causes of this volatility to form a view of prospects for the stock over coming months. This author believes that more growth may be expected in the price of Nvidia shares.

Investors saw a pronounced drop in Nvidia before an outstanding full-year’s earnings report. Thereafter the stock entered a very volatile range. That volatility continues and is to date more than double that of the weeks before the marked fall, and is greater than at any time in more than a year.

For example, on February 21 Nvidia fell more than $10.00 (4.00%) as the stock exemplifies high beta. To compare with its competitors, Nvidia registers a beta of 1.87, while Advanced Micro Devices, Inc. (NASDAQ:AMD) shows 1.58, and Intel Corp. (NASDAQ:INTC) has a beta of 1.41. Whenever beta becomes elevated, that is a time for investors to exercise increased vigilance as it may presage transitions, trend reversals and fake-outs.

Heightened Volatility Persists

In light of continuing volatility persisting after announcement of earnings outperformance, understanding the cause of the drop and its volatile aftermath should aid investors in reconciling these contradictions to determine the future direction of the stock.

Between January 21, 2018 and February 6, Nvidia fell precipitously by $45.27 (18.16%) to lose in just four trading days what it had taken nearly one month to gain. During such rapid market moves, valuation offers no protection. Then on February 8 the company announced that 2018 financial year profit grew by 83%, revenue climbed nearly 41%, and gross margin grew by 110 basis points. This outperformance has now taken the stock beyond previous highs, yet heightened volatility persists and may trouble holders.

Chart
NVDA data by YCharts

The 18.16% fall in price was caused mainly by technical market factors, not fundamental considerations particular to Nvidia. Approximately 85% of the total volume of stock market trades are based on algorithmic or quant criteria, and consequently by virtue of that sheer volume of technical trading, markets often rise and fall around technical trigger points.

Market Correlations

Underscoring this prominence of technical considerations is the correlation that the fall in Nvidia stock had with the drop in both the semiconductor sector as a whole and in the entire stock market. Compare the similarity in the charts below of both the semiconductor sector and the S&P 500 with that of Nvidia above.

As regards the overall stock market, a significant technical element on this occasion was the volume of short volatility trades using instruments tied to volatility indexes like the VIX. As a result of the power of market correlation, the downdraft in the stock market as a whole depressed stock prices in the semiconductor sector and pulled Nvidia down.

Chart
SOXX data by YCharts
Chart
SPY data by YCharts

This view of the attribution of the market pullback to technical factors was also stated by fellow Seeking Alpha contributor, Mohamed El-Erien:

It is driven by technicals, not fundamentals. The ongoing market correction doesn’t reflect a worsening of economic and corporate fundamentals. Rather, it is being driven by technical factors, including the unwinding of “short-volatility” trades . . . the testing of relatively new products and a shift in investor conditioning away from the “buy-the-dip” paradigm.

Demand May Weaken

Continuing volatility in Nvidia’s stock is in significant part due to concerns in some quarters regarding Nvidia’s exposure to cryptocurrency demand, as there are factors at play which may cause that demand to weaken in the foreseeable future. Cryptos generate approximately 10% of the company’s revenue, compared to approximately 3% of revenue for rival Advanced Micro Devices, Inc. (NASDAQ:AMD).

The future evolution of cryptocurrencies, especially Ethereum, threatens to render mining less profitable as it diminishes the block reward and reduces the difficulty of algorithms. In areas characterized by high energy costs, the profitability of mining is also waning. A mooted move to proof of stake settlement would reduce the need for mining.

To be considered additionally, Nvidia’s switch from in-car entertainment systems to AI driving systems is demonstrating lower than anticipated cash flow from the automotive segment. In the fourth quarter, automotive income grew 3% year-on-year, while falling 8% sequentially. However, 1Q19 automotive revenue is projected to climb above 1Q18 levels.

First Driving Processor

This market promises much increased revenue from approximately 2020 when mass market car manufacturers are expected to launch their first wave of autonomous vehicles. Nvidia is to launch the world’s first autonomous driving processor, named Drive Xavier, constructed with more than 9 billion transistors in the first quarter of 2019. Nvidia’s road to a sizable share of the autonomous driving market will be based on its alliances with Volkswagen, Uber, Mercedes-Benz, Baidu Inc. (NASDAQ:BIDU) and China’s ZF among others.

While there are valid concerns as discussed above, it may be expected that Nvidia’s increasing revenue derived from the cloud enterprise segment with their Volta chips, with capital expenditure in this market rising annually at a rate of 20-30%, will more than compensate for any reductions in cryptocurrency or auto market revenue. To underscore this point, Nvidia’s sequential growth in data center revenue exceeds 20%. A further growth area for Nvidia promising markedly increased earnings is that of AI inference applications and the IoT as these markets, presently in their infancy, evolve exponentially.

Nvidia’s financial base is healthy and growing, forming a foundation for projecting a continuing rise in share price. Sales growth in financial year 2018 was 40.58% year-on-year. The cost of sales in the same period grew at a slower rate than sales revenue, while EBITDA in 2018 was $3.41 billion compared to $2.16 billion in 2017. Total assets rose to $11.24 billion in 2018 from $9.84 billion in 2017, and total liabilities fell from $4.08 billion to $3.77 billion in the same period.

The drag on net income of Nvidia’s transition away from in-car entertainment towards AI driving systems, with their inherent cash flow lag, has been minimal with net income rising in 2018 to $3.05 billion from $1.67 billion in 2017. Free cash flow rose in 2018 to $2.91 billion from $1.5 billion the previous year.

Conclusion

After a jolting fall in share price, which can largely be attributed to technical factors, the full year’s earnings report has led Nvidia stock into a very volatile period with heightened beta relative to its peers. However, this phase promises to resolve into a continued upward trend as a result of growing demand in the enterprise segment. Concerns about a downturn in cryptocurrency revenue or lag time in realizing a higher volume of auto revenue are unlikely to halt that uptrend.

Consider following this author. To receive immediate alerts upon publication of future articles by this author, please click on either of the “Follow” buttons at the top and bottom of this page, and then select “Real Time Alerts.” To review previously published articles by The Structure Of Price, click on the author’s name at the top of this page.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Related Posts:

  • No Related Posts

Paul Rosen