Taking a Look at Nvidia's Stock Amidst The Semiconductor Chip Gut

Nvidia NASDAQ: NVDA continues to lead competitors in providing chips for GPU and has done well to catch up in the database segment. Nvidia is an American software and fabless company which designs graphics processing units (GPUs), application programming interfaces (APIs) for data science and high-performance computing as well as system-on chip units (SoCs) for the mobile computing and automotive market.

Nvidia’s stock is currently down close to 50% since its 52-week high. Despite the stock retracing, the company has continued to increase its market share over the past couple of years, increasing its discrete market share by 7%, in the GPU market over the past couple of years.  Meanwhile, sales grew by 84% y-o-y, in the first quarter despite the semiconductor overhang.

Nvidia Market Share

Nvidia currently has a 10% market share in the overall GPU market, and  82% of all the GPU market share in the discrete graphics card market. GPU demand is driven by a range of reasons, including an increase in gaming demand and the cryptocurrency mining market. The cryptocurrency mining market is the most significant source of short-term risk, and while total sales remain strong despite a drop in cryptocurrency prices, future sales may not be as durable should prices remain down. But at the moment, despite these issues, GPU demand remains strong.

According to analysts, growth in the GPU market can increase anywhere from 25%-35% over the next couple of 5-6 year period. But competition is increasing from numerous sources.  Intel brought out its own GPU in the first quarter of 2022 and finally released it for sale in late July, and AMD is also bringing new chips to the market. But NVIDIA remains the best-in-class GPU maker and is set to bring in its set of new GPUs in the latter part of the year or in 2023, along with new datacentre chips, which should allow it to compete with Intel, which is aiming to gain market share in primarily the CPU market, through its new Intel ARC chipset.

Nvidia Pricing Power

One of the major factors driving Nvidia's revenue in recent times was pricing power. Nvidia's pricing power stemmed largely from a shortage of chips. That shortage is slowly turning into a glut as demand from crypto-miners starts to fade, and demand from more traditional industries such as gaming becomes central to growth. The crypto industry, in general, is facing a downturn and that downturn is likely to continue for a while. Interest rates and liquidity continue to be sucked out of the market as assets rotate out of risk assets into more traditional safe-haven assets and as a result, the crypto market is slowly retracing. Demand for miners is unlikely to go back to its peak, as the crypto market will consolidate as speculators are replaced by investors, who will look to far more fundamental factors.

As a result prices for GPUs are down anywhere 20-30% during the last 6-8 months. And while prices should steady out later on this year as the market bubble clears, Nvidia stock, which is down significantly, looks far more in value territory. Chip makers tend to go through cyclical cycles, and management has been cognizant of this. However, management significantly capacity and output significantly in order to meet demand. The fall in demand and utilization could affect future cash flow and therefore valuation.

Nvidia’s outlook and valuation

Nvidia’s earnings are expected to grow anywhere from 30-35% for the year and with the current P/E of 43x, forward P/E would come in anywhere from 30-33x. Nvidia’s valuation is primarily dependent on its ability to maintain cash flow through the cycles, which depends on pricing power.  But with a high return on equity of almost 40%, and a profit margin of 33%, which could fall to around 27-28% due to pricing issues, the stock remains around an intrinsic value that might be worth taking a look at.

Overall, the semiconductor industry has held up quite well despite the headwinds and cyclical downturn. Prices have corrected, as they should, and so has the stock. And now the industry is slowly heading towards a more sustainable outlook. This creates an entry opportunity for investors who are looking for an entry point and are looking to hold the stock for a longer period of time.