A Mountain of Cash and a Bargain Price!

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When you buy a share of a company, you are buying a piece of that company's cash flow. If the company has any excess cash on the books you're also buying a piece of that. Occasionally you'll find a company with a mountain of excess cash on its balance sheet. If you subtract the per-share value of this cash from the share price and value earnings against this adjusted share price, a more accurate picture of the company's profitability emerges. An example of a company fitting this description is Nvidia (NASDAQ: NVDA).

Company Profile

Nvidia is a leading designer of graphic chips, outsourcing all production to third parties. Its products show up in a slew of devices, including PC's, workstations, smart phones, tablets, and servers. Nvidia's main products are listed below.

  1. GeForce GPU - Line of graphics processors used in consumer PC's. Much more powerful then integrated graphics, allowing cutting-edge graphics in games. Powers the Retina display in Apple's MacBook Pro.
  2. Quadro - Line of graphics processors used in professional applications. Used to render visual effects in films,  power software used to design planes, automobiles, and other products, and for other graphics intensive work
  3. Tesla - Line of processors used for parallel processing tasks. The Tesla GPU can be utilized to crunch numerical data instead of simply graphics information, allowing Tesla to perform the same tasks as a supercomputer. Of the top 500 supercomputers in the world as of June 2012, more than 50 systems are powered by Nvidia GPU's.
  4. Tegra - Line of mobile processors for smart phones and tablets. Used in the Nexus 7 tablet from Google as well as dozens of other devices.

Nvidia faces stiff competition from many sources. In the PC GPU market Nvidia competes with Advanced Micro Devices (NYSE: AMD), which acquired ATI Technologies in 2006. AMD sells the Radeon line of graphics processors, which perform the same function as Nvidia's GeForce line. Many PC's include an integrated graphics chip directly on the motherboard instead of a discrete GPU from either Nvidia or AMD. Intel (NASDAQ: INTC) is the main supplier of integrated graphics solutions, which are much cheaper and much less powerful than dedicated GPU's. 

At the beginning of 2012 Nvidia commanded 15.7% of the GPU market, compared to a 24.8% share for AMD and a 59.1% share for Intel. The market as a whole is in decline, with volume declining 3.5% from 2011. This is tied to the general malaise in the PC market.

In the mobile market Nvidia faces even more competition. Qualcomm (NASDAQ: QCOM) is the market leader, capturing 31.4% of the market in 2011. Qualcomm's Snapdragon processor is used in a huge number of devices, including Android and Windows phones. Nvidia has a small market share of just 3%, although more tablets than phones have adopted the Tegra chip. There is certainly plenty of space for Nvidia to grow its mobile business, and with a declining PC market the company will need to.   

The Stock

<img src="http://media.ycharts.com/charts/ccf55735a2c613b06462c8d1f9c0c5fb.png" />

NVDA data by YCharts

Nvidia currently trades at $12.67. After peaking at nearly $40 per share in 2007 the stock plummeted to well under $10 per share in 2008. In the beginning of 2011 the stock traded for about twice the current share price. 

Financial Performance

Let's take a look at Nvidia's revenue and cash flow for the past five years.

<table> <thead> <tr><th>(In Million $) </th><th>2007 </th><th>2008 </th><th>2009 </th><th>2010 </th><th>2011 </th></tr> </thead> <tbody> <tr><th>Revenue </th> <td>$4,097 </td> <td>$3,424 </td> <td>$3,326 </td> <td>$3,543 </td> <td>$3,997 </td> </tr> <tr><th>Operating Cash Flow </th> <td>$1,270 </td> <td>$249 </td> <td>$487 </td> <td>$675 </td> <td>$909 </td> </tr> <tr><th>Capital Expenditure </th> <td>$-188 </td> <td>$-408 </td> <td>$-78 </td> <td>$-98 </td> <td>$-139 </td> </tr> <tr><th>Free Cash Flow </th> <td>$1,082 </td> <td>$-159 </td> <td>$410 </td> <td>$577 </td> <td>$770 </td> </tr> </tbody> </table>

The financial crisis of 2008-2009 hit Nvidia hard, reducing revenues and throwing the company into the red in 2008. In 2011 Nvidia recorded almost $4 billion in revenue and $770 million if free cash flow, a free cash flow yield of 19.26%.

I like to look at owner earnings instead of free cash flow. Owner earnings take net income and add depreciation and certain non-cash charges, excluding changes in working capital. To this I add interest payments adjusted for taxes and subtract the average capital expenditures. My calculation of owner earnings is below.

<table> <thead> <tr><th>(In Million $) </th><th>2007 </th><th>2008 </th><th>2009 </th><th>2010 </th><th>2011 </th></tr> </thead> <tbody> <tr><th>Net income </th> <td>$797 </td> <td>$-31 </td> <td>$-68 </td> <td>$253 </td> <td>$581 </td> </tr> <tr><th>Depreciation & amortization </th> <td>$133 </td> <td>$185 </td> <td>$196 </td> <td>$186 </td> <td>$204 </td> </tr> <tr><th>Investment/asset impairment charges </th> <td>$0 </td> <td>$9 </td> <td>$0 </td> <td>$0 </td> <td>$0 </td> </tr> <tr><th>Stock based compensation </th> <td>$0 </td> <td>$162 </td> <td>$242 </td> <td>$100 </td> <td>$136 </td> </tr> <tr><th>Other non-cash items </th> <td>$79 </td> <td>$-22 </td> <td>$1 </td> <td>$-14 </td> <td>$-34 </td> </tr> <tr><th>Interest Payments </th> <td>$0 </td> <td>$0 </td> <td>$3 </td> <td>$3 </td> <td>$3 </td> </tr> <tr><th>Avg Capital Expenditure </th> <td>$-182 </td> <td>$-182 </td> <td>$-182 </td> <td>$-182 </td> <td>$-182 </td> </tr> <tr><th>Owner Earnings </th> <td>$828 </td> <td>$124 </td> <td>$193 </td> <td>$347 </td> <td>$708 </td> </tr> </tbody> </table>

Owner earnings will be the value which I use for valuation purposes, since it gives a more smoothed-out picture of a company's profitability. 

The last piece of the financial puzzle is the balance sheet. Nvidia has $3,278 million in cash and no debt. On a per-share basis the company has $5.26 in cash for each diluted share. With a share price of $12.67 as of this writing the cash represents 41.5% of the total market capitalization. This means that the market is valuing Nvidia's future cash flows at $7.41 per share. With owner earnings of $708 million in 2011, or $1.13 per share, the ratio of effective price to owner earnings is a paltry 6.56. Even without doing a valuation Nvidia looks like a serious value.


I'll use a discounted cash flow analysis to estimate the fair value of Nvidia. I will use a discount rate of both 12% and 15% and use these values to define a fair value range. In an effort to be conservative I will assume that owner earnings grow at just 3% per year. Using these parameters and factoring in the excess cash from above I arrive at a fair value range of $15.17 - $18.48.

The Bottom Line

Nvidia is cheap. Period. Yes, there is a lot of competition. Yes, the PC market is growing at an ever slower rate. But Nvidia is trading at near-ridiculous levels. Even under extremely conservative assumptions Nvidia is priced well below my fair value range. I don't think there's any doubt about it - Nvidia is a bargain.  

TheBargainBin has no positions in the stocks mentioned above. The Motley Fool owns shares of Intel and Qualcomm. Motley Fool newsletter services recommend Intel and NVIDIA. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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