The Business Of

Semiconductors | Nvidia | What Do They Do With Their Profits?

Morning All!

Yesterday we put together Nvidia’s cost structure with their revenues. And we’ve covered a fair amount this week. So let’s have a little recap…

Gaming: Selling the GPUs that sit in the graphics cards used by PC gamers was what made Nvidia initially a success. And the company’s 83% share of the market gave Nvidia gaming revenues of ~$9bn in 2023!

Datacenter: Over the last decade though, Nvidia’s GPUs have been used for much more than gaming. The company now supplies Amazon, Microsoft, Tesla, etc. for their cloud computing/AI/ML needs! And these revenues totalled ~$15bn last year!

Margins: The rise in popularity for Nvidia’s GPUs (from gamers, crypto miners, supercomputers) has given Nvidia strong pricing power. And the higher ASP of GPUs has seen gross margins grow pretty remarkably from ~29% in 2004 to ~65% in 2022!

But what about EBIT margin? Well, in our famous TBO EBIT margin rankings chart below. I’ve put two bars in for Nvidia. One’s for the margin in 2022 (37%) and the other’s for the margin in 2023 (16%). We can see that the 2022 margin is even higher than the margins we saw for LVMH and Ninety One! But the 2023 margin puts them quite a bit lower on our TBO margin rankings!

So, what’s behind that huge drop in margin? Well, today we’ll dig into that. And also figure out what Nvidia does will all their profits! Because even on a 16% margin, Nvidia’s EBIT in 2023 was $4.2bn… not bad! So, without further ado…

Pile The Cash Up High!

First, let’s look at how Nvidia uses their profits/cash. Do they reinvest most of it back into their business? Do they return a lot of it to shareholders through dividends? Well, in the table below we see that in the decade from 2013-2022, Nvidia made a total of $32.3bn in cash from operations. And spent $13bn of that on capex, buybacks and dividends.

But $32 billion - $13 billion = $19bn. What happened to the other $19bn?! Well, as the chart below shows, Nvidia have just been adding that extra cash to their balance sheet! Cash + marketable securities (which is very short-term securities) was only $3.7bn in 2013. But by 2022, it had grown considerably to $21.2bn - an increase of $17.5bn!

Okay, so whilst the increase in cash looks great. This isn’t something we’ve seen previously in the other companies we’ve covered on TBO. Usually we’ve seen companies spend most of their cash from operations (CFO) by reinvesting into the business. Like how Netflix did with their content creation. Or we’ve seen companies return a lot of their cash through dividends. Like Ninety One who’ve been returning >70% of their earnings to shareholders through dividends.

So what’s going on here with Nvidia? Well, it’s a great question. But there’s a fairly straightforward answer. Because Nvidia already reinvests in their business. And the way Nvidia reinvests in their business is through R&D! We saw yesterday that the company have not let up on their R&D expenditure. With R&D costs coming in at over $7bn in 2023…

Okay fair enough. They reinvest a lot into their business. But then why can’t they return more of that cash to shareholders? And that question has been asked by many investors. Because at a paltry dividend payout ratio of ~5%, Nvidia really trails their competitors here. However, we have left out one thing…

Because in 2023, the company did return a huge amount of cash back to their shareholders. In the form of a $10.3bn share buyback! Clearly management thought there was no need for the $21bn of cash sitting on the balance sheet. And thought they would reward shareholders with it!

But to be honest, what an incredible position for a company to be in. Where they make so much cash, they’re wondering how on Earth to get rid of it!

Stop Piling The Inventory Up High!

So, we’ll keep this section short. Because it’s technically not to do with how Nvidia use their cash. But it’s to do with the company’s EBIT margins. And more specifically, why did Nvidia’s margin fall from its perch of 37% in 2022 to 16% in 2023?

Well, a good place to start is always looking at what the company had to say themselves. So, below is an excerpt from Nvidia’s 2023 financial report. I hope everyone can see that!

What does that all mean? Well, what Nvidia are saying is that because of the super high demand for their GPUs over the last few years. The company ordered more and more GPUs to keep up with the demand. However, the worsening macro environment has seen the demand for gaming laptops and PCs fall. Gamers have been less desperate to upgrade their systems and get the latest graphics cards. As we saw on Tuesday, Nvidia’ gaming revenues fell 27% in 2023 due to this falling demand.

How does that impact margin? Well, the falling demand and prices of GPUs led to Nvidia sitting on a lot of GPU inventory. And Nvidia realised that the book value of that inventory was actually worth less than the market value of that inventory. What do we mean?

Well, because of the falling demand for graphics cards, prices have been falling over the last 12 months. And Nvidia realised that their partners, like Gigabyte, wouldn’t be able to sell their graphics cards at as high a price as in 2022. So in order to help their partners’ margins. Nvidia realised they would have sell their GPUs (sitting in inventory) to partners like Gigabyte at a lower price.

We saw yesterday that one of the main drivers of Nvidia’s margin expansion has been higher average selling prices (ASPs). Well, in 2023 we saw a reversal with Nvidia writing down the value of their inventory due to the expectation of lower ASPs! And it’s this write down of inventory that has impacted gross margin and hence EBIT margin in 2023. Will EBIT margins recover back towards 37%? Well, you’ll have to wait till tomorrow as we’ll chat about this then!

4th May 2023

Nigel Jacob CFA