Nvidia: Triple Play Not Enough To Justify $3.6T Valuation (Rating Downgrade)

Summary:

• NVIDIA Corporation surpassed Q3 FY2025 expectations with $35.1B in revenue and $0.81 EPS, driven by strong Data Center segment performance.
• Despite robust results, concerns linger over supply constraints for Hopper and Blackwell GPUs, and ongoing gross margin contraction.
• Nvidia’s stock remains overvalued at $145 per share, with a 5-year expected CAGR of ~3.4%, falling short of my investment hurdle rate.

Introduction

In my article “Magnificent 7 Are Alive And Well, But A Rest Is Inevitable,” I foresaw a robust Q3 FY2025 report from NVIDIA Corporation (NASDAQ:NVDA) (NEOE:NVDA:CA):

Over the past two to three decades, “Mag-7” tech conglomerates have continuously delivered disruptive innovation and proven themselves to be growth compounding engines. Today, each of these businesses rake in annual revenues of more than $100B; however, scale isn’t holding back growth due to past re-investments. Now, the capital allocation at “Mag-7” companies has undoubtedly shifted towards capital return in recent years, aggressive re-investments continue – with CAPEX to Revenue for this group ranging from 10-20% [Apple is an exception] and R&D to Revenue ranging from 5-30%.

As you may know, a huge chunk of this big tech CAPEX spending is going towards GenAI infrastructure – GPUs and long-lived real estate leases, especially in the case of cloud infrastructure providers, i.e., Amazon [AWS], Alphabet [Google Cloud Platform], and Microsoft [Azure]. And based on management commentary, this AI rush is set to continue in 2025:

• Hyperscaler capex forecasts to hit $300B in 2025: Morgan Stanley

In addition to unlocking GenAI capabilities for other organizations, these tech giants are using these resources to improve their existing products and services. For example, Alphabet and Microsoft are redefining the Search market with GenAI-powered user experiences, Meta is using Gen-AI across its Family of Apps to boost ad performance and spending billions on Reality Labs to build the next big computing platform, and Tesla is attempting to solve vehicle autonomy using a cluster of 100,000+ GPUs.

Now, given its dominant positioning in the GPU market, Nvidia is receiving almost all of this CAPEX spending as revenue!

And, with the AI spending boom still in full swing, Nvidia’s upcoming Q3 2024 report on 20th November is likely to be robust.

How Did Nvidia Fare In Q3 FY2025?

With Nvidia reporting $35.1B in revenues (up +94% y/y, vs. est. $33.1B) and $0.81 in normalized EPS (vs. est. $0.75) for Q3 FY2025, I think it is fair to conclude that the semiconductor behemoth eased past consensus street estimates on top and bottom-line estimates.

In Jensen Huang’s words –

The age of AI is in full steam, propelling a global shift to NVIDIA computing. Demand for Hopper and anticipation for Blackwell — in full production — are incredible as foundation model makers scale pretraining, post-training and inference.

AI is transforming every industry, company and country. Enterprises are adopting agentic AI to revolutionize workflows. Industrial robotics investments are surging with breakthroughs in physical AI. And countries have awakened to the importance of developing their national AI and infrastructure

While Nvidia’s quarterly gross margin moderated to 75% in Q3 FY2025, hypergrowth in Data Center revenues [$30.77B, +112% y/y] continued unabated as “Compute” revenues soared to $27.64B [+132% y/y] on the back of strong demand for Nvidia’s Hopper GPUs, totally overpowering a -15% q/q decline in “Networking” revenues.

Given the outsized weight of Nvidia’s Data Center segment within the business, Gaming, Professional Visualization, and Automotive segments seem irrelevant at this point; however, each of these segments saw healthy y/y growth in Q3 FY2025.

Now, buoyed by its robust Q3 performance and strong demand for both Hopper and Blackwell, Nvidia’s management have provided above-consensus sales guidance of $37.5B for Q4 FY2025 — completing Nvidia’s 8th consecutive triple play, i.e., “double beat and raise” quarter.

That said, Nvidia’s Q4 revenue guide did fall short of buy-side whisper number of $39B, and the semiconductor giant expects ongoing gross margin contraction to continue next quarter, with Q4 non-GAAP GM expected to land at 73.5%, down from 75% in Q3.

And as I said in one of my previous reports,

Nvidia’s gross margins contracting to a low 70% level could be an indication of deteriorating pricing power [despite Nvidia’s plan of generating SaaS revenues with Blackwell GPUs].

Source: Nvidia Q1 FY2025: AI Party Rolls On, But I Refuse To Dance.

Now, lately, we have seen reports about “overheating” issues tied to Blackwell servers. However, as per Nvidia’s latest quarterly report, Blackwell production remains on track, with shipments set to begin in Q4 FY2025 and ramp in FY2026. Furthermore, Huang & Co. called out “supply constraints” for both Hopper and Blackwell, dismissing concerns around near-term demand outlook despite projected revenue growth deceleration.

That said, the semiconductor industry is cyclical in nature, and Nvidia’s largest customers — cloud hyperscalers [50% of revenues] — are building their own in-house AI chips and partnering with other players [like Advanced Micro Devices (AMD)] in the industry. Hence, I think Nvidia’s medium-to-long-term demand [growth and margins] remains questionable.

If you have been following my work on Nvidia, you know that I do not hold a long position in this counter. While my opinion could still have an element of a bias, I am flabbergasted by Nvidia’s aggressive stock buybacks, which rose to $11B in Q3:

Yes, Nvidia is experiencing a massive AI windfall right now, with Q3 FCF reaching a record high $16.78B and “cash and short-term investments” soaring to $38.5B. However, if and when the historical cyclicality associated with semis strikes again, stock buybacks at ~20x FY2025E revenue [or ~$3.6T market cap] will look absolutely horrendous. I would rather see Nvidia stockpiling cash through this period (if no better use of capital is possible) ahead of the next down cycle in semis.

Concluding Thoughts: Is NVDA Stock A Buy, Sell, Or Hold After Q3 Earnings?

In light of Nvidia’s Q3 FY2025 report, I am updating my valuation model’s revenue base to FY2025E revenue of $130B [baking in a $1.5B sales beat on management’s guidance for Q4 FY2025]. All other assumptions have been held constant from our last assessment and are self-explanatory, but if you have any questions, please share them in the comments section below.

Here’s my updated valuation model for Nvidia:

Nvidia Corporation remains the most obvious “picks and shovels” play in the AI gold rush; however, a lot of future success is already baked into Nvidia’s current stock price, with TQI’s fair value estimate of $80.45 per share pointing to a downside of -45% from current levels.

More importantly, Nvidia’s long-term risk/reward [derived from aggressive assumptions for long-term growth, future margins, and exit multiples] as measured by 5-year expected CAGR return has deteriorated down to 3.44%; well under risk-free treasury yields of 4-4.5%. In the past, I have rated Nvidia a “Hold;” however, with NVDA now being less attractive than risk-free treasuries, I now view it as a tactical “Sell.”

Key Takeaway: I rate Nvidia a tactical “Sell” in the $140s.

Thanks for reading, and happy investing! Please share your thoughts, questions, or concerns in the comments section below.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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