S&P Upgrades NVIDIA (NVDA) to 'BBB-'; Outlook is Positive

September 7, 2016 10:49 AM EDT

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S&P Global Ratings said it has raised its ratings on Nvidia Corp. (Nasdaq: NVDA), including the corporate credit rating to 'BBB-' from 'BB+'. The rating outlook is positive.

Our upgrade of Nvidia reflects the company's success in maintaining a significant technological advantage in graphics processing unit (GPU) design and its track record of double-digit revenue growth from both core gaming end markets and adjacent applications in data center acceleration and automotive infotainment platforms. We believe Nvidia's investments in both silicon architecture as well as the software tools used to write code for the firm's hardware provide significant barriers to competitors. Nvidia is well positioned to capitalize on fast-growing emerging technologies such as machine
learning and self-driving cars, in our view.

Nvidia reported significant revenue growth in the first two quarters of the current fiscal year, with revenues for the first half 19% higher year over year. The rapidly growing datacenter and automotive end markets have contributed to the company's increasing end market and customer diversity, with second quarter revenues increasing 107% and 67% year over year, respectively. We believe that datacenter acceleration applications, where one or more GPUs are deployed alongside a traditional central processing unit (CPU) in a server to enhance performance, is a particularly promising source of long-run growth for the company. As increasingly difficult manufacturing processes have slowed the pace of CPU technology advancement, the significant performance advantages that GPUs can offer in a number of high performance computing tasks, such as training machine learning algorithms, has driven significant demand expansion.

We also expect Nvidia to sustain recent strength in the automotive market due to the increasing silicon content in automobiles. Although most of Nvidia's automotive revenues currently come from high end infotainment assemblies, we believe that the increasing use of sensor-driven driver assistance and the eventual adoption of fully-automated vehicles provide potential sources of long-term growth, although we view this market's long-term growth trajectory as less visible than that of the datacenter market.

Although we assess the risk of Advanced Micro Devices Inc. or Intel Corp. overtaking Nvidia's current technological leadership in gaming GPUs as remote, we continue to view the company's concentration of revenues from the PC gaming end market as a risk and potential threat to its growth trajectory. PC and console gaming have been cyclical industries, and top-selling mobile games targeted at casual players have become a growing competitive threat to the high-end graphics intensive titles that drive demand for Nvidia's hardware. However, widespread adoption of virtual reality headset-driven gaming could prove a catalyst for sustained growth in demand for Nvidia's GPUs due to the significant graphical processing capability required to render a virtual reality experience. This technology remains commercially unproven in consumer markets, however, despite impressive technological demonstrations, and we view the timing and rate of consumer adoption as fairly uncertain.

We expect Nvidia to remain in a comfortably net cash position over the next 24 months, as existing cash balances are more than sufficient to cover any cash outflows from upcoming convertible note redemptions. We expect the company to consistently generate over $1 billion of free cash flow annually, which should provide further support to the firm's strong credit ratios. We are projecting revenue growth to slow somewhat from approximately 20% in fiscal 2017 to the mid- to high-single-digits in fiscal 2018 and 2019 as the near term impact from the launch of the new Pascal GPU architecture abates. Still, we believe that growth could accelerate to the double-digit area in fiscal 2019 and 2020 if Nvidia is able to fully capitalize on the long term opportunity set in datacenter and automotive markets, absent a significant slowdown in gaming revenues.

We believe Nvidia will maintain adjusted leverage well below our 1.5x downgrade trigger, absent a significant unexpected change to financial policy.

The positive outlook reflects our view that Nvidia's sustainable competitive advantages and leading positions in rapidly growing end markets will support further revenue growth and business diversification. We expect Nvidia to sustain its strong credit ratios through considerable free cash flow generation and lower than historic levels of share buybacks.

We would consider an additional upgrade over the next 12 months if Nvidia is able to sustain its above-market revenue growth trajectory and recent margin expansion, while maintaining exceptional liquidity and adjusted leverage below 1.5x. We would view a growing share of revenues from end markets outside of PC gaming as a positive factor and supportive of an upgrade.

Although less likely given the company's strong liquidity and modest leverage, we are unlikely to revise the outlook to stable. However, we could lower our corporate credit rating on Nvidia if the company's fails to maintain technological leadership, diminishing its competitive position, margins, or profitability. We could also consider lowering the rating if Nvidia adopts a more aggressive financial policy, leading to leverage sustained over 1.5x.

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