Nvidia Inc. (NVDA, Financial) produced blowout revenue growth and earnings on February 21 for its quarter ending Jan. 31. Quarterly sales were up 265% from a year ago and up 22% quarterly.
But the AI chip maker's results were also impressive due to its huge free cash flow (FCF) margins. The company said it generated $11.2 billion in FCF during its latest fiscal quarter ending Jan. 28. That represents 50.8% of total revenue of $22.1 billion.
In other words, over half of all its sales went straight into its checking account after all cash expenses. This includes all of capex spending, which was lower by $217 million in the quarter, as well as net changes in its working capital needs.
It's very possible that if these huge FCF margins continue, the stock could be worth substantially more, as much as 48% more. This article will discuss how that could occur, based on FCF margin and FCF yield metrics.
Free Cash Flow Margins
This huge margin was significantly higher than last quarter when Nvidia made just $7.04 billion in free cash on $18.12 billion in revenue. That worked out to an FCF margin of just 38.9% compared to this quarter's 50.8% FCF margin.
This is clearly the result of operating leverage. That happens when a company's sales improve dramatically and its cash expenses don't rise commensurately. As a result, its cash profits are jacked up or leveraged higher.
This is due to the tremendous demand for Nvidia's AI chips, especially for use in data centers. The company's data center revenue was up over 409% to $18.4 billion, or over 83% of total revenue. For example, last quarter its data center revenue was $14.5 billion, or 80% of sales.
Moreover, this is a truly astounding FCF margin for a tech company. Only a few tech companies, such as Palantir (PLTR, Financial) have generated over 50% of their sales as free cash flow. I recently wrote an article in GuruFocus about this company.
This high FCF margin has huge implications for Nvidia's target price based on analysts' sales forecasts.
Forecast FCF and Target Price
For example, analysts now forecast that for the year ending Jan. 2024, sales will reach $104.5 billion and $121 billion by Jan. 2025. That implies that sometime in the next 12 months (NTM) the company will be on a run rate revenue forecast of at least $112.75 billion.
So, we can apply a 50% FCF margin, assuming Nvidia's latest 50.8% margin lowers slightly each quarter on average. That implies that the company will generate over $56 billion in FCF (i.e., $112.74b x 0.50 = $56.375b).
That is substantially higher than the company's quarterly $11.2 billion in FCF this past quarter (i.e., an annual run rate of $44.8 billion). This has huge implications for the company's stock price.
FCF Yield Metric Implies Nvidia Stock is Worth Much More
For example, what if the company decided to pay out a dividend with all of its free cash flow? After all, its capex spending requirements are more than covered by the cash flow it generates.
Rather than have the cash pile up on its balance sheet Nvidia might want to reward shareholders. Nvidia does pay a dividend but it only costs the company $99 million. If it were to pay out all the $56 billion in dividends, what would happen to NVDA stock?
NVDA would likely have at least a 2.0% dividend yield, and more likely a 1.0% dividend yield.
In other words, the FCF yield can be used to value Nvidia's market valuation. For example, if we divide $56.375 billion by 2.0%, the potential market capitalization of Nvidia would be $2,819 billion. Dividing by 2.0% is also the same as multiplying by 50x (i.e., 1/0.02 = 50), so if we multiply $56.375 billion x 50, the market cap would be $2.819 trillion.
Price Target
This market cap is 47.5% higher than today's market cap of $1.911 trillion. In other words, NVDA stock could be worth 47.5% more than its price of $778 per share, or $1,147.55 per share.
And if the stock were to eventually have a 1.5% FCF yield, its market cap would rise to $3,758 billion (i.e., $3.76 trillion). That is 97% over today's price.
Keep in mind that this assumes that Nvidia will continue to generate huge 50% FCF margins over the next 12 months and during 2025. That depends on its huge operating leverage. This could falter if the company's capex spending rises substantially. But so far, there are no indications that will happen.
Analysts are reviewing the company's finances, especially its huge FCF margins. They may come to the same conclusion that Nvidia is worth substantially more.
