Nvidia’s Growth in AI Chips Doesn’t Depend on China

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NVIDIA Corporation witnessed a surge in revenue during fiscal Q3 ’24, particularly in the data center sector, which grew an impressive 48% year-over-year (YoY) on a trailing twelve-month (TTM) basis. Gaming and professional visualization also returned to high-growth rates of 16% and 20%, respectively. The renaissance of generative artificial intelligence (AI) appears to be ongoing, and the growth momentum may persist as companies strive to stay competitive in managing their data lakes. Considering the growth potential, I recommend a BUY for NVDA shares, setting a price target of $666/share at 20 times my forecasted eFY25 revenue.

Despite these positive developments, an important consideration arises with challenges related to doing business with China, as outlined in the Wall Street Journal on January 8, 2024. The articles shed light on specific risks for Nvidia, including the shift of Chinese cloud companies, such as Alibaba and Tencent, away from Nvidia’s AI chips to alternatives like Huawei’s in-house developed chips. This transition could impact Nvidia’s sales significantly, with projections suggesting a reduction in exposure from 80% to 50-60% in the next five years.

Moreover, proposed tariffs on less-advanced chips could indirectly affect Nvidia’s automotive business. While only a small fraction of Nvidia’s revenue (around 2.5-3%) is linked to the automotive industry, potential increased costs in this sector might have repercussions on the sales of more advanced chips to the automotive industry.

Despite these challenges, the impact on Nvidia’s growth trajectory in the automotive sector is anticipated to be minimal. The company’s initiative to manufacture low-powered chips domestically may even lead to economies of scale, though challenges like sourcing skilled labor for foundries and increased manufacturing costs for low-dollar chips must be addressed.

Tariffs on Chinese chips and performance restrictions on chips sold to Chinese firms pose risks, as sales to China accounted for 22% of total sales in Q3’24. The data center and gaming sectors face potential challenges due to the geopolitical landscape, and competition from domestic hyperscalers designing their AI chips may intensify.

On the positive side, Nvidia sees opportunities in sovereign government bodies utilizing their chips for AI cloud infrastructure. The flexibility to sell or throttle and sell chips to foreign entities positions Nvidia well, especially as data privacy and protection laws become more stringent.

For gaming, Nvidia launched the GeForce RTX 4090 D, complying with U.S. regulations. The company continues to enhance its gaming series GPUs, introducing the AI-enabled RTX SUPER series with promising speeds and competitive pricing. Despite the anticipated seasonal decline in gaming revenue for Q4’24, the latest gaming chips are expected to sustain consumer growth.

Looking ahead to FY25, challenges related to China and other restrictive regions are expected to contribute 20-25% of data center revenue. Management believes this can be offset by sales in other countries. Although growth figures might moderate due to new competitors entering the market, the overall demand should accommodate this competition.

Considering the growth potential and the ongoing demand for Nvidia’s AI chips, the company appears well-positioned for a robust year ahead. The additional manufacturing capacity planned by Taiwan Semiconductor Manufacturing Company Limited (TSM) for CY24 should alleviate supply chain challenges, contributing to increased chip manufacturing and sales, though the full impact may be more pronounced in FY26.