Nvidia: Risk Reward Not Nearly As Compelling Now – Reducing Rating – BMO

BMO Capital Markets’ Ambrish Srivastava, PhD is downgrading Nvidia (NASDAQ:NVDA) to Market Perform from Outperform with a $22 price target (prev. unch).

BMO notes that when they upgraded the stock, they had firmly believed that NVIDIA was an underpriced asset, with a fundamental tailwind that the market was missing. They now believe that, fundamentally,the company’s position both in its core business and in the emerging Tegra businessis fairly well understood and is now reflected in the stock.

Impact
Neutral. It’s always hard to give up on winners. And this is not an easy call for us to make either, but after having run various scenarios ranging from bullish to very bullish on several variables – Tegra, discrete GPU share, and opex, they get to extremely bullish peak earnings of $1.70, and very optimistic earnings of $1.48. Note that the last peak earnings for NVIDIA were $1.31 in FY2008 when competitor ATI was on the mat. On peak earnings, BMO thinks a 15x earnings multiple, would be more appropriate; hence, they believe the stock is now fairly valued at current levels.

What Has Happened Since?
1. Trends have continued to turn positive for the core business
2. Tegra Design Wins Have Gained Visibility and Traction
3. Valuation Not as Attractive Any More, in BMO’s View

Are they possibly leaving money on the table?
Possibly, but, BMO does not believe they are leaving tons of outperformance on the table over the next 6-12 months.

From a portfolio perspective, at around $11, the firm notes they would have made NVDA a large position. However, at current levels, they would still own the stock, but, would start to cut their position meaningfully. As BMO has laid out in their scenario analysis, even in the very optimistic scenario, where NVIDIA’s share in graphics goes back close to the prior peak level, and the company ships 40 million units in Tegra, the firm gets earnings of $1.70, and on peak earnings, they do not believe the stock will be valued higher than at a P/E of 15x. BMO believes that a more realistic “very optimistic” scenario is $1.48 in earnings. In either case, they do not believe the stock will get a higher than a 15x multiple; hence, they believe the stock is fairly valued at current levels.

Notablecalls: Ambrish Srivastava made an excellent call on NVDA back in September 2010 when the stock was trading around $11. Now, 4 months later the stock is trading at $22 and he is telling clients to cash in their chips. Well, majority of their chips.

Will people listen?

I’m betting they will. It’s not evident here in pre-market but I suspect NVDA will see sub-$23 levels today. If it breaks 23..it should go toward $22.50.

Let’s see how it works out.

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