Nvidia: Short-Term Headwinds, Long-Term Opportunity
Nvidia is a technology leader in high-performance GPUs for Gaming. Read why NVDA's Q2 weren't as bad as many analysts had expected.
Nvidia: Short-Term Headwinds, Long-Term Opportunity
Summary
- Nvidia is a technology leader in high-performance GPUs for Gaming.
- The company generated poor financial results for the second quarter, FY23, but they weren't as bad as many analysts had expected.
- Nvidia is facing short-term headwinds from lower gaming demand and the "crypto winter."
- The business is poised to ride long-term growth trends across Gaming, AI, Self-Driving Cars, Data Centers, and much more.
Nvidia (NASDAQ:NVDA) is a technology powerhouse that provides specialist building blocks for the gaming, data center, and even the AI industry. The company's share price has been butchered and is now down 54% from its all-time highs, which were in November 2021. Its most recent decline was driven by poor earnings results for the second quarter, but it still beat analyst expectations as they weren't as bad as expected. Nvidia is facing short-term headwinds, but in my opinion, these do not impact the long-term secular growth trends. In this post, I'm going to filter the signal from the noise and breakdown of Nvidia's Q2 earnings report and its valuation, let's dive in.
Filter the Signal from the Noise
Nvidia reported mixed financial results for the second quarter FY23. Revenue was $6.7 billion which was up just 3% year-over-year and down 19% Q/Q. This may seem terrible at first glance, but when we dive under the hood, it's clear the reasons why. Gaming revenue was $2.04 billion, which declined by an eye-watering 33% year-over-year. Again, this was driven by a combination of factors such as the tepid consumer demand for gaming which also showed up in Microsoft's (MSFT) earnings for the Xbox. Taking a step back, it's clear the gaming market is cyclical and had an unexpected boom over the lockdown of 2020, where the gaming market increased by 23% in value, which was the fastest rate in over a decade. So now we are just seeing a correction in demand to "normal levels", but the long-term secular trend is still clear. According to a study by PwC, the gaming market is forecasted to grow at a rapid 9% Compounded Annual Growth Rate [CAGR] between 2021 and 2026, reaching ~$321 billion by the end of the period.
Due to the secular growth trends, I expect Nvidia's gaming revenue to start to grow again longer term. Intel (INTC) has the largest market share in the Graphical Processing Unit (GPU) industry with ~60% market share. But Nvidia and AMD are leading in "high performance" GPUs which are necessary for gaming. Diving into the chart below, it's clear to see Nvidia [light blue] had just 15% of the overall GPU market in Q1,21 but by Q1,22, the company had a substantial 21% of the market, while Intel's market share got squeezed.
The second major factor which caused a large decline in Nvidia's gaming revenue was the "Crypto correction". It has been wildly known that a portion of Nvidia's GPUs are bought and used for Bitcoin mining. But with the price of Bitcoin plummeting, it is just not economical to mine bitcoin for most people. But this cyclical trend is not something new for Nvidia, and we saw the same boom in "Gaming" revenue during the first crypto bull market of 2017. A slight difference this time is many miners are now using ASICs or (application-specific integrated circuits). In addition, Ethereum is switching to a proof-of-stake model, as with the Proof-of-Work model, the cryptocurrency uses as much power as the Netherlands [yes, the country!] to validate its blocks.
Therefore, if we combine, a boom in gaming and a boom in crypto at the top of the cycle, we are now just seeing the cycle reverse. I expect the gaming market to rebound and continue to grow strong following the secular trend. I believe the crypto revenue may not bounce back as high due to the aforementioned reasons. But there are other positive secular trends such as the growth in video editing, driven by the popularity of YouTube and video-based social media apps, which also require high-powered GPUs.
Nvidia's management has used this decline to execute inventory adjustments and "pricing programs" with channel partners. My best guess is these are a series of discounts to help sell old inventory, which will impact the company's margins, but it would be better than holding expensive inventory. The company has also announced a series of Gaming laptops and Monitors, which really will help expand the company's total addressable market.
As someone who runs a large YouTube channel [Motivation 2 Invest] where I interview CEOs and Hedge Fund Managers, video editing is a prime purpose I need high powered computing for. My extensive research online brought me to Nvidia GPUs which are usually sold inside high-powered $3000+ laptops such as the Dell XPS. But with Nvidia's venture into laptops, it now may make more sense to purchase directly from Nvidia, which would effectively enable them to capture more value from its products. After all, the most complex and important parts of any PC are the GPU and CPU, the other components can generally be purchased from many manufacturers cheaply.
Data Center Boom
Nvidia is not just a gaming company, its Data Center segment is rapidly growing with strong industry tailwinds. Nvidia generated $3.81 billion in Data Center revenue for Q2, which was up just 1% Q/Q but increased by a blistering 61% year-over-year. The recent quarter-over-quarter decline was down to "supply chain disruptions," according to management. But in my opinion, this may also have been driven by a short-term slowdown in IT spending due to the macroeconomic conditions [discussed in the risk section]. However, it's great to remember the long-term secular trend is up. The Data Center market is forecasted to grow at a blistering 21.98% CAGR between 2021 and 2026. Over this period, an extra $615 billion is expected to be added to the market value. Large companies are "digitally transforming" their IT operations to the cloud. This is for a few reasons which include more "agility" and the ability to lower costs long term, as you only pay for the computing power you need. The boom in data centers is already showing up across the board in other companies' earnings reports, such as Amazon (AMZN), where AWS is its fastest growing and most profitable segment.
Nvidia's expertise in Artificial intelligence is also another major advantage, given the AI industry is forecasted to grow by a blistering 38% CAGR between 2022 and 2030.
Metaverse?
Professional Visualization revenue for Q2 was $496 million, which did decline slightly by 4% year-over-year and 20% over the prior quarter. This decline was driven by "macroeconomic headwinds" and slowing enterprise demand. Management expects these trends to persist in the third quarter, which isn't a great sign. However, there were some positives in the quarter, which included Nvidia's expanded partnership with Siemens to enable the "industrial Metaverse" and increase the adoption of AI digital twins. This is an amazing technology that enables entire manufacturing plants to be replicated digitally, and thus, new layouts and adjustments can be made virtually before implementing inside the real factory. For example, Amazon Robotics is using Nvidia's technology to build AI digital twins of its warehouses.
Nvidia also announced its Omniverse Avatar Cloud Engine, which makes it easier to build "lifelike" virtual assistants and "digital humans" powered by AI.
The Metaverse industry is forecasted to grow at a blistering 39.1% CAGR between 2022 and 2030, reaching a value of $824.53 billion by the end of the period. Nvidia is in prime position to ride this trend as a leader in both gaming, visualization and AI. The company even co-founded the Metaverse Standards Forum, which is basically like the declaration of independence but for the Metaverse. Nvidia even created a "Virtual CEO" for its GTC keynote, which was switched seamlessly with the real person and the majority of people didn't even notice.
Automotive Revenue Growth
Nvidia's automotive segment generated $220 million in the second quarter and popped by 45% year-over-year and a rapid 59% over the prior quarter. This is a small but fast-growing segment with a huge market opportunity across self-driving vehicles. Nvidia's hardware for self-driving cars called "DRIVE Orin" is expected to be rolled about by partners such as NIO (NIO), Li Auto (LI), JIDU, and many more. Pony.ai even plans to use the hardware for its range of self-driving trucks and robotaxis.
Profitability?
Nvidia has achieved an extremely high gross margin historically of over 65%, however, this has been compressed in the most recent quarter to 43.7%. The good news is management believes its "long-term gross margin profile remains intact".
Nvidia's operating expenses popped by a substantial 36% year-over-year, which was driven by a one-off expense of $1.35 billion related to the acquisition of Arm, which didn't go through. Nvidia also increased the salaries of its employees (which I do not think is a bad thing long term) and also continued to invest heavily into R&D for new products. The good news is operating expenses actually decreased by 32% quarter-over-quarter which is a positive sign.
Despite declining Net income, Earnings per share was $0.26 in the second quarter, FY23, which was $0.06 better than analysts had expected.
Share Buybacks Continue
Nvidia has returned $5.5 billion to shareholders in the form of buybacks and cash dividends in the first half of fiscal 2023. The company plans to "continue stock buybacks" as the CFO foresees "strong cash generation and future growth".
Nvidia has a solid balance sheet with $17 billion in cash, cash equivalents and short-term investments, in addition, to total debt of $11.7 billion.
Moving Forward
Management expects Gaming and Visualization revenue to continue to decline sequentially next quarter as channel partners "reduce inventory levels" to "align with current demand". But the company is forecasting solid growth in its Data Center and Automotive segments.
For Q3,23, Revenue is forecasted to be ~$5.9 billion, plus or minus 2%, with a return to strong gross margins of over 62%, which is a positive.
GAAP operating expenses are forecasted to be $2.59 billion, which would represent a further ~8% increase quarter-over-quarter.
Advanced Valuation
In order to value Nvidia, I have plugged the latest financials into my advanced valuation model, which uses the discounted cash flow method of valuation. I have slashed my revenue growth forecast from previous rates of 30% to 40% to a 10% decline in revenue for next year, followed by 22% revenue growth compounded over the next 2 to 5 years. This valuation is based upon a rebound in cyclical gaming revenue and continued growth in the Data Center and Automotive segments.
I have also forecasted a 45% operating margin over the next 8 years, as the company continues to expand and benefits from greater economies of scale. This also includes an adjustment for the company's R&D expenses which I have capitalized.
Given these factors, I get a fair value of $140 per share, the stock is trading at $150 at the time of writing and is thus ~7% overvalued.
As an extra data point, Nvidia is trading at a Price to Sales Ratio [FWD] = 14.23, which is ~3% below its five-year average. Therefore, overall, I deem the stock to be "fairly valued" as the bad news for the next quarter has already been priced in.
Risks
Sales stopped in China
Nvidia has recently received a notice from the U.S. government, which has imposed a new license requirement to stop the sale of its A100 and new H100 Integrated circuits in China. This is for national security reasons as it believes the products may have a "military end user" in China and Russia. This makes sense from a security perspective, but it also means a $400 million hit to revenues that were expected to come from China in Q3,23.
Lower IT spend/Recession
A Recession has also been forecasted due to the rising interest rate and high inflation environment, which is expected to further impact consumer sentiment and reduce spending.
Final Thoughts
Nvidia is a leader in high-performance GPUs and is a technology powerhouse. The company's financials are coming off a strong high last year and the cyclical gaming and crypto industry has taken a major hit. However, the long-term trends are still intact and Nvidia's innovation is still strong. The majority of the bad news next quarter is already baked into the stock, thus, for long-term investors, the recent panic is mostly noise.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of NVDA either through stock ownership, options, or other derivatives. 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.
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Comments (50)
Including his understanding of long term semi conductor demand ...or lack of.
And boy is the long term 5 year demand dying rapidly. I am really close to semi conductor manufacturing and supply and I know the demand forecast has just been cut in half for 2024 25. Good luck anyone selling modern snake oils
You are just not exposed to how valuations are set, which is not in your control.
Semi stocks have not corrected 50% normalized to demand. They been pushed up by 300% and still over 200% valuation.
Typically things get undervalued in a downturn, but you don't need to react now. Just help validate my hypothesis as we go
Nvidia q2 @ 83.2% = 8,634,186 Nvidia game revenue $2.042 B / JPRs q1 unit volume appears to be $236 per unit and rolling R&D and MG&A back into net JPR gross is $370. I have on channel supply data $375.34 at x3 margin over cost (TMSC price to Nvidia) before pulling R&D and MG&A. Note I don't believe Nvidia price was ever x3 over cost however played with x3.63 as price over cost the Vivek Arya mystical magical $482 gross for RTX 30x0 and I do not believe that for this product line. x3.63 would mean a $684 GA102, a $430 GA 104, a $300 GA106/104 and I dismiss as not competitive.I have AMD N6x dGPU full line gross in q2 at $165.96 on all the down bin run end. AMD does not like less $180 and in q1 gross was at $257.On Nvidia channel supply data I'm getting gross $250.27 at * 1.64 margin over TSMC cost : price and $183.43 on x2 over price before the TSMC 20% 2021 price increase. $263 net is my q1 gross but less R&D and MGA = $159.99 net for 22,500,527 q1 units that is 91% more than JPRs q1. The first question is the price to the customer which on Professional Visualization side is easy because there are Nvidia board MSRPs for determining Average Weighed Price from which to pull costs but not for gaming component sales direct to board houses.My TSMC price to Nvidia is based on TSMC MC x2 = MR = P to Nvidia determined from AMD total revenue total cost assessment for processors. Nvidia price then to the board house is range x 1.5 to x 2 over TSMC price to Nvidia the basic profit maximization rule.q2 Pro Vis $1K AWP = $593.36 net < 44% from q1 same as gaming
q1 Pro Vis $1K AWP = $1150.13 netMy suspicion is on Nvidia q2 2022 gaming revenue down 44% that Nvidia pulled an Intel sales discount called Buy 1 Get 1 or Buy 2 Get 1?At * 1.64 margin over component cost (TSMC price to Nvidia) $250.27 sold in q2 12,761,655 gaming dGPUs < R&D < MG&A = net $160 each that points to Buy 2 get 1. And for Pro Visualization Buy 1 Get 1.Looking back JPR has q1 dGPU at 13,400,000 units which I divide by my channel share data;AMD q1 @ 12.4% = 1,659,176
Nvidia q1 @ 87.6% = 11,740,824 but I think it was double.On JPR method my AMD q1 dGPU is at 62.3% of 7,919,007 units fabrication ON CHANNEL SUPPLY with a quarter to go. JPR has AMD q1 dGPU share at 17% for a positive change now at 70% of my q1 7,919,007 units produced supplying through RDNA lll;AMD q1 @ 17% = 2,278,000
Nvidia q1 @ 83 % = 11,122,824JPR Board Association volume smooths from quarter to quarter where AMD production is sporadic and opportunistic swinging from vine-to-vine what fits in any quarter. What product category gets fabricated opportunistically to fill a quarterly production void. Nvidia q2 2022 GPU production by category on channel supply data;Data Center A100 Accelerator = 0.15%
CMP Mining = 0.14%
Pro Visual = 4.86%
Gaming Desktop = 64.85% (68% RTX 30x0 no Pro Vis)
Gaming Mobile = 30.0% (32% RTX 30x0 no pro Vis)q2 is a transition quarter and about cleaning out inventory at run end. The only production is next generation and I don't have the channel data to call that yet although can predict into future production volume from Turing and Ampere.
Puts AD at 11.5 M units for the second half and 13 M to 15 M units per quarter through run end at 94 M units over eight quarters. Which is 19 M units or 25% over what JPR would likely project. If a dGPU slow down can back off to 67 M units.On channel data in relation NVDA financial Camp Marketing places Nvidia GPU production in q2 at,Data Center A100 Accelerator = 1,591,882
CMP Mining = inclusive in data center
Pro Visual = 835,904 units + 54% over q1 = Buy 1 Get 1
Gaming Desktop = 8,672,277 revenue units that's equal to JPRs total
Gaming Mobile = 4,049,378 not counted dGPU by JPR but something else?JPR counts Switch as iGPU my take is Maxwell is past run end = 0
Auto / robotics = 142,834 control modules
Embedded = 964,535Total Revenue Units = 16,296,810
Sales Sacrifice Units = 11,000,000
All up = 27,296,810 Note that 11,000,000 RTX 30x0 for free at a net loss of $1.749 B is the revenue difference for gaming q2 + 5% over q1. In relation 12,721,655 combined RTX 30x0 desktop + mobile revenue units it seems like Buy 1 Get 1 got Nvidia this round.Mike Bruzzone, Camp Marketing
Crypto is gone forever and China was the catalyst for data centers. I am not saying people won't pay a premium over fair valuation, but not 140.
Ask yourself, are things better or worse when Nvidia hit it's last 52 week low of 140? I think it is obvious that things are much, much worse.
Nvidia is great at creating and maintaining some new hype.
Unfortunately they are running out of hypes and facing the reality now.
It is extremely overvalued.
Metaverse hype is a joke.