Nvidia Stock: The Market is in Denial (NASDAQ: NVDA)

justin sullivan

Over the past two years, NVIDIA Corporation (NASDAQ: NVDA) and Advanced Micro Devices, Inc. (AMD) both performed much better than expected due to strong demand for processors and graphics processing units that was fueled by an unprecedented global pandemic and a simultaneous boom in cryptocurrency mining. While selling GPUs is only part of Nvidia’s business, the pre-publication of second quarter results strongly indicate that Nvidia’s growth and margins have peaked. Going forward, I expect a continued slowdown in revenue growth and gross margins and for this reason I sold my Nvidia shares!

Nvidia: FQ2’23 pre-release was a horror show

The first warning that the PC market is in a much worse state than expected came from Intel (INTC) not long ago when the company presented a terrifying outlook for fiscal year 2022 due to slower shipments. of pc. According to consulting firm Gartner, the global PC market contracted by 12.6% in Q2’22 and CPU and GPU makers are starting to feel the pain, including Nvidia.

Nvidia on Monday provided preliminary results for its fiscal second quarter that showed a dramatic deceleration in the chipmaker’s growth. Companies typically submit preliminary results to notify the market of significant changes in their operating and financial conditions, and that’s exactly what happened here.

Nvidia announced a 17% revenue shortfall – compared to the company’s forecast in May – and now expects to report revenue of $6.7 billion versus $8.1 billion +/- $162 million for FQ2’23. Along with a significant deceleration in Nvidia’s revenue growth, the company is also witnessing a massive and simultaneous collapse in its gross margins…a strong indication that the current expansion cycle is ending and Nvidia’s margins have peaked. According to Nvidia’s May forecast, the company expected to generate a non-GAAP FQ2’23 gross margin of 67.1% +/- 50 basis points. Nvidia’s preliminary results show a non-GAAP gross margin of just 46.1%… which is a huge and totally unexpected 21 PP decrease in margins from Nvidia’s forecast just three months ago. The implication is that the PC market is falling much faster than expected and this could lead to severe price weakness for Nvidia’s GPU products in the future.

Nvidia: preliminary results FQ2'23

Nvidia: preliminary results FQ2’23

The slowdown in Nvidia’s revenue growth is mainly due to the gaming segment, which depends on strong sales of Nvidia-branded graphics cards such as the RTX 30 series, which enjoy huge popularity among gamers. Nvidia’s Gaming segment saw a 33% decline in revenue compared to the prior year period and is only expected to bring in $2.04 billion in revenue for FQ2’23. Due to declining gaming revenue, the data center business now generates nearly twice as much revenue as gaming…a segment that data centers only surpassed in FQ1’23.

Nvidia: Preliminary Segment Performance FQ2'23

Nvidia: Preliminary Segment Performance FQ2’23

Gaming revenue is now Nvidia’s second largest business after data centers in terms of dollar contributions, so a slowdown in that segment is seriously clouding the company’s growth prospects. The drop in gaming revenue is tied to lower PC shipments as well as a rapidly easing GPU supply shortage that pushed graphics card prices to record highs last year. Graphics cards are used by gamers, designers but also cryptocurrency miners who use GPUs to mine digital assets. With cryptocurrency prices collapsing in 2022, demand for GPUs has normalized, and it looks like the drop in GPU sales – and accompanying deterioration in pricing power – is worse than expected.

Nvidia’s RTX 30 prices fell to 0.91x the manufacturer’s recommended retail price in July and fell from a high of 3.20x in May last year. GPU prices have been falling for over a year now, but I’m surprised by the unexpected drop in Nvidia’s second-quarter gaming revenue, which also points to a massive drop in average GPU selling prices.

wccftech.com: GPU Price Trend

wccftech.com: GPU Price Trend

Why is the game slowing down?

Three factors began to weigh on the PC market in Q2: (1) PC demand peaked during Covid-19 and PC sales hit a 20-year high in Q1’21. Consumers upgraded their gear during the pandemic to prepare for remote work and study, which now reduces the need for additional gear upgrades; (2) cryptocurrency prices have crashed, limiting demand for dedicated GPUs for mining; and (3) inflation is likely causing consumers to be more careful about how they spend their money. The three factors combined could continue to weigh on Nvidia’s gaming business for some time to come.

The market is in denial

The speed of Nvidia’s declining revenue and gross margin growth is a huge warning that things are about to get worse. This definitively and completely invalidates my arguments regarding a potential revenue acceleration this year.

Research firm Gartner recently reported that it expects a continued slowdown in the PC market for fiscal 2022, which could lead to a total market contraction of 7.6%. AMD also warned that the PC market was declining faster than expected, leading the company to submit a disappointing Q3’22 forecast.

Due to Intel and AMD submitting much weaker forecasts than expected, Nvidia’s hand was forced to pre-release FQ2’23 results. Based on Nvidia’s preliminary results, I suspect Nvidia’s gross margins peaked in the first quarter of 2023 and won’t return to the 60% level for quite some time. Nvidia’s gross margins have increased for five consecutive years due to strong demand for the company’s processors and GPUs.

Nvidia: Gross margins for fiscal year 2018-2022

Nvidia: Gross margins for fiscal year 2018-2022

After the release of preliminary results, the market is poised to see some serious declines in revenue and EPS. What may make matters worse is that Nvidia has about two weeks left before officially presenting the results of FQ2’23, which creates huge uncertainty and negative sentiment for Nvidia.

Nvidia shares only slipped 6.3% yesterday, which I don’t think is a percentage that does justice to the extraordinarily steep drop in revenue and gross margins.

Earnings estimates have already started to drop, but it could get significantly worse from here.

Chart
NVDA Revenue Estimates for Current Year Data by YCharts

Nvidia’s EPS estimates for this year and next are also down sharply…

Chart
NVDA EPS Estimates for Current Year Data by YCharts

Risks with Nvidia

The biggest risk, of course, is a continued slowdown in revenue at Nvidia’s Gaming-led business. A widespread decline in Nvidia’s segments poses a big challenge for the company, but also for the stock, as it was primarily assessed based on Nvidia’s revenue growth prospects and the possibility of expansion of the gross margin. What would change my mind about Nvidia is if the company reports a reversal in gross margins as well as a rebound in revenue growth over the next few quarters.

Final Thoughts

Nvidia shares fell just 6.3% after a devastating release of preliminary FQ2’23 figures. The market denies the rapid pace of the PC market downturn and the extent to which Nvidia is affected by it. I sold Nvidia yesterday due to three factors: (1) Nvidia’s revenue growth is seriously slowing; (2) Gross margins contracted by 21 PP compared to forecast, indicating that a cyclical downturn has begun; and (3) Nvidia is experiencing large-scale revenue issues, particularly in the games market where the company is likely to experience significant weakness going forward. After the pre-publication, the risk profile has fundamentally changed, and it is no longer on the upside!

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