Nvidia FQ2 2023 – The hangover

Crypto gives Nvidia a big headache.

• Nvidia reported difficult results and soft guidance as the hangover from the crypto party continues to be a big headache.
• FQ2 2023 revenues / EPS were $6.7bn / $0.51 in line with revised guidance but well below its forecasts made three months ago (see here).
• As expected, the main culprit was Gaming where revenues fell by 44% QoQ and 33% YoY.
• Although data centre and automotive grew well, they could not overcome the sudden decline in Gaming, which forced Nvidia to warn so suddenly.
• The good news is that the 25.4% point hit to gross margins was caused by $1.22bn in charges for inventory, unused fab manufacturing capacity, provisions taken against weaker future demand and a $122 provision for warranty reserves.
• If I take these out, I end up with gross margins of 63.5% which is close to the levels that the company has recently enjoyed.
• Therefore, I expect that gross margins will bounce back in FQ3 2023 but there is going to be pressure from the sudden fall in demand which looks set to continue into FQ3 2023.
• Nvidia has taken this into account in its guidance where it is expecting FQ3 2023 revenues / gross margins of $5.9bn / 62.4% (+/- 50bp).
• This is below the already reduced FQ3 2023 revenue consensus of $6.92bn and the shares fell by 9.2% on 26^th August although this was doubtless exacerbated by the so-called “hawkish” speech from Federal Reserve chairman Jay Powell.
• The biggest problem is that Nvidia has no real idea how much of the demand for graphics cards it has enjoyed in the last 12 months has been due to the crypto craze which is now solidly in full-scale crash territory.
• This is because it sells its chips into the channel and not directly to end users and so it can’t tell how much of its silicon goes into mining rigs and how much into games machines.
• My suspicion for a long time has been that a big piece of this demand has come from mining rigs but many of the miners are now unable to make money thanks to the rising price of energy and falling crypto valuations.
• This combined with the crash in sentiment towards Bitcoin and its peers as well as some high-profile collapses has put crypto into a deep freeze and there is no knowing when it is going to emerge.
• Hence, a lot of miners are now looking to exit and are putting their graphics cards into the second-hand market which is depressing prices and demand for new cards.
• The poor macro outlook has also had an impact, but the suddenness of the correction as well as anecdotal data points from the crypto industry leads me to believe that the majority of this is due to the crypto crash.
• The silver lining here is that this means that the core markets of gaming, AI, data centre and automotive continue to fare reasonably well and that the long-term outlook for Nvidia remains largely unchanged.
• Hence, the investment case all comes down to valuation and unfortunately, Nvidia’s valuation remains too high compared to its peers.
• Assuming a FY2024 recovery to $40bn in revenues and $5.50 per share, the company is still trading on a FY2024 PER of 30.0x and an EV / Sales of 10.0x.
• In this environment and with the outlook that Nvidia has given, this is still too high and so I think the share price is going to continue to struggle to make headway.
• This is where the defensive nature of Nvidia’s competitors plays in their favour as Qualcomm and MediaTek are also seeing slower growth, but their valuations are far less demanding at around 14.0x 2023 PER and they are outperforming as a result.
• Hence, I am more than comfortable to stick with the defensive end of the semiconductor sector safe in the knowledge that the market is likely to give me an opportunity to get interested in Nvidia once again.