Nvidia, the most valuable US semiconductor company, is in a big groove. This week, the chipmaker cut guidance from analysts’ estimates for the third time in a row in the past three months, blaming a softer economic environment and a sharp decline in demand for its gaming graphics cards.
Although some investors are hoping for a quick turnaround, I’m skeptical.
(ticker: NVDA) faces several threats, including increasing competition, an unsustainable pricing structure, and a potential glut of used crypto cards that will be difficult to overcome.
On Wednesday, Nvidia issued a forecast for the October quarter that was significantly below expectations, projecting a revenue range with a midpoint of $5.9 billion, compared with the consensus of $6.9 billion. The weak outlook came after Nvidia pre-announced another miss earlier this month when it said it would report $6.7 billion in revenue for the July quarter, against guidance of $8.1 billion in May.
Barron’s readers should not be surprised by Nvidia’s recent stumbles. In April, we warned investors about the company’s deteriorating fundamentals, citing growing game inventory at retailers, high prices and exposure to cryptocurrency mining — all risks that materialized. In the months that followed, the vast majority of Wall Street analysts missed the air pocket in demand for Nvidia products, the stock fell, and it went from steadily increasing revenue by 50% year-over-year to an estimated 17% year-over-year. -annual revenue decline in just two quarters.
On the earnings call this past week, Nvidia management said that both product prices and the number of units sold fell dramatically during the quarter. Nvidia’s stock trimmed its initial losses and closed up 4%, at $179.13, in trading on Thursday. The shares are still down around 40% this year.
The same analysts who had a Buy rating on Nvidia stock during the fall this year aren’t giving up just yet. They now believe that financial revenue estimates have been fully disclosed, and predict that new Nvidia products, expected to launch soon, will boost performance.
But the bulls are overlooking a number of significant risks. First, the negative aftermath of the crypto bust is ongoing. To recap, Nvidia’s gaming cards have primarily been used to mine Ethereum, the second largest cryptocurrency by market capitalization. While demand for mining has already spiked this year as digital currency prices have fallen, the biggest shoe still hasn’t dropped.
Ethereum is expected to migrate as soon as September from a so-called proof-of-work model to proof-of-stake, eliminating the need for graphics card-based mining. As we’ve warned, when that happens, billions of dollars worth of Nvidia cards could flood used marketplaces and create a glut. Wedbush estimates that Ethereum mining may have accounted for $800 million of the company’s quarterly revenue over the past year and a half, totaling about $4.8 billion.
Second, Nvidia’s profitability could be crushed when prices fall to more normal levels. Over the past couple of years, the company has enjoyed unprecedented demand for higher-priced cards that sold for $1,200 to $2,000, fueled by the crypto boom. It is now history. Prices and demand need to come down to a normal non-crypto driven level of $800 and below, hurting profit margins.
Veteran industry analyst Jon Peddie, who previously told Barron’s in April that the demand for more expensive cards would disappear, is still adamant that Nvidia’s high prices are unsustainable. He adds that
Advanced Micro Devices’
(AMD) next-generation graphics cards, expected later this year, will be more price competitive and gain share thanks to the innovative “chiplet” architecture.
It could be a game changer. A new era of competition from AMD may be the biggest unrealized risk for Nvidia. None of the half-dozen Nvidia analyst notes I read this week mentioned AMD as a threat, despite AMD noting that its upcoming line of cards, codenamed RDNA 3, will offer more than a 50% improvement in performance per watt compared to with the previous generation. A more efficient design would enable AMD to gain a manufacturing cost advantage over Nvidia.
In an interview with Barron’s, Nvidia Chief Financial Officer Colette Kress says the company is “unable to quantify” the negative demand impact from crypto miners and the eventual Ethereum proof-of-stake transition. When asked if the price of the current generation of Ampere cards is sustainable for the next, she says that Nvidia will look at market conditions at launch to set a price. On the potential for stronger competition from AMD, Kress says that while efficiency is important, Nvidia’s cards have a stronger brand with gamers and dominate rankings for the most used cards on gaming services. She also expresses confidence that partnerships with game publishers and Nvidia’s more advanced software will help it beat the competition.
While Kress may have some points, I agree with Peddie that AMD will take business from Nvidia.
The setup is eerily reminiscent of four years ago, when this column was bullish on a similar performance-per-watt advantage, at the time, for AMD’s Roma server processor against the dominant market leader
(INTC). AMD went on a multi-year rampage fueled by Rome, quintupling its stock price and surpassing Intel in market capitalization.
It could happen again, this time in playing cards against Nvidia. Better price-to-performance products are everything in technology.
Finally, even after its share price stumbled this year, Nvidia’s valuation looks expensive, as earnings estimates have also fallen. The chipmaker now trades at 48 times expected earnings per share for the next four quarters, which is nosebleed territory for a company expected to show negative growth in the immediate future.
Ultimately, given the risks, it’s too early to be optimistic about an Nvidia turnaround. The worst is probably yet to come for the chip.
Write to Tae Kim at firstname.lastname@example.org