Nvidia Stock: Expect a pullback (NASDAQ: NVDA)

justin sullivan

Nvidia (NASDAQ: NVDA) had a very bad quarter and its outlook was not much better, while its shares are still trading at a very high valuation. Long-term investors should wait for a pullback as a lower share price is justifiable short term.

Background

As I’ve explained in previous articles, I’m bullish on NVIDIA over the long term due to its highly exposed business profile to several secular growth trends, making it an excellent choice for long-term investors in the semiconductor industry.

However, the short-term outlook has turned much more negative in recent months as the semiconductor industry faces a downturn, one of which NVIDIA is obviously not immune to. The company had already warned investors a few weeks ago that last quarter revenue was below expectations, so a weak report was already expected regarding the second quarter of fiscal 2023.

Since I haven’t covered NVIDIA since last November, I think now is a good time to revisit its investment record and look at its most recent earnings, to see if NVIDIA is still a good long-term investment in the theme of investing in semiconductors, or whether the global economic downturn is affecting company fundamentals.

Analysis of the results of the second quarter of fiscal 2023

NVIDIA released its fiscal 2023 second quarter results yesterday, reporting revenue in line with expectations, while its EPS was able to beat by a slight margin, as seen in the following chart. NVIDIA has a long history of beating market estimates, but this quarter was particularly weak, showing that the semiconductor industry continues to be exposed to economic cycles, and weak electronics sales large public and PC is also hurting NVIDIA’s growth.

Q2

Surprise earnings (Bloomberg)

NVIDIA’s revenue was $6.7 billion last quarter, representing only a 3% year-over-year increase and a 19% decline from the prior quarter, a severe slowdown in growth over a relatively short period. Indeed, in the first quarter of FY2023, NVIDIA reported 46% year-over-year revenue growth, showing that revenue growth has collapsed very rapidly over the past three months through 31 July 2022.

The decline in its earnings is even more severe than the drop in revenue in the quarter, given that GAAP EPS was $0.26, down 72% year-on-year and 59% quarter-on-quarter. This clearly shows that this was a weak quarter for the company, which was largely unexpected, as operating trends remained resilient in the prior quarter and the company’s outlook was for revenue of around 8 .1 billion in the second quarter. This means that NVIDIA did not anticipate such a rapid slowdown and missed its own prospects by a long shot.

Beyond weak revenue growth, another factor that significantly affected its earnings was the decline in gross margin, which was just 43.5% in the second quarter, down 22 percentage points from compared to the previous quarter. This is justified by an inventory write-down of $1.22 billion, a temporary setback due to changing market conditions, as NVIDIA expects its long-term profitability to remain the same.

The segment that accounted for this weak performance is mainly gaming, which recorded revenues of $2.04 billion (down 44% quarter-on-quarter and 33% year-on-year), due to weak market conditions . Investors should note that both Intel (INTC) and Advanced micro-systems (AMD) were also hit by weak PC sales and gaming revenue, but NVIDIA is clearly the hardest hit chip company here. This weakness is most likely also related to the crypto winter and lower demand for GPUs from crypto mining companies, but since NVIDIA does not disclose the revenue it derives from crypto mining, it does not is not possible to quantify the company’s income. lost this quarter due to this effect.

Another segment that saw weak numbers was professional visualization, which recorded revenue of $496 million in the second quarter, down 4% year-on-year and 20% quarter-on-quarter, due to lower demand from business customers.

While gaming and professional visualization posted a weak quarter, on the other hand, NVIDIA’s automotive segment and data center continued to show positive momentum. Automotive recorded revenue of $220 million, representing an increase of 45% year-on-year and 59% quarter-on-quarter, and data center was another positive segment with an increase in revenue of $220 million. $3.81 billion in business (up 61% YoY and 1% QoQ), although Data Center was somewhat below. company expectations due to supply chain issues.

Expenses were up 36% year-on-year to $2.4 billion, driven by higher salaries and R&D. Considering falling revenue and rising expenses, it’s no surprise that NVIDIA’s net income fell 72% year-over-year to $652 million. Despite these lower earnings, NVIDIA maintained its strategy of returning excess capital to shareholders, which amounted to some $3.4 billion during the quarter through share buybacks and dividends.

While recent trends were pretty lackluster, the operating outlook isn’t much better given that NVIDIA’s guidance for the third quarter of fiscal 2023 wasn’t particularly optimistic. The company expects to post revenue of around $5.9 billion, down 12% QoQ, with weakness again coming from the same segments (gaming and professional visualization) which are not expected to be offset by strength in automotive and data centers. Gross margin will return to a more “normal” range of 62-65%, and capital expenditures are expected to be between $550 million and $600 million.

I consider this earnings and outlook to be very poor, as revenues are heavily impacted by its games division, which doesn’t seem to be solely related to high inventories ahead of new releases. While it’s true that NVIDIA will be launching new chips in the coming months and some of the demand may be temporarily pushed back, the magnitude of the revenue drop is too severe and may be indicative of a bigger impact. hard from the economic downturn that NVIDIA, and the market, expected just a month ago.

As can be seen in the following chart, consensus estimates called for revenue of around $8.5 billion in the third quarter, while this was quickly revised down to $5.9 billion (red line) . This is a drop of around 30% over a very short period of time, which may be more than just a seasonal effect and may take some time to recover as new products come to market and stocks balance out.

Q2

Revenue revisions (Bloomberg)

Going forward, NVIDIA should maintain strong operational momentum in data center and automotive, two segments less exposed to economic cycles, but gaming is key to a recovery from recent weakness. Nonetheless, the Street is expecting revenue for fiscal year 2023 of just $27.1 billion, whereas in my last article I was expecting revenue in excess of $31 billion. This clearly shows that NVIDIA’s growth prospects have dimmed, at least in the short term.

Estimates & Valuation

While NVIDIA has reported strong operational momentum over the past few years, this profile has completely changed over the past quarter due to weakness in its gaming segment. This also happened in 2018 when crypto prices crashed, which shows that NVIDIA still has quite a lot of exposure to this market, although it’s not possible to quantify it as the company doesn’t disclose the revenue from crypto mining.

Nonetheless, the company’s long-term outlook remains good as its business gradually shifts from gaming to other segments that have good secular growth prospects, such as artificial intelligence or self-driving.

Indeed, as far as medium-term estimates are concerned, NVIDIA’s revenue is still expected to grow by around 13% per year, over the next four years. This is still a high growth rate, but well below the 20% per year expected at the end of 2021. NVIDIA is now expected to grow revenue to over $43 billion by FY2026, so that in November, the street forecast $56 billion in revenue. Its net income is now expected to be nearly $16 billion, also lower than the $20 billion expected a few months ago.

Q2

Revenue estimates (Bloomberg)

Unsurprisingly, falling revenue and earnings estimates have driven the stock price down, but its valuation has also been devalued in recent months, as has happened for most growth stocks. As can be seen in the following chart, NVIDIA’s forward earnings ratio has been quite volatile over the past year, with a peak valuation of over 60x in November and a trough of 25x in June. Currently, NVIDIA is trading at nearly 42 times forward earnings, a slight discount to its historical two-year average.

Q2

Valuation (Bloomberg)

That seems like a somewhat high valuation for a company that reports weak trends and offers a very bleak outlook, so the risk-reward proposition for its stocks appears to be more biased to the downside.

Conclusion

NVIDIA is a formidable company and the long-term growth prospects are supported by several secular growth trends, including data centers, AI and autonomous vehicles. Despite this, its business is still largely exposed to gaming, which is showing weakness and should not recover any time soon.

For long-term investors, I still consider NVIDIA a big player in the semiconductor industry, but I’m not a buyer at current prices. Its valuation is quite high, and this does not seem justified by the company’s current results. Therefore, I think it’s best to wait and buy more stocks during pullbacks, as a lower stock price may be warranted in the short term to reflect NVIDIA’s weaker growth outlook. .

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