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Even after the stock price has fallen 40% this year, Nvidia’s valuation looks expensive.
Sam Yeh/AFP via Getty Images
Nvidia, the most valuable US semiconductor company, is in deep trouble. This week, the chipmaker cut its guidance from analysts’ estimates for the third straight time in the past three months, blaming a soft economic environment and a sharp slowdown in demand for gaming graphics cards.
While some investors are optimistic about a quick recovery, I am skeptical.
Nvidia
(brand: NVDA) faces multiple threats, including increasing competition, an unsustainable pricing structure, and a potential inflation of used crypto cards that will be difficult to overcome.
On Wednesday, Nvidia gave a forecast for the October quarter that was significantly below expectations, projecting a revenue range averaging $5.9 billion, compared to the consensus of $6.9 billion. The weak outlook came after Nvidia announced another loss earlier this month, when it said it would report revenue of $6.7 billion for the July quarter, up from $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 rising retail gaming inventory, increased prices, and exposure to cryptocurrency mining—all risks that played out. In the months that followed, the vast majority of Wall Street analysts missed demand for Nvidia products, the stock plummeted, and it went from steadily growing revenue at a 50% year-over-year rate to a 17% year-over-year forecast. -Revenues for the year decreased in just two quarters.
On the earnings call last week, Nvidia management said both product pricing and sales numbers fell dramatically during the quarter. Shares of Nvidia recovered early losses and closed up 4% at $179.13 in Thursday trading. Shares are still down about 40% this year.
The same analysts who had a Buy rating on Nvidia stock during its decline this year aren’t giving up just yet. They now believe that the financial profit estimates have been completely belied, predicting that new products from Nvidia, which are expected to be released soon, will boost its performance.
But the bulls are overlooking a number of important risks. First, the negative consequences of encryption failure continue. To recap, Nvidia’s gaming cards have primarily been used to mine Ethereum, the second largest cryptocurrency by market capitalization. While mining demand has already skyrocketed this year as digital currency prices have fallen, the biggest shoe still hasn’t dropped.
Ethereum is expected to move from a so-called proof-of-work model to proof-of-stake in September, negating the need for graphics card-based mining. As we’ve warned, when that happens, billions of dollars of Nvidia cards could flood the used markets, creating 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, for a total of about $4.8 billion.
Second, Nvidia’s profitability may be limited as prices fall to more normal levels. Over the past two years, the company has enjoyed unprecedented demand for higher-priced cards selling from $1,200 to $2,000 due to the cryptocurrency boom. This is now history. Pricing and demand should drop to a normal non-crypto-based level of $800 and below, hurting its margins.
Veteran industry analyst Jon Peddie, who presciently said Barron’s In April that demand for higher-priced cards would disappear, he remains adamant that Nvidia’s increased pricing is not sustainable. He adds that
Sophisticated Micro Devices’
Next-generation (AMD) graphics cards, due later this year, will be more price-competitive and gain share thanks to their innovative chip architecture.
This could be a game changer. A new era of competition from AMD may be Nvidia’s biggest underestimated risk. None of the half-dozen Nvidia analyst notes I read this week mentioned AMD as a threat, despite the fact that AMD has gone on record as saying that its upcoming line of cards, codenamed RDNA 3, will offer more than 50% improvement in performance per watt compared to the previous generation. A more efficient design will allow 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 impact on demand from crypto miners and the eventual transition to proof-of-stake Ethereum. When asked if the pricing for current-gen Ampere cards is sustainable for the next, he says Nvidia will look at market conditions at launch to determine pricing. On the potential for stronger competition from AMD, Kress says that while efficiency is important, Nvidia’s cards have a stronger brand name with gamers and dominate the rankings for cards most used in gaming services. He’s also confident 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 over the 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 Rome server processor over the dominant market leader
Intel
(INTC). AMD went on a multi-year rally fueled by Rome, quintupling its share price and overtaking Intel in market value.
It could happen again, this time in gaming cards against Nvidia. The best value for money products are everything in technology.
Finally, even after its share price has fallen this year, Nvidia’s valuation looks expensive as its earnings estimates have also fallen. The chipmaker now trades at 48 times expected earnings per share for the next four quarters, which is bleeding territory for a company expected to show negative growth in the foreseeable future.
Ultimately, given the risks, it’s too early to be optimistic about a turnaround for Nvidia. The worst is likely yet to come for the king of chips.
Write to Tae Kim at tae.kim@barrons.com
