Even after its 40% share price stumble this year, Nvidia’s valuation looks expensive.
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Nvidia, the most valuable U.S. semiconductor company, is in a big rut. This week, the chip maker cut its guidance versus analysts’ estimates for the third consecutive time over the past three months, blaming a softening economic environment and a sharp slowdown in demand for its gaming graphics cards.
While some investors are hopeful for a quick turnaround, I’m skeptical.
(ticker: NVDA) is facing multiple threats, including rising competition, an unsustainable pricing structure, and a potential crypto used-card glut 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 with a midpoint of $5.9 billion, compared with the $6.9 billion consensus. The weak outlook came after Nvidia preannounced another miss earlier this month when it said it would report $6.7 billion in revenue for the July quarter, versus its $8.1 billion guidance in May.
Barron’s readers shouldn’t be surprised by Nvidia’s recent stumbles. In April, we cautioned investors about the company’s deteriorating fundamentals, citing rising gaming inventories at retailers, elevated pricing, and exposure to cryptocurrency mining–all risks that came to fruition. In the ensuing months, the vast majority of Wall Street analysts missed the air pocket in demand for Nvidia products, the shares tumbled, and it went from consistently growing revenue at 50% year-over-year rate to forecasting a 17% year-over-year revenue decline in just two quarters.
On the earnings call this past week, Nvidia management said both product pricing and the number of units sold fell dramatically during the quarter. Nvidia’s stock pared its initial losses and closed up 4%, to $179.13, in trading on Thursday. The shares are still down about 40% this year.
The same analysts who had a Buy rating on Nvidia shares during its drop this year aren’t giving up yet. They now believe financial earnings estimates have been fully derisked, predicting that new Nividia products, expected to launch soon, will boost its performance.
But the bulls are overlooking a number of significant risks. First, the negative aftereffects of the crypto bust are ongoing. To recap, Nvidia’s gaming cards have been used primarily to mine Ethereum, the second-largest cryptocurrency by market capitalization. While mining demand has already sputtered 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, negating the need for graphics card-based mining. As we have warned, when that occurs, billions of dollars of Nvidia cards may flood used marketplaces, 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 half, totaling about $4.8 billion.
Second, Nvidia’s profitability may get crunched as pricing falls to more normal levels. During the past couple of years, the company feasted on unprecedented demand for higher-priced cards that sold for $1,200 to $2,000, driven by the crypto boom. That is now history. Pricing and demand will need to come down to a normal non-crypto-driven level of $800 and below, hurting its profit margins.
Veteran industry analyst Jon Peddie, who presciently told Barron’s in April that demand for higher-priced cards would disappear, remains adamant that Nvidia’s elevated pricing is 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 its innovative “chiplet” architecture.
That could be a game changer. A new era of competition from AMD might be the biggest unappreciated risk for Nvidia. None of a half-dozen notes from Nvidia analysts I read this week mentioned AMD as a threat, despite the fact that AMD has gone on record that its coming lineup of cards, code-named RDNA 3, will offer more than a 50% improvement in performance-per-watt versus the prior generation. A more efficient design will 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 pricing for the current generation Ampere cards is sustainable for the next one, she says Nvidia will look at market conditions at launch to set pricing. 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 to 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 Rome server processor against dominant market leader
(INTC). AMD went on a multiyear rampage fueled by Rome, quintupling its stock price and surpassing Intel in market value.
It could happen again, this time in gaming cards against Nvidia. Better price-to-performance products are everything in tech.
Finally, even after its share price stumble this year, Nvidia’s valuation looks expensive, as its earnings estimates have also tumbled. The chip maker now trades at 48 times expected per-share earnings for the next four quarters, which is nosebleed territory for a company expected to show negative growth for the immediate future.
Ultimately, given the risks, it is too early to get optimistic over a Nvidia turnaround. The worst is likely yet to come for the chip king.
Write to Tae Kim at email@example.com