Justin Sullivan
NVIDIA Corporation (NASDAQ:NVDA) just released their Q2 financials, and boy was it ugly! We already knew that revenues and gross margins were going to be down dramatically from the pre-announcement 2 weeks ago. Revenues were $6.7 billion, down 19% sequentially, and GAAP gross margins dropped 22 points from 65.5% to 43.5% sequentially. As I predicted, GAAP earnings per share fell off a cliff to $0.26, down 59% sequentially.
Management also guided for Q3 revenues to continue downwards to $5.9 billion-down almost 1/3 from just a few months ago in Q1.
Beyond the headline numbers, there were some land mines strewn throughout the disclosures and on the earnings call. We’ll focus on the big ones here.
Gaming and Professional Visualization Lines May Have Been Mostly Crypto
During the earnings call, CFO Kress indicated that the Gaming and Professional Visualization lines would be down again more than 30% sequentially in total. The guidance indicates the two lines would combine to be around $1.7 billion. This would be down from $4.24 billion a few months ago in Q1-a stunning decline of over $2.5 billion, or 60%.
As I pointed out recently, the Gaming and Professional Visualization lines were wildly inflated by cryptocurrency mining demand. Now that Ethereum is not going to use GPUs to mine anymore, that demand to mine Ethereum is gone permanently. It appears that revenues from these two lines may have been mostly due to mining demand. CEO Huang indicated that the Gaming and Professional Visualization lines would face inventory issues for multiple quarters, despite the inventory charges realized in Q2.
In addition to the loss of sales, CEO Huang also indicated that margins would be lower without crypto demand due to a shift in mix to lower-end cards. This supports the thesis I presented earlier as well, indicating lower earnings power in the business.
Gaming and Professional Visualization Lines May Have Negative Growth Past Two Years
Eight quarters ago, the Q3 FY21 Gaming and Professional Visualization lines totaled to $2.5 billion. With management guiding for Q3 to be around $1.7 billion total for those two lines, the business will have actually declined over the last 2 years. Negative growth is not the kind of thing people paying 56 times trailing earnings want to see.
Data Center Warning Flags
In the CFO Commentary, management disclosed that $1.22 billion of the charges in the quarter were partially attributed to a reduction in expectations of demand for Data Center.
The $1.22 billion charge for inventory and related reserves is based on revised expectations of future demand, primarily relating to Data Center and Gaming. The charge consists of approximately $570 million for inventory on hand and approximately $650 million for inventory purchase obligations in excess of our current demand projections, and cancellation and underutilization penalties.
Management declined to elaborate on how much they expected demand to decline for Data Center from their prior expectations.
The CFO Commentary also disclosed that the Data Center line benefitted from a pull-in of $287 million in orders from Q3. Without this pull-in, the Data Center line would have been down 7% sequentially.
Just like with the Gaming and Professional Visualization lines, it’s possible that Data Center has been inflated the past few years by some temporary demand factors that may start to slow down. We will have to watch and see.
Analysts Starting to Doubt Management
I was surprised to hear the analysts on the earnings call begin to ask tough questions of management. Analysts have been cheerleaders for the company for years. But to my ears, the tone definitely changed this quarter.
An analyst questioned why management blamed supply chain problems for the poor quarter when the company has performed very well over the past two years when supply chain problems were rampant throughout the industry. The analyst pointed out that supply chain problems have improved recently. It is also curious that they had supply chain problems but yet were also able to pull-in a large amount of their Data Center revenue from Q3.
I also believe analysts were skeptical about how the guided Q3 margins and revenues would be possible without further charges to reduce inventory costs and improve sell-through.
I also heard questions from analysts expressing concern about Data Center demand going forward. And concern about how low the Gaming and Professional Visualization lines would be once crypto mining demand is gone.
Other Warning Signs
Management emphasized they were working to decrease inventory in the channel. However, they also disclosed that inventory was $3.89 billion compared with $2.11 billion a year ago and $3.16 billion a quarter ago. It will be more difficult to move the increased amount of inventory now that demand has fallen off a cliff. Perhaps more product discounts will be required.
Management indicated they were working to cut costs but disclosed that they expected full-year non-GAAP operating expense to grow by over 30%. Increased costs will hurt earnings even more when combined with reduced sales.
Nosebleed Valuation
Using the market closing price before the Q2 release, NVDA is trading at 56 times trailing GAAP earnings. This is a very high earnings multiple for a company experiencing declining earnings and an uncertain future. Analysts asked a number of questions on the earnings call about what demand will look like going forward.
As EnerTuition recently pointed out, over the past 4 years, NVDA has not grown very much despite the hypergrowth narrative that has driven the stock price. From Q3 FY 2019 revenues of $3.1 billion to the $5.9 billion guided for Q3 FY 2023, corresponds with a CAGR of 17.5%. It is difficult for some to realize this because of the massive crypto and COVID bubble in the middle that drove temporary demand. Bet let’s generously assume that sustainable growth increases to 20%, and assign a 20x multiple to earnings. For a firm that just announced GAAP earnings of $0.26 per share, and non-GAAP EPS of $0.51, a 20 multiple could put the stock around $40 using the higher non-GAAP result – very, very far below recent trading levels.
Even if someone is bullish on the firm and believes that sustainable earnings are double what the firm just reported, doubling the higher non-GAAP EPS and applying a generous 20x multiple yields an $80 share price – still very, very far below recent trading levels.
For comparison, peer company Advanced Micro Devices, Inc. (AMD) has grown at a much faster rate (85% CAGR last 2 years) and is trading at only 21x 2022 estimates.
There is simply no reasonable justification based on current business conditions to justify a $440 billion market cap.
Owning NVDA appears to be a shaky proposition at this point. I rate NVDA a strong sell.
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