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Even after its share price has tumbled 40% this year, Nvidia’s valuation looks expensive.
Sam Yeh/AFP via Getty Images
Nvidia, the most valuable semiconductor company in the US, 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 softening economic environment and sharp delay in demand for its gaming graphics cards.
While some investors are hoping for a quick turnaround, I’m skeptical.
Nvidia
(ticker: NVDA) faces multiple 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 gave a forecast for the October quarter that fell well short of expectations, projecting a midpoint revenue range of $5.9 billion, compared with the consensus of $6.9 billion. The weak outlook came after Nvidia pre-announced another pass earlier this month when it said it would report revenue of $6.7 billion for the July quarter, down from estimates 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 rising game inventories at retailers, increased prices, and exposure to cryptocurrency mining—all risks that have materialized. In the coming months, the majority of Wall Street analysts missed the air pocket in the search for Nvidia products, the stock tanked and went from consistently growing revenue at a 50% annual rate to forecasting a 17% annual revenue decline in just two quarters.
During last week’s earnings call, Nvidia management said that both product prices and the number of units sold fell dramatically in the quarter. Shares of Nvidia pared early losses and closed up 4%, to $179.13, in Thursday trading. The stock is 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 financial earnings estimates are completely undervalued, predicting that new products from Nvidia, expected to be released soon, will improve its performance.
But the bulls are ignoring a number of significant risks. First, the negative effects of the crypto crash continue. To recap, Nvidia’s gaming cards have mostly been used to mine Ethereum, the second largest cryptocurrency by market capitalization. Although mining demand has already decreased this year as digital currency prices have fallen, the biggest shoe has yet to drop.
Ethereum is expected to migrate as soon as September from the so-called proof-of-work model to proof-of-stake, negating the need for graphics card-based mining. As we warned, when this happens, billions of dollars worth of Nvidia cards could flood the used markets, creating a glut. Wedbush estimates that Ethereum mining could account 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 collapse as prices fall to more normal levels. Over the past few years, the company has enjoyed unprecedented demand for higher-priced cards selling for $1,200 to $2,000, driven by the crypto boom. That’s history now. Pricing and demand will have to fall to a normal non-crypto level of $800 and below, which will hurt profit margins.
Veteran industry analyst John Peddy, who presciently said Barron’s in April that demand for higher-priced cards would disappear, remains adamant that Nvidia’s increased prices are unsustainable. He adds that
Advanced Micro Devices’
(AMD) next-generation graphics cards expected later this year will be more competitively priced and gain share thanks to their innovative chiplet architecture.
This can be a game changer. A new era of competition from AMD could be Nvidia’s biggest underappreciated risk. None of the half-dozen Nvidia analyst notes I’ve read this week mention AMD as a threat, despite the fact that AMD has announced that its upcoming lineup of cards, codenamed RDNA 3, will offer more than a 50% performance boost 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 CFO Colette Kress says the company is “unable to quantify” the negative impact on demand from crypto miners and the eventual transition to Ethereum proof-of-stake. When asked if the pricing of the current generation of Ampere cards is sustainable for the next, she says Nvidia will look at market conditions at launch to determine pricing. On the potential for stronger competition from AMD, Kress says that while performance is important, Nvidia’s cards have a stronger brand among gamers and dominate the charts for the most used cards in game services. She also expressed confidence that partnerships with game publishers and Nvidia’s more advanced software will help beat the competition.
While Cress may have some points, I agree with Paddy AMD will take business from Nvidia.
The setup is eerily reminiscent of four years ago, when this column was bullish on a similar per-watt performance advantage, at the time, for AMD’s Rome server processor against the dominant market leader
Intel
(INTC). AMD began a multi-year revolt fueled by Rome, raising its stock price fivefold and surpassing Intel in market value.
It could happen again, this time in gaming cards against Nvidia. Better value for money products are everything in technology.
Finally, even after its share price has collapsed this year, Nvidia’s valuation looks expensive as its earnings estimates have also collapsed. The chipmaker now trades at 48 times expected earnings per share for the next four quarters, which is bloody territory for a company expected to show negative growth in the near term.
Ultimately, given the risks, it’s too early to be optimistic about Nvidia’s turnaround. The worst is probably yet to come for the chip king.
Write to Tae Kim c [email protected]