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from Nvidia (NASDAQ: NVDA) consistent execution, expanding computing platform ecosystem, and partner landscape are not being fully recognized by Wall Street. I believe this company will generate above-market returns for the next three to five years on average due to its one-of-a-kind accelerated computing platform and ecosystem. This company is mislabeled and misunderstood when it is pigeonholed by investors as a high-priced semiconductor stock.
Nvidia is the first full-stack accelerated computing platform for clients. It is a company that is a hybrid of hardware, software, and artificial intelligence that spans four main business units: gaming, data center, professional display, and automotive. I think the media and some investors are not taking into account the full total addressable market that these areas of opportunity will present to Nvidia. We’ll explore how Nvidia’s computing platform creates a flywheel effect for exponential revenue, earnings growth, and shareholder returns. But first, we need to acknowledge the gamble, the failed execution, and the challenges the company had in the second quarter of FY23.
The Impact of Missing Your Forecast
Nvidia delivered total revenue of $6.7 billion, which was 19% less sequentially and just 3% more year over year. This was significantly below the $8.1 billion outlook they provided on their previous earnings call in the first quarter of FY23. This drop in performance and lack of expectations was primarily due to the large lack in revenue. of the $2.04 billion game, which decreased 44% sequentially. The lack of overall performance in the second quarter can be attributed in part to weak earnings in Europe, related to the war in Ukraine and the COVID-19 lockdowns in China.
For example, hyperscale customers in North America nearly doubled their revenue year over year, but this was not the case in other regions internationally. The data center business grew 61% year over year to a record $3.81 billion. But this also fell short of Nvidia’s own expectations and was due to supply chain disruptions.
Another factor in the failure in the second quarter was the combination of underestimating macroeconomic headwinds for gaming consumers and ordering too many gaming chips to overcompensate for earlier supply chain concerns. This led to Nvidia having to take a charge of $1.34 billion in inventory, consequently reducing gross margins to 45% in the second quarter.
During the earnings call, CFO Colette Kress said:
The decline in gaming GPU revenue was steeper than anticipated, driven by both lower units and lower ASPs. Macroeconomic headwinds around the world caused a sudden slowdown in consumer demand. We have implemented programs with our gaming channel partners to adjust in-channel pricing and position the price of today’s high-end desktop GPUs as we prepare for the launch of a new architecture.
Kress later said the following on the same earnings call:
We expect gaming and ProViz revenue to decline sequentially as OEMs and channel partners reduce inventory levels to align with current demand levels and prepare for our next generation of products. We expect that decline to be partially offset by sequential growth in data centers and automotive. Revenue is expected to be $5.9 billion plus or minus 2%. GAAP and non-GAAP gross margins are expected to be 62.4% and 65%, respectively, plus or minus 50 basis points.
Risks for Nvidia and the semiconductor industry
The semiconductor industry in general can be cyclical at times and earnings can be spotty at times, especially when forecasts are miscalculated. The other potential risk with Nvidia relates to tensions between China and Taiwan escalating to the point of affecting Taiwan Semiconductor Company (TSM). TSM produces a large number of chips for Nvidia, and because of this, the company is beginning to explore expanding production with additional foundries.
Exponential performance offered by one architecture on one platform
The short-term drop in Nvidia’s performance due to the macro environment provides long-term investors with an opportunity to dollar cost average their position with a company that is innovating and impacting the healthcare, automotive, gaming, finance, entertainment, education, telecommunications, and more. Everything we do can generate some kind of data, and for that data to be actionable, solve problems, and deliver results, a computing platform is required. Nvidia has everything you could need and want for the data center from a hardware, AI, and software perspective. In fact, they even sell a supercomputer that is a data center in a box small enough to fit under your desk.
Nvidia has historically delivered amazing results for shareholders, including returns of over 300% for those who owned shares in the last three years. One of the key things to remember is that these results were mostly based on your graphics card and GPU technology, and that’s about it. Nvidia is launching new software and hardware revenue streams in 2022. Nvidia is about to launch its first data center CPU (central processing unit) called the “Grace CPU Super Chip”, and it will deliver exponential speeds and cost reductions in power per watt vs. any of the leading CPUs on the market today. This super chip also runs on all of Nvidia’s software stacks and platforms, including Nvidia RTX, HPC, Nvidia AI, and Nvidia Omniverse.
Nvidia recently released its new “Bluefield-3” DPU (Data Processing Unit) chip and plans to release a new CPU, GPU, or DPU chip every 18 months. The key to this is that these chips are much faster with each release prompting enterprise customers to upgrade their hardware much sooner than before. Now Nvidia is tying all the software offerings they have with their different chipsets, and has provided an ecosystem for their customers to adopt.
This revenue flywheel effect that the software, hardware, and AI that Nvidia creates is similar to how you would see a SaaS-based company and its net revenue expansion. Consequently, except for the recent performance in Q2 FY23, Nvidia has had gross margins consistently above 62% to 65%, which is what they are estimating for Q3 FY23. These high gross margins they are heavily impacting the net income and free cash flows that Nvidia continues to generate.
What catalysts should I pay attention to for the future of Nvidia?
I recommend paying attention to Nvidia’s automotive business as it generated $220 million in the second quarter with 59% sequential growth. Nvidia believes this will be its next business segment to achieve an annual run rate of $1 billion a year. The CFO said it best about the future of his auto business:
We believe that the second quarter was a turning point for our automotive revenue as NVIDIA Orin has a lot of momentum. During the quarter, we announced plans to launch new vehicles from OEM partners, NIO, Li Auto, JIDU and Human Horizons, as well as Pony.ai’s line of autonomous trucks and robot taxis, all built on NVIDIA DRIVE. Looking ahead, we expect our winning $11 billion automotive design portfolio to translate into continued growth.
Therefore, there is much more to come from this business segment, both in the short and long term.
Is Nvidia Stock Buy, Sell, or Hold?
If your time horizon is greater than three years and you can invest with discipline using dollar cost averaging on the position, I think Nvidia is a “must buy” to beat the market average. It is my second largest shareholding and to this day I continue to increase my position. In the short term, we could see some positive movement in the stock due to the VMware Explore Conference 2022, where Nvidia will be making some announcements, and the Nvidia GTC AI Conference 2022. Be sure to check out their website, previous GTC AI conferences, and reports from financial gains to draw their own conclusions about the stock.