Quick Thoughts: NVDA – The Aftermath

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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Novermber 15, 2018

Quick Thoughts: NVDA – The Aftermath

  • We underestimated NVDA’s exposure to crypto. AMD gave us a warning that we should have recognized. The small miss on datacenter sales was a blindside given strong 3FQ19 capex.
  • We remain bullish on datacenter demand. Despite the miss, growth was still 58% Y/Y. Datacenter investment is notoriously lumpy, cloud opportunity is huge, and NVDA is extremely well positioned as spending shifts toward AI.
  • The traditional graphics card business is returning to basics, with Fortnite now the key driver as crypto fades away. NVDA will sell down its GPU channel inventory hitting holiday sales. We note that inventory gluts often have a hangover beyond a single quarter.
  • We would hold off on buying this drop until we can be confident that the inventory issue is settled. Long term, we believe consensus builds in an overly pessimistic deceleration of datacenter demand and would be buyers once the coast is clear.

NVDA shares traded off more than 18% afterhours on Thursday after delivering a sharp negative surprise for its third quarter sales and 4Q guidance. The naysayers on the stock will be out in force Friday, and without good news on the horizon, we expect the stock to be under pressure until its next report in February. In retrospect, AMD’s similar miss a month ago should have been the tip off that NVDA would face weakness in its PC card business. 6-months ago we estimated that crypto was about 7.6% of NVDA’s 2017 revenue (http://www.ssrllc.com/publication/nvda-ai-upside-greatly-outweighs-crypto-risks/). This new guidance is consistent with that estimate, but we didn’t anticipate it. Mea culpa.

Datacenter sales were also disappointing. Growth was 52% YoY, but we wanted more. Still, capex for the big hyperscale datacenter operations was strong in 3Q and spending by category can be very lumpy. A dip from 70% growth to 58% could easily bounce back with a vengeance in a quarter. We believe consensus expectations for further deceleration to sub 40% growth next year is far too pessimistic. The shift to the cloud continues to show great momentum, with strong growth from IaaS platforms and SaaS applications strong indicators for hyperscale datacenter capex. Within that growth, AI spending is even hotter, with NVDA the prime beneficiary. We believe datacenter AI processor spending should grow at a greater than 50% CAGR through 2022 (http://www.ssrllc.com/publication/hyperscale-semiconductors-processor-diversity-coming-to-the-cloud/). That’s the good news.

The future of the PC GPU card market is ambiguous. On one hand, low cryptocurrency prices and the dramatic advantage of ASIC powered mining rigs have clobbered that market for NVDA and AMD. While a year ago, retail card prices skyrocketed as would-be miners drained inventories, the opposite is true now. NVDA allowed supplies of its mid-range Pascal graphics cards to run ahead of demand and now must pay for it and the inventory clears at discount. Inventory gluts can be difficult to manage, and often spill past the date projected for the return to business as usual. On the other hand, Fortnite remains a phenomenon, while armies of software nerds are hard at work to catch lightning in their own bottle. E-sports could be a saving grace, but we’re inclined to be cautious for now.

We would not be inclined to buy this drop until we can be more confident that the inventory problem is just a one-quarter thing, and we don’t expect to get that confidence until holiday season results are posted in February. It would also be nice to get a comforting uptick in datacenter growth. It could be a long quarter for shareholders. Still, we expect that when this dust settles, NVDA will start to make investors very happy once again.

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