Failure To Reiterate Annual Guidance Tells Investors A Lot About Nvidia Story
In an article published yesterday, we claimed that Nvidia (NVDA) was going to miss guidance for Q1 due to weakness across the board and would have to drop FY2020 guidance by about 10%. Nvidia’s Q1 report, on the other hand, indicated that the Company delivered a slight beat and Q2 guidance of 15% jump in revenues appeared strong.
Does that mean we misread Nvidia’s financial condition and the Company exceeded expectations?
As we go on to show in this article, appearances can be deceptive.
Lack Of FY2020 Guidance Is Telling
Let us first start with CEO Jensen Huang’s comments in the earnings press release:
“We’ve returned to growth in gaming, with nearly 100 new GeForce Max-Q laptops shipping. And NVIDIA RTX has gained broad industry support, making ray tracing the standard for next-generation gaming.
Despite the near-term pause in demand from hyperscale customers, the application of AI continues to accelerate. AI adoption is accelerating in the world’s largest industries, moving beyond the cloud to the edge where AI processing has to be instantaneous.”
However, despite this supposed growth, CFO Colette Kress had this to say:
"Our Q2 outlook is somewhat lower than our expectation earlier in the quarter, when our outlook for fiscal 2020 revenue was flat to down slightly from fiscal 2019. The Data Center spending pause around the world will likely persist in the second quarter and visibility remains low.”
In other words, Q2 is tracking below expectations compared to when they gave previous guidance and revenue visibility remains low. That should imply that the Company should reduce the annual guidance. Should it not?
But, instead, the Company chose not to provide FY2020 guidance! Repeated questions from analysts about FY2020 guidance were stonewalled other than to say that conditions remain challenging.
Management has previously given guided FY2020 to be flat or down slightly compared to FY2019 revenue of $11.7B. With Q1 at $2.22B and given $2.55B Q2 guidance, the Company needs to deliver slightly under $7B in H2 to meet its previous FY2020 guidance. That is over 40% growth from H1 to H2. This, as we go on to show, when many of the Company’s businesses are underperforming and shrinking. There is no amount of seasonality that will get the Company to this target – especially in an environment where visibility is low, and competition is increasing.
We submit that the Company needed to reduce FY2020 guidance by 10% and chose not to do it and is keeping investors in the dark.
Business Unit Performance Is Anemic
Consider how each of the Company’s business units are performing.
The gaming sector is clearly in doldrums and is now operating at pre-Q2FY18 levels.
Data Center, what was and is, the darling sector of many investors, has now stagnated for 6 straight quarters and is down on a quarter-to-quarter and year-to-year basis.
Professional visualization has also stagnated for many quarters.
Auto segment does not show much growth either and has lost its marquee customer Tesla (TSLA) in Q1. This sector is likely headed lower for rest of the year.
With this backdrop and with inventory problems not fully worked out, to hit its H2 guidance, Nvidia has to beat two of the best quarters in its history – which benefited from crypto tail winds – to even come close.
In our assessment, Nvidia’s FY2020 guidance is NOT credible.
Did Nvidia Really Beat Estimates In Q1?
Now that the guidance part is picked apart, let us consider what Nvidia delivered in Q1. To do that, let’s first take a second look at Q2 guidance.
Nvidia management guided Q2 to be $2.55B at the mid-point – that is about a 15% jump from $2.22B in Q1. While that may sound respectable, note that Q1 was depressed due to unseasonably weak quarter and inventory correction. Due to these factors, the Q1 to Q2 snapback should have been harder – especially given Nvidia FY2020 guidance. As a reference, in FY2018, prior to peak crypto bubble, Nvidia revenues jumped from $1.937B in Q1 to $2.23B in Q2. That is a jump of 15% without channel issues and unseasonably slow Q1.
On questioning by analysts, management stated that the main drivers for this 15% growth were Data Center and Nintendo Switch.
This is interesting! What happened to the commentary about strong growth in gaming driven by laptop, Turing cards, etc? (see first Jensen Huang quote in the article). Shouldn’t PCs have strong snap back from an abysmally low Q2? Shouldn’t demand for GPU cards have picked up strongly now that the channel correction is over? Current guidance is not indicative of these dynamics.
We cannot predict the upside in Data Center but we can reasonably approximate the growth for Nintendo Switch business. Based on past shipment trends Nvidia will likely ship about a million units more to Nintendo Switch in Q2 than Q1 at an ASP of approximately $65. In other words, about $65M of the upside is due to Nintendo Switch seasonal ramp. This number could be larger if Q1 Switch revenues were unseasonably lower (for reference, total contribution from Nintendo Switch in FY2019 for Nvidia was likely about $1.1B)
The data center and Nintendo switch dynamics suggest that the core gaming GPU business is not even delivering the 15% growth suggested by the guidance.
It was also telling that management refused to give guidance for gaming – their apparent “strong growth” area. Management also pointed to Intel’s CPU shortage as an uncertainty:
“In gaming, the CPU shortage while improving will affect the initial round of our laptop business.”
However, it is widely known that the widely publicized Intel CPU shortages are at the low-end where customers do not use discrete graphics cards from Nvidia. In other words, Nvidia is not impacted by these shortages. Once again, the management commentary is not credible.
What explains these inconsistencies?
We submit that Nvidia has stuffed the channel once again as it has done in previous quarters.
The evidence for this can be once again found in the AR and Inventory line items.
Notice the difference between these line items between FY2019 and FY2020.
Now consider that Q1 FY2020 revenues were $2.22B compared to $3.12B in FY2019. Inventory and AR bloat of the Company continues (although slightly reduced) despite the steep reduction in revenues.
Various channel partners and Nvidia are indicating that the inventory problem at the high end is now behind and the current inventory overhang is primarily at the low-end. If so, should we not have seen much more substantial reductions in both inventories and accounts receivables?
In our assessment, Nvidia is continuing to over produce beyond its needs causing inventory gains and is continuing to over-ship to customers and channel, especially at the end of the quarter, thus leaving it with high Account Receivables. We believe Nvidia continues to rob from the future quarters to make current quarter numbers. Without such maneuvers, we submit that our assessment of $2B in revenues would be more realistic.
Nvidia does not stand alone in these kinds of shenanigans. Intel adopted similar technique during Q1 earnings: Shift revenues to save the current quarter and sink guidance in the process. Intel paid the penalty for its guidance reset and saw a 20%+ valuation compression. (From $58 to $45).
The difference here is that Nvidia management is refusing to reiterate the fantastic guidance it provided as recently as three months back despite low visibility and a broken growth story.
With a single digit opex growth target in the face of declining revenues, Nvidia is set for much earnings misery in FY2020. Due to management refusing to provide guidance, it is unclear if the market will reward Nvidia with a 20% shave in valuation it deserves.
Regardless, we continue to maintain that the hypergrowth story for this stock is long gone and the Company is headed for a valuation reset.
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Disclosure: I am/we are short NVDA, TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.