All eyes will be on NVIDIA Corporation (NASDAQ:NVDA) when it reports its Q3 results after the market close tomorrow, November 16, 2022. Semiconductor companies around the world have been hurt by subdued consumer demand, and investors will be watching Nvidia’s development closely Revenue was depressed during the quarter. But in addition to simply tracking financials, investors might also want to keep an eye on inventory purchase commitments, segment financials, management’s stance on normalizing channel inventories, and revenue prospects for the upcoming quarter. These points will give us clues as to where Nvidia and its stock could head next. Let’s take a closer look.
Measurement of demand dynamics
First, let me say that Nvidia’s top executives have stayed at the forefront of innovation, aggressively releasing industry-leading products time and time again. As a result, they have revolutionized various segments of computing and have grown their business at a rapid pace over the past decade. But this time, there is great uncertainty about just how strong consumer demand really is, as inflationary pressures and rising interest rates weigh on disposable incomes for consumers around the world. Therefore, the first task for investors should be to assess Nvidia’s inventory planning in its upcoming earnings report.
We can do this by monitoring Nvidia’s purchase commitments. This is the dollar value of all cancelable and non-cancellable contracts that the company has placed with its suppliers. If Nvidia’s management anticipates a quick resumption of demand, they may not cancel or postpone their existing purchase commitments. However, if the company’s top executives suffer a significant revenue slump, they will likely cancel or postpone some of those commitments to be financially prudent and avoid an unprecedented inventory build. So this metric essentially reflects the amount of financial risk Nvidia’s management is taking.
You see, overall demand for computer products and peripherals has been weak for other similar companies. Intel (INTC) and Advanced Micro Devices (AMD) for example, investors have warned of weak selling momentum. AMD has even slashed the prices of its Ryzen 7000-series CPUs by up to 100% 27% which were released just a few weeks ago to stimulate demand again. So it’s only natural that Nvidia will also face similar headwinds in Q3 and Q4, prompting management to scale back purchase commitments. However, if the number of purchase commitments remains stable or increases, this is of concern as it would present the possibility of oversupply in the coming months.
There was also an unconfirmed one report However, Nvidia wanted to cut orders at its chip manufacturing partner Taiwan Semiconductor (TSM). That makes sense — if demand dynamics are slowing, then it’s financially smart to reduce cancellable contracts and reduce the risk of unnecessary inventory builds. Needless to say, I think, but a drop in commitments to buy inventory will confirm that the sales slump is deepening, and shareholder returns will remain subdued for the foreseeable future, at the very least. So pay close attention to Nvidia’s inventory purchase commitments.
Twofold impact on revenue
Now let’s turn our attention to Nvidia’s finances. The chipmaker classifies its revenue into 5 reporting segments namely Datacenter, Auto, Gaming, Professional Visualization and OEM/IP. Of these, the data center business is the largest revenue driver, accounting for nearly 57% of the company’s total revenue last quarter. Even more interesting is that this revenue stream has grown sequentially for 14 consecutive quarters, which is a commendable achievement and an enviable position for any mature company.
But this time, I expect a small setback in Nvidia’s data center revenue. I say this because companies around the world have been cutting discretionary spending and postponing expansion plans until we’re past the recessionary period. Therefore, Nvidia will naturally see order cuts from its customers during these tough macroeconomic times. At the same time, there is a growth catalyst to mitigate this decline.
A few weeks ago, US regulators imposed an export ban on certain Nvidia and AMD data center chips destined for China. I have argued that both chipmakers would find a way to serve these concerned data center customers in China, as these foreign companies would try to quickly build up an inventory buffer and be willing to pay top dollar until they found a way out of the dilemma. This scenario appears to be playing out exactly as I predicted.
Nvidia artificially reduced the data throughput of its affected A100 chips 33%, renamed it the A800 to circumvent US export restrictions and continue its sales to Chinese companies. So I expect the emergence of this new catalyst for growth will mitigate the sales slowdown caused by broader macroeconomic weakness around the world. As far as estimates go, I’m guessing that Nvidia’s data center revenue was down 5% sequentially and was $3.61 billion in the third quarter.
Nvidia’s gaming division is the second-biggest driver of revenue, accounting for about 30% of the company’s total revenue in the second quarter. With the crypto crash deepening, consumers’ disposable incomes declining around the world, and Nvidia’s new budget GPU offerings just weeks away, there’s no standout catalyst to mitigate the negative impact on this business. So I’m expecting Nvidia’s third-quarter gaming revenue to decline 30% sequentially, with the actual number coming in at about $1.4 billion.
Finally, the remaining three segments — auto, OEM/IP, and professional visualization — are immaterial to the company’s overall revenue, as they averaged just about 4% of Nvidia’s total revenue last quarter. There are no material catalysts that would change the status quo and/or cause a major turnaround in any of these revenue streams in the near future. As such, I expect each of these segments to post a 10% sequential revenue decline in Q3.
That brings us to a companywide third-quarter revenue estimate of about $5.81 billion, which would represent a year-over-year decline of 18.1% and a sequential decline of 13.3%. Coincidentally, my estimate falls within the Street’s consensus volume estimates ranging from $5.5 billion to $6 billion.
That said, we also need to keep a close eye on Nvidia management’s revenue outlook, consumer demand forecasts, and product strategy for the fourth quarter. In particular, look for references to:
- how they plan to prioritize production across different product lines to mitigate the sales slump,
- Do they plan to throttle production until older stockpiles are destocked,
- Do they plan to lower prices like AMD did to rekindle consumer demand?
Nvidia shares are trading at more than 13 times their trailing 12 months. This is an exorbitant number, both on its own and in relative terms. There are several other semiconductor companies that are growing revenue faster than Nvidia but are trading at much lower price-to-sales multiples. So, I contend that Nvidia’s Q3 earnings report and the accompanying slump in sales will encourage investors to wonder why the stock deserves such a heavy premium and will also trigger a stock sell-off.
But on the key points, investors should keep a close eye on Nvidia’s purchase commitments, segment financials, and management’s outlook for the upcoming quarter in the Q3 report. These points will better highlight how Nvidia has been impacted by the global macroeconomic turmoil, and will likely influence where NVDA shares head next. Much luck!