High-flying chipmakers NVIDIA (NVDA +0.64%) and Micron Technology (MU +3.86%) came crashing to the ground in the second half of 2018, thanks to a big change in end-market conditions. While NVIDIA lost an important catalyst that had been driving up sales and prices of graphics cards, memory industry oversupply finally caught up to Micron after two years of massive stock market gains.
However, both companies believe that the slowdown won't last for long. NVIDIA predicts that graphics card sales will rebound in a quarter or two, once the existing channel inventory clears out. Micron is singing a similar tune, pointing out that its customers are already adjusting inventory levels to account for the recent drop in memory prices. But which of these two stocks is more likely to walk the walk and make a quick turnaround? Let's find out.
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The case for NVIDIA
Check out the latest NVIDIA earnings call transcript.
NVIDIA's near-term outlook is concerning, as its revenue is expected to drop year over year in the current quarter. This has spooked investors, who had grown used to seeing solid double-digit increases in revenue and earnings from the company. However, NVIDIA management has made it clear that the company is witnessing a post-cryptocurrency-frenzy hangover that has caused a graphics card glut, and it shouldn't be a problem in the long run.
NVIDIA seems to be on point when it says that channel inventory will get leaner over the next couple of quarters. While the supply of pre-owned graphics cards is on the rise, this has forced graphics card retailers to slash prices to move inventory. Once this inventory is cleared out, NVIDIA looks all set to bounce back for a couple of reasons.
First, demand for PC gaming hardware is expected to keep growing. Jon Peddie Research predicts that sales of gaming PCs will increase by 9% between 2017 and 2021, expanding NVIDIA's addressable market.
Furthermore, as of early 2018, 30% of NVIDIA's installed user base was using graphics cards based on the Pascal architecture, while the remaining 70% were on older architectures. Now that NVIDIA has launched the next-generation Turing architecture with advanced technologies like ray tracing, its existing user base can be expected to begin upgrading to the new GPUs.
Moreover, NVIDIA controls nearly three-quarters of the discrete graphics card market, so it is in a solid position to take advantage of this market's secular growth. At the same time, investors shouldn't forget that the company is doing really well in other segments, such as data centers, and could also mint big money from emerging opportunities like self-driving cars.
Micron's case isn't that strong
Check out the latest Micron Technology earnings call transcript.
The problem with Micron is that its customers have stopped buying memory chips in anticipation of a drop in prices. Memory customers stocked up on Micron's chips when prices were on the rise, hoping to lock in lower rates to avoid paying higher prices in the future. But with memory prices now trending lower, those customers are in no hurry to buy Micron's memory chips.
This dynamic has created a supply glut. Memory industry players were originally planning to boost capacity to capitalize on rising prices, but those plans are on hold for now as the industry has effectively gone into oversupply mode. Micron expects revenue of $6 billion this quarter and a gross margin of 50%-53%. Those figures represent massive declines from the prior-year period's gross margin of 58.1% and revenue of $7.35 billion.
Micron believes that customers will work through their existing inventories within two quarters. The memory specialist seems to expect that everything will be back to normal once that happens. However, that would be easier said than done, as Micron isn't the biggest fish in the pond.
There seems to be a general consensus among memory suppliers that supply needs to be controlled to avoid a glut. That's why industry leader Samsung is reportedly going to curtail output in 2019, while second-place SK Hynix also plans to lower its capital spending this year thanks to weak smartphone sales and low Chinese demand.
Micron has toed the line of its bigger rivals and plans to reduce capital expenses by 13% in fiscal 2019 as compared to last year. But the problem is that Samsung and SK Hynix together account for nearly three-quarters of the dynamic random-access memory (DRAM) market. Clearly, Micron's rivals enjoy greater control over supply and pricing, so Micron might find it difficult to scale up its production quickly in case demand eventually increases.
It's also possible that the memory industry will remain oversupplied thanks to several headwinds: weak GPU demand (as outlined earlier), a fading smartphone market, and the ongoing inventory correction. These problems could pose a big headache for the industry by triggering a 15% to 25% drop in DRAM prices this year, according to DRAMeXchange.
Micron's DRAM segment accounts for 68% of its total revenue, so the possibility of sustained memory oversupply spells bad news for the company.
The verdict
There are two basic differences between Micron and NVIDIA. While the former plies its trade in a cyclical industry, the latter operates in a market with secular growth. Second, NVIDIA leads the discrete graphics card market by a mile, while Micron is the smallest of the three major memory industry players.
Moreover, NVIDIA's path toward a turnaround is more predictable, both because of the expected increase in PC gaming hardware sales and because it has other fast-growing segments to fall back on. But Micron has to contend with several variables on both the demand and supply fronts and doesn't really have a revenue stream beyond memory chips. That's why NVIDIA looks like the better turnaround bet of the two.
