On Aug. 8, Nvidia (NVDA 0.76%) shook investors' confidence with a preliminary announcement of its results for the second quarter of fiscal year 2023 (ended July 31). In that bombshell announcement was the abysmal news that Q2 revenue would only rise 3% year over year, driven mainly by the fall of its gaming segment revenue, which was down 33% from a year ago.
Another item that worried me was this quote from Nvidia's CEO and founder Jensen Huang: "We took actions with our Gaming partners to adjust channel prices and inventory." This action caused Nvidia's gross margin to fall to 43.7%, a far cry from Nvidia's usual mid-60% range.
Although CFO Colette Kress stressed the company's "long-term gross margin profile is intact," many investors wanted to see if that was true when Nvidia released its final Q2 results and gave third-quarter projections.
On Aug. 24, Nvidia announced its final Q2 results, and although the news was mainly bad, I think there are a couple of positives that investors can extract from this quarter.
Nvidia's quarter was atrocious in nearly every aspect except for one
Unfortunately, Nvidia didn't find $1.4 billion stuffed in the couch cushions to make up for its original $8.1 billion Q2 projection. Revenue still came in at $6.7 billion. However, its data center division continued to display incredible growth, with revenue rising 61% year over year to $3.81 billion.
That metric speaks to how bad of a quarter the gaming division had. To be clear, consumers didn't just stop buying gaming consoles or upgrading their PCs. There is a hidden element in this segment: cryptocurrency. The graphics processing units (GPUs, Nvidia's primary product) used by gamers are the same hardware crypto miners use. If you've followed the crypto space recently, you know just how awful of a year it's been. This has caused many miners to shut down their operations.
Because these GPUs can be used for either gaming or mining, management has no visibility of crypto's effect on its quarter. Although clearly, it wasn't a positive one.
As mentioned before, Nvidia's margins also got whacked in Q2. Gross income was down 31%, operating income was down 80%, and net income was down 72%.
But management's projections for Q3 should give wary Nvidia investors some hope in one area.
Q3 won't be much better overall
For Q3, management expects revenue to be about $5.9 billion. That's still not great. For context, Nvidia's Q3 fiscal 2022 revenue was $7.1 billion. In Q2, revenue still rose 3% year over year. In Q3, revenue is expected to drop 17% year over year.
However, the one silver lining in Nvidia's projections is its gross margin. The company expects it to be 62.4%, a return to normal operating conditions. That's a great sign for investors, as Nvidia won't be selling its products at a steep discount because there isn't as much demand. Still, because of reduced revenue and higher operating expenses than a year ago, earnings will also be significantly down from last quarter.
Unfortunately for investors, the pain is just beginning. Nvidia has a long road to recovery, and it's not clear whether the revenue from cryptocurrency miners captured in its gaming segment will ever return. However, with the long-term growth opportunity of its data center division, Nvidia won't stay beaten down for long.
It has already proven it can bounce back from cryptocurrency headwinds (Nvidia had an enormous inventory problem in 2019 caused by a crypto crash), so investors shouldn't be too worried. However, the stock is still expensive for a company with falling revenue. At 14 times sales, Nvidia is well above its valuation in 2019 when it was working through its inventory glut.
NVDA PS Ratio data by YCharts
Although I remain an Nvidia shareholder and believer, this is likely too high of a price to pay for a struggling company. I think there will be better entry points along the way, but if Nvidia blows its expectations out of the water in Q3, I expect the stock to rocket higher solely due to the market's mindset.
However, if you believe Nvidia's stock represents a decade-long investing opportunity, then there's no time like the present to take a position in Nvidia's stock, as these headwinds will not be present even three years from now.
