Consumers are reeling from the impact of inflation, which is hovering near 40-year highs, and interest rates that are climbing with each passing month. Given that harsh reality, it isn't surprising that gamers are putting off big-ticket purchases, which include upgrading to the latest and greatest graphic processing units (GPU) from Nvidia (NVDA -0.74%).
Until recently, the gaming segment has historically represented roughly half of Nvidia's sales. Since the beginning of this year, however, it has taken a back seat to the data center business, which represents sales of semiconductors and other gear used for cloud computing, artificial intelligence (AI), and data centers. When the company reported its latest results, this trend continued, helping save Nvidia investors from what could have been a far-more troubling fate.
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It's the economy!
For Nvidia's fiscal 2023 third quarter (ended Oct. 30), the company generated revenue of $5.9 billion, which sank 17% year over year and 12% sequentially. The decline weighed heavily on Nvidia's bottom line, as adjusted earnings per share (EPS) of $0.58 fell 50% year over year. But the good news is that it actually improved 14%, compared to the second quarter.
For context, analysts' consensus estimates were calling for revenue of $5.8 billion and EPS of $0.71. While sales were better than expected, profits continued to suffer.
The biggest factor weighing on the results was gaming revenue, which declined 51% year over year and 23% sequentially, as demand for Nvidia's high-end gaming processors slumped. CFO Colette Kress cited both macroeconomic headwinds and COVID-19 lockdowns in China for the hit to consumer demand.
Another factor weighing on sales was a glut of processors previously used in cryptocurrency mining. The wide-ranging and ongoing crash in cryptocurrency prices has made the process less profitable, forcing some miners out of business and flooding the market with their used Nvidia processors.
As a result of the aforementioned issues, Nvidia is working its way through a surplus of current inventory as it prepares to release the next generation of its cutting-edge GPUs. The launch is scheduled for next year.
Cloudy skies
Robust growth in the data center segment helped counter weakness in the gaming segment. Revenue grew 31% year over year, with broad-based demand across cloud computing and consumer internet companies. There were challenges, however.
In early September, the U.S. government levied new restrictions on the sale of high-end processors to China -- specifically those used for AI, high-performance computing, and data centers. Management estimated this would result in a $400 million hit to revenue.
True to form, Nvidia's engineers got right to work redesigning its processor to fall within the guidelines of the new regulatory restrictions, thereby minimizing the damage. The company has already started shipping the revamped processor to Chinese customers.
Nvidia also announced a host of new partnerships and collaborations that will help drive demand for its processors far into the future. One such alliance is a multiyear collaboration with Microsoft. This will deploy tens of thousands of Nvidia processors to help enterprise-level businesses "train, deploy and scale AI, including state-of-the-art models, through Microsoft Azure," the company's cloud-computing platform.
Nvidia also inked a deal with Oracle to bring Nvidia's full accelerating computing stack to Oracle Cloud. This will deploy tens of thousands of additional processors and accelerators.
A light at the end of the tunnel?
For the upcoming fourth quarter, Nvidia forecast an uptick in sales, guiding for revenue of roughly $6 billion, which is comparable to Wall Street's expectations of $6.1 billion. Management is also forecasting a return to more robust adjusted gross margin of 66%, which should help improve the company's profits.
Nvidia's current woes are almost entirely the result of macroeconomic headwinds that are completely out of its control. That said, management isn't resting on its laurels. It's completing a redesigned processor for Chinese customers that meets U.S. government guidelines, while simultaneously ramping up for delivery of its next generation of processors. CEO Jensen Huang said these semiconductors form "the foundation of our next phase of growth."
As the industry leader providing cutting-edge processors used in both gaming and cloud computing, Nvidia is well-positioned to rebound quickly once the economy recovers. The headwinds have taken a toll, however, driving Nvidia stock down 52% off last-year's high. This has forced the stock's valuation to its lowest level in years.
Some investors might balk at paying 13 times next-year's sales, when a "reasonable" price-to-sales ratio is between 1 and 2. I would argue, however, that it's a bargain price for a best-in-breed company that generated record results just before the economic downturn started.
For these reasons and many more, Nvidia stock is a buy.
