Nvidia (NVDA -10.01%) had a rough outing in 2022. The graphics chip specialist experienced slowing demand as uncertainty about the economy increased during the year, which sent the stock price down 41%.
However, as the world continues to invest in artificial intelligence and advanced computing applications, Nvidia is not done growing by a long shot. Management sees a $400 billion addressable market in selling chips to data centers and gaming enthusiasts.
For the stock to rebound in the near term, investors will be looking for more stable revenue performance. There are a few reasons to be optimistic about a turnaround.
Why the worst might be over
Nvidia reported a 17% year-over-year drop in revenue in the fiscal third quarter, with gaming revenue, the company's second-largest revenue source, falling 51% year over year. Nvidia was caught with too much inventory as demand weakened. This contributed to a 72% year-over-year decline in earnings per share.
HSBC analyst Frank Lee said he believes it will take a few more quarters for Nvidia to work through the excess inventory, which is longer than the market expects. Since hitting a 52-week low of $108 a share in October, the stock rallied to $160 on the expectation that Nvidia is currently navigating through the worst of the situation.
Those expectations are based on management's comments during the last earnings report. Within the gaming segment, CFO Colette Kress said, "We believe channel inventories are on track to approach normal levels as we exit [the fiscal fourth quarter]." Kress noted "tremendous demand" for the new GeForce RTX 4090 graphics processor for gaming that launched in October.
Management is giving investors a hint of what to expect in 2023. Those who follow Nvidia might remember a similar inventory problem pressuring financial results in calendar 2019. In the fourth-quarter earnings report in February of that year, the company reported a 24% decline in total revenue. But during the conference call with analysts, management said the inventory correction was behind them and believed the business had bottomed.
Sure enough, Nvidia's revenue began to recover the next quarter. The stock hit a 52-week low at the end of 2018 and rose 76% in 2019.
While the circumstances are different this time around with respect to the economy, Nvidia has been shipping fewer gaming chips than the demand in the marketplace to bring down inventory levels in retail channels. This means even with a weak economy, Nvidia should see revenue and profitability start to recover once inventory levels are better matched with demand.
What is Nvidia's data center outlook?
As for Nvidia's data center business, it wasn't a good sign to see revenue growth slowing toward the end of 2022, but there are encouraging signs that Nvidia can keep its largest segment growing in 2023.
Some of Nvidia's largest customers, including Meta Platforms, Alphabet, and Microsoft, are still investing heavily in data centers and artificial intelligence (AI) capabilities. As the leading provider of GPU chips that are used for accelerated computing, such as AI, this is good news for Nvidia.
The data center accelerator market is expected to grow 25% per year to reach $64 billion by 2027, according to Markets and Markets. Next quarter's results will include early shipments of Nvidia's new H100 data center chip, which is expected to see strong demand as customers upgrade their hardware.
Nvidia might be in a slump right now, but the long-term growth trajectory for advanced chips is in investors' favor. For the fiscal fourth quarter, management's guidance calls for modest sequential growth in gaming, data center, and automotive, which could signal the beginning of a turnaround.
I believe Nvidia is likely moving through the worst of its slump, and the stock could finish 2023 higher than it started.
