August 8, Nvidia (NVDA -2.08%) shook investor confidence with a preliminary earnings announcement for the second quarter of fiscal 2023 (ending July 31). Included in that explosive announcement was the abysmal news that second-quarter revenue would only increase 3% year-over-year, primarily due to falling revenue from its gaming segment, which was in down 33% from a year ago.
Another item that worried me was this quote from Nvidia CEO and Founder Jensen Huang: “We have taken action with our gaming partners to adjust pricing and channel inventory.” This action caused Nvidia’s gross margin to drop to 43.7%, a far cry from Nvidia’s usual 60% range.
Although Chief Financial Officer Colette Kress stressed that “the company’s long-term gross margin profile is intact”, many investors wanted to see if this was true when Nvidia released its final second quarter results and gave comments. projections for the third quarter.
On August 24, Nvidia announced its final second quarter results, and while the news was mostly bad, I think there are some positives investors can take from this quarter.
Nvidia’s neighborhood was atrocious in almost every aspect but one
Unfortunately, Nvidia couldn’t find $1.4 billion in couch cushions to make up for its original projection of $8.1 billion in the second quarter. Revenues still amounted to $6.7 billion. However, its data center division continued to show incredible growth, with revenue up 61% year-over-year to $3.81 billion.
This metric shows how bad the games division had a quarterback. To be clear, consumers haven’t just stopped buying game consoles or upgrading their PCs. There is a hidden element in this segment: cryptocurrency. The graphics processing units (GPUs, Nvidia’s main product) used by gamers are the same as those used by hardware crypto miners. If you’ve been following the crypto space lately, you know how awful this year has been. This caused many miners to shut down their operations.
Since these GPUs can be used for gaming or mining, management has no visibility into the effect of crypto on their neighborhood. Although clearly, it was not positive.
As mentioned earlier, Nvidia’s margins were also squeezed in the second quarter. Gross income decreased by 31%, operating income by 80% and net income by 72%.
But management’s projections for the third quarter should give wary Nvidia investors some hope in one area.
The T3 won’t be much better overall
For the third quarter, management expects revenue of approximately $5.9 billion. It’s still not great. For context, Nvidia’s revenue in the third quarter of fiscal 2022 was $7.1 billion. In the second quarter, revenue was up another 3% year over year. In the third quarter, sales should drop 17% year over year.
However, the only silver lining in Nvidia’s projections is its gross margin. The company expects it to be 62.4%, a return to normal operating conditions. This is a good sign for investors, as Nvidia won’t be selling its products at a steep discount because there isn’t as much demand. Yet, due to reduced revenues and higher operating expenses than a year ago, earnings will also be significantly lower last quarter.
Unfortunately for investors, the pain has only just begun. Nvidia has a long road to recovery, and it’s unclear whether revenue from cryptocurrency miners captured in its gaming segment will ever return. However, with the long-term growth opportunity in its data center division, Nvidia won’t stay down for long.
It has already proven that it can bounce back from cryptocurrency headwinds (Nvidia had a huge inventory problem in 2019 caused by a crypto crash), so investors shouldn’t be too worried. However, the stock remains expensive for a company with declining revenues. At 14 times sales, Nvidia is well above its valuation in 2019 when it was working on its inventory glut.
While I remain a shareholder and believer in Nvidia, that’s probably too high a price to pay for a struggling company. I think there will be better entry points along the way, but if Nvidia exceeds its expectations in the third quarter, I expect the stock to soar just because of the state of market spirit.
However, if you think Nvidia shares represent a decade-long investment opportunity, then there’s no better time than the present to take a position in Nvidia shares, because those headwinds won’t be over. present even in three years.