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Earnings Outlook: Nvidia’s gambit to salvage China data-center sales, gaming-card market questioned heading into earnings

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How Nvidia Corp.’s gambit to salvage $400 million in at-risk data-center sales to China will play out and when gaming-card sales will normalize as the sector faces a crowded holiday lineup appear to be the two big questions investors want answers to this week.

Nvidia
NVDA,
+1.76%

is scheduled to report third-quarter earnings after the market closes on Wednesday.

Recently, Nvidia said that in order to avert an estimated $400 million in lost sales, it will begin selling a limited version of its A100 data-center chip called the A800, which inhibits AI and supercomputing use and thus meets U.S. restrictions for sale to China.

While Susquehanna Financial analyst Christopher Rolland said he believes Nvidia’s third quarter “has been largely de-risked” and that the fourth-quarter forecast “should have a few mitigating positives,” he noted that the China sales are still in question, even with the A800 tweak.

Rolland, who has a positive rating on the stock and a $180 price target, said that while he has a good read on the company’s gaming business, the data-center business is more difficult to predict because it’s unclear how many A800s would make up for the estimated $400 million in lost A100 sales.

Analysts surveyed by FactSet expect Nvidia to see $3.72 billion in data-center sales, or an increase of 27% from a year ago.

Read: Nvidia’s ‘China Syndrome’: Is the stock melting down?

Also not clear is when the current slump in demand for gaming cards will bottom out. Analysts are split on whether it has already done so or whether demand will hit bottom next year as the market gets flooded with new gaming cards not only from Nvidia but also from Advanced Micro Devices Inc.
AMD,
+3.63%

and Intel Corp.
INTC,
+0.31%
.

Earlier in the month, AMD launched its own next-generation gaming cards and assured Wall Street that data-center and embedded-chip sales would continue to grow, after posting a 45% rise in data-center sales to $1.6 billion versus Intel’s 27% drop to $4.2 billion. This comes as PC and consumer demand collapsed after two years of pandemic-fueled sales, contributing to a $1 billion shortfall in AMD’s third-quarter sales.

AMD’s gaming cards join new cards from Intel and Nvidia that went on sale Oct. 12. That puts a lot of inventory in the holiday channel at a time when PC shipments are dropping at their steepest recorded rates and a wave of secondhand graphics-processing units, or GPUs, are hitting the market as unprofitable cryptocurrency-mining operations fold. Bitcoin
BTCUSD,
+2.79%

is down 64% and ethereum
ETHUSD,
+1.95%

is down 66% year-to-date, putting their performance on par with the worst the S&P 500 index
SPX,
+0.31%

had to offer, including shares of Facebook parent Meta Platforms Inc.
META,
+1.28%
,
which have lost two-thirds of their value in 2022.

Just a month after its launch, Nvidia’s flagship RTX 4090 card is in stock and selling, according to more than a few online retailers suggested by Nvidia, for around $2,300, compared with the suggested retail price of $1,599. The RTX 4080, which starts at $1.199, is scheduled for release on Wednesday, the same day as the earnings report comes out, while the last-generation low-end RTX 3060 Ti is selling online for around $400 and the RTX 3080 Ti for $900.

Analysts expect $1.42 billion in gaming sales from Nvidia, or a drop-off of 56% from a year ago.

Meanwhile, the three chipmakers continue to stick their fingers into each other’s pies. Recently, AMD launched the fourth generation of its Epyc data-center processor in a bid to gain even more share from the likes of Intel in the CPU arena, which Nvidia recently entered with its own Grace CPU.

What to expect

Earnings: Of 37 analysts surveyed by FactSet, Nvidia on average is expected to post adjusted earnings of 71 cents a share, down from the $1.17 a share reported a year ago and down from the $1.33 a share expected at the beginning of the quarter.

Revenue: Wall Street expects revenue of $5.78 billion from Nvidia, according to 34 analysts polled by FactSet. That’s down from the $7.1 billion in sales in the year-ago quarter and well short of the $8.41 billion forecast at the beginning of the quarter.

Stock movement: Over Nvidia’s third quarter ended in October, shares dropped 25.7%, while the PHLX Semiconductor Index
SOX,
+2.49%

fell 19.6% over that period. Meanwhile, the S&P 500 index 
SPX,
+0.31%

declined 6.2%, while the Nasdaq Composite Index 
COMP,
+1.05%

 shed 11.3%.

Shares of Nvidia, along with the broader chip market, rallied Tuesday ahead of the report following a disclosure that Warren Buffett’s Berkshire Hathaway 
BRK.A,
+0.11%

BRK.B,
-0.07%

acquired a brand new 60-million American depositary receipt position in third-party fab Taiwan Semiconductor Manufacturing Co.
TSM,
+11.32%
,
sending those shares soaring more than 10% Tuesday, and the SOX index up 4%.

With Tuesday’s gains, Nvidia shares are down about 43% for the year, compared with a 28% drop in the SOX index, a 16% decline in the S&P 500, and a 27% fall on the Nasdaq.

What analysts are saying

In the broader data-center market, Susquehanna’s Rolland expects that AI and investment in the so-called metaverse will hold the market together.

“Additionally, hyperscale capex commentary suggests continued investment in AI, and Meta Platforms Inc.
META,
+1.28%

issued a higher capex guidance for 2023,” Rolland said. “In short, we believe gaming may have seen its bottoming in 3Q, while [data center] may still be holding together.”

Supporting his bottom call in gaming cards, Rolland said retail GPU premiums for Nvidia cards, which had been as high as 130% in mid-2021, swung to a discount 2% below suggested retail in the third quarter, and he noted that the company had been clearing out old inventory as its ramps up to the 40-series launch.

Read: Meta spending slams Facebook stock, but here are the chip stocks that are benefiting

Bernstein analyst Stacy Rasgon, who has an outperform rating and a $180 price target, he’ll leave the $400 million out of his estimates for now, even though that amount may be “too punitive” now that sales in China might not be a total wash.

“While we have fully removed China headwinds from our numbers, it seems plausible that the actual impact will not be as bad as all that given the likelihood of alternative products making up some of the gap in the near-term,” Rasgon said.

In gaming, Rasgon said the segment is “currently undergoing a flush, a new cycle is beginning and underlying demand still seems good (with new products selling out quickly and price points even on older legacy products still holding up) with fairly conservative assumptions seemingly in numbers going forward.”

Stifel analyst Ruben Roy, who has a hold rating and a $165 price target, is also unsure how much of the $400 million hole gets filled given “that potential adoption of this workaround is likely to take time.” In gaming, Roy believes the bottom process “has begun” and said that he doesn’t expect a normal run rate in gaming until the end of 2023.

Oppenheimer analyst Rick Schafer, who has a buy rating and a $225 price target, also said the A800 “needs time to prove out” and that be believes gaming will correct into the first half of 2023.

Focusing more on the wider cloud market, Jefferies analyst Mark Lipacis, who has a buy rating and a $225 price target, said Nvidia accounted for nearly 100% of new accelerator deployments since February — with the exception of June, when it was 98% — according to data from six cloud-service providers, and that its overall share in the accelerator market is 88%.

“In 2016, Nvidia’s GPUs started capturing share of Data Center compute cycles,” Lipacis said. “In aggregate, we estimate that data center processor revenues have grown at a 14% [compound annual growth rate] over the past 15 years, and we expect that growth rate to continue for the next 5 to 10 years.”

BofA Securities analyst Vivek Arya, who has a buy rating and a $205 price target, said that while he expects cloud capital spending to remain “under pressure near term,” chip stocks “remain ideally positioned to benefit from the exponential growth in computing complexity required for AI and high-speed networking.”

Arya expects demand for public cloud services to nearly triple by 2026 to $300 billion, a structural positive for his top pick Nvidia.

Of the 42 analysts who cover Nvidia, 30 have buy ratings, 11 have hold ratings and one has a sell rating, with an average price target of $188.10, a 15% premium over the current price, according to FactSet data.

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