Nvidia Q4: Good Quarter, Still Watching Competitive Threats

Summary:

• Nvidia reported a strong Q4, driven by its data center unit and rapid AI adoption.
• Forward expectations are still high for Nvidia, and I am worried about competition.
• Management noted that gross margins may decrease after Q1. I think this could be the start of competitive pricing pressure.
• Overall, I am a hold until we learn more as the year goes on (management did not guide past Q1).

Investment Thesis

I believe that while NVIDIA (NASDAQ:NVDA), a leading force in the AI and data center chip market, produced powerful numbers in this recent quarter, investors should still take caution. Despite its impressive revenue surge, with overall revenues topping $22.1 billion in Q4 FY 2024, reflecting a strong 265% year-over-year growth, I am concerned there are emerging trends plus technological advancements from competitors like Advanced Micro Devices (AMD) and Intel (INTC) that present significant challenges to future growth at a rate that supports the current valuation multiples.

For example, AMD’s MI300X series, with its high-performance 2.5/3D chip technology, directly competes with Nvidia’s offerings, potentially reshaping the competitive landscape in data centers and AI computing. Intel’s introduction of the 5th Gen Xeon Scalable processors further pressures Nvidia, offering strong AI performance for local LLMs and efficiency at a more cost-effective price point. Finally, new in-house chips like what Microsoft is building through Intel’s foundries means more of their customers may choose to make chips for themselves.

Since last November, I have been a hold on Nvidia given initial competition risks (which are starting to play out, see below) and the risk of smaller LLMs on their business model. Given this context, I believe the prudent stance for Nvidia’s stock is a hold until the FY 2025 first quarter plays out. This position allows investors to assess Nvidia’s response to the competitive threats posed by AMD and Intel’s new products and evaluate the sustainability of Nvidia’s growth trajectory (plus gross margins) in the face of these challenges.

Earnings Recap

While I think Nvidia stock is a hold, we do have to recognize the powerful financial results they reported. Nvidia reported record financial results for the fourth quarter and fiscal year 2024. The fourth-quarter revenue reached $22.1 billion, a 22% increase from the previous quarter and a 265% increase from the previous year (revenue beat estimates by $1.55 billion). Data center revenue for the quarter was $18.4 billion, marking a 27% increase from the previous quarter and a staggering 409% increase from the previous year. Full-year revenue was $60.9 billion, up 126% from the previous year. GAAP earnings per diluted share for the quarter were $4.93, up 33% from the previous quarter and up 765% from the previous year. Non-GAAP EPS of $5.16/share also beat estimates by $0.52/share.

The company believes their successes were attributed to the “tipping point” reached by accelerated computing and generative AI, with demand surging worldwide across various sectors.

Nvidia’s ability to maintain its leadership in the AI chip market is powered by its market share, estimated to be around 70% for AI chips. Nvidia’s secret to their success is not just in hardware, but also in software, with its CUDA computing platform providing a significant competitive advantage. Their strategy of selling entire AI supercomputing systems rather than just chips has been a game-changer, enabling it to meet the sophisticated demands of large companies seeking to build state-of-the-art AI data centers​​.

Why I Am Worried About Competition

The Artificial Intelligence chip market is in flux as a result of significant transformations with the launch of new chips from key players such as AMD and Intel, I believe creating a potential challenge to Nvidia’s dominance in this space. AMD’s MI300X series is a standout in the AI GPU market, touted for its high performance and efficiency in presentations by management and by market demand.

AMD has positioned this series to capture a significant portion of the AI chip market, which is estimated to be worth $45 billion this year. With AMD post earnings now forecasting $3.5 billion in sales from its AI chips in 2024, the company is making a bold entry into a market traditionally dominated by Nvidia. This move could diversify the market’s offerings and potentially attract customers with its high-bandwidth memory and advanced features tailored for generative AI applications and supercomputers​​​​.

Intel, on the other hand, is making strides with its 5th Gen Xeon processors, known for their AI performance improvements and efficiency gains over previous models. These processors, launched in December 2023, boast up to 64 cores and offer a 40% performance improvement, making them highly competitive in AI and high-performance computing applications. This level of innovation and cost-effectiveness presents a direct challenge to Nvidia on the lower end, more cost conscious market, potentially affecting its market share and pricing power in the high-end GPU market​​.

Microsoft’s Partnership Announced With Intel is Big

Adding more competition, Intel just unveiled a significant partnership with Microsoft (MSFT), leveraging its new foundry system tailored for AI applications. Their collaboration is centered around Intel’s 18A process for manufacturing, a chip design chosen by Microsoft. Intel’s foundry business, generating $291M in revenue last quarter, showcases a strategic push into advanced packaging and chip production, with a lifetime deal value exceeding $15B for wafer and advanced packaging. This move underscores Intel’s commitment to bolstering its position in the AI chip market, potentially challenging Nvidia’s dominance by offering innovative, high-quality processors for AI and other demanding applications to specific customers.

The goal for Microsoft is to develop their own in-house chips to train LLMs that cater to their needs for their business. Microsoft knows about the incredible margins Nvidia makes and knows they can save literally billions of dollars annually by making chips in house. They join companies like Amazon building chips for their own high-performance computing.

Earnings Call Takeaways & Current Quarter Guidance

During the call, management continued to emphasize how they believe we are at the beginning of an AI revolution. I agree, and I believe the potential will be immense. My concern (and why my rating is a hold) has to do with whether the market is overpricing this opportunity.

For example, management noted on the call that gross margins are expected to be between 76.3% (GAAP) to 77% (Non-GAAP) in FY 2025 Q1. These are impressive gross margins, but management then noted that they expect gross margins to decrease to the mid-70s in subsequent quarters.

This isn’t a major change in gross margins, but it’s one that caught my eye. I believe Nvidia’s key to its rapid share price appreciation has been its incredible gross margins in addition to strong top-line growth.

With this, Nvidia’s net income margin stands at 42.10%. This is an astonishing 1,767.36% above the sector median of 2.25%.

For the current quarter (FY 2025 Q1) Nvidia is guiding for revenue to be $24 billion on top of the gross margins between 76-77%.

Wall Street analysts are starting to notice softness in the forward Nvidia orderbook, noting that lead times have shortened to just a few months (these were over 52 weeks at one point). Management noted on the conference call they have increased capacity. Some analysts believe that lead times have shortened up to just 3-4 months, which represents near the end of FY 2025 Q1. While the analysts believe this means they will be able to sell more H100s/H200s (or other GPUs), I am worried about gross margins.

Assuming Nvidia is able to use this opened capacity in 2nd half 2024 for more chip sales, in order for them to support this revenue and overall net income trajectory, they would likely have to maintain a similar gross margin (higher prices per GPU sold). I am concerned this is hard to maintain with viable competitors coming to market like the AMD MI300X chip.

As CEO Jensen Huang noted on the call, Nvidia only forecasts revenue one quarter ahead, so the company has not provided guidance far enough out to address analysts’ questions about increased capacity. This further leads into why I am a hold.

While Valuation Is More Conservative, I Don’t Think This Is A Moment To Jump In

While this may sound counterintuitive, Nvidia’s forward P/E, in my opinion, is not an obvious indication that the market is presenting us with a buy opportunity. While this forward P/E ratio (56.01) is much lower than other recent forward multiples trailing 12 month P/E ratio is 79.92, I think this is the market starting to price in lower forward top line growth (like I am) due to potentially lower margins on GPU sales as a result of increased competition. With this, we need to look at the PEG ratio.

The company’s PEG ratio, at 1.29, may be below the sector median of 2.06, but it’s the percentages that matter. Nvidia’s PEG ratio is 37.66% below the sector median, but its forward P/E is 122.02% above the sector median. I believe this PEG ratio discount does not seem to account (enough) for the premium valuation.

This upcoming FY Q1 may prove me wrong -and show that the company is likely to continue to grow this fiscal year at a triple digit growth rate, plus maintain high gross margins. However, while this scenario could justify the current PEG ratio and forward P/E multiples, I remain skeptical.

Conclusion

Nvidia’s fiscal year 2024 performance and strong Q4 demonstrates its current leadership in the AI chip market, with significant revenue growth and a strong position in data center sales.

However, the emerging competition from AMD’s MI300X series and Intel’s 5th Gen Xeon processors (along with in-house solutions like what Microsoft is building) introduces challenges that could impact Nvidia’s market share and pricing strategy, affecting margins. As the FY 2025 cycle kicks into gear, I believe the focus shifts to Nvidia’s ability to maintain its dominance amidst these new sources of competition. In my opinion, since Nvidia’s margins appear to be going down in the near future (per management on the call) I remain a hold. I believe in their product and the power of the AI revolution, but I am not as convinced on valuation multiples of Nvidia stock.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of INTC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Noah Cox (account author) is the Managing partner of Noahs' Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

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