Nvidia: Smooth Sailing

Summary:

• Although investors are increasingly concerned about new entrants, unsustainable margins, and export restrictions, Nvidia Corporation should see sustained top and bottom-line growth for at least another two to four quarters.
• Investors should not let these concerns overshadow Nvidia’s meteoric trajectory.
• Overall growth in the AI accelerator business could very well more than offset the financial impact by the time these concerns materialize.
• Nvidia should, therefore see smooth sailing for at least another two quarters, and potentially much longer, and investors can confidently hold through earnings and the coming quarters.

After Nvidia’s Q1 earnings, I predicted that Nvidia (NASDAQ:NVDA) would likely see smooth sailing for a couple of quarters. Here’s what I wrote then:

For the time being, there is no real substitute for Nvidia’s newest chips. The most likely alternative would be AMD’s upcoming MI300 chip, but even if it is competitive, it will only launch at the end of the year and then require more time for production to ramp. So at least for a few quarters (and possibly longer), it should be smooth sailing for Nvidia. There may be challenges in the long run, of course, but for now, investors can probably wait comfortably for a couple of quarters while Nvidia rapidly grows and then evaluate how the market for AI chips is evolving.

Two quarters later, I again think that Nvidia will face smooth sailing for the next two to four quarters. Although concerns about new entrants, margin contraction, and China export restrictions certainly have merit, investors should not lose sight that Nvidia’s top and bottom lines will most likely keep growing at a rapid clip for another few quarters. The aforementioned concerns should not have a significant impact on Nvidia’s impressive growth trajectory for some time. By the time the impact materializes, Nvidia will be in a stronger financial position and be able to absorb some of the impact due to the rapid growth of the overall AI accelerator market. Hence, I again think that investors can confidently hold Nvidia stock for another couple of quarters and then evaluate how the industry is evolving. In this article, I explain my rationale for this view.

Background: Two Great Quarters

Since my earlier prediction, Nvidia posted an outstanding earnings report for Q2, handily beating its previous guidance for both the top and bottom lines. The top line came in at $13.5b (versus guidance of $11.0b), and non-GAAP EPS was $2.70 (versus guidance of $2.03).

Nvidia’s guidance for Q3 suggests that this quarter’s results – due post-market tomorrow (November 21) – will also be impressive. Nvidia is guiding revenue of $16b and non-GAAP EPS of about $3.35.

Even if Nvidia misses on earnings, it should still have had two outstanding quarters.

Growth Should Continue

Although Nvidia has not yet provided guidance beyond Q3, it seems very likely that Nvidia’s top line will keep growing. Nvidia is currently selling every AI chip it can make, with a backlog of multiple quarters. As long as Nvidia keeps expanding its supply each quarter – which is their plan – the top line should keep growing.

Moreover, the wild demand for AI accelerators could persist for some time even beyond Nvidia’s current backlog. If new AI-based services like Adobe’s Firefly and Microsoft’s Co-pilot meet with success over the coming quarters, this could encourage further investments toward both training of new models and inference to run these new services.

Hence, Nvidia is well-positioned for at least a few quarters of strong growth, with potential upside beyond that if the AI revolution meets with early success.

Concerns About New Entrants

Given the size of the AI chip pie, it is no surprise that new entrants are at Nvidia’s heels. Advanced Micro Devices, Inc. (AMD) is shipping its new MI300 accelerators, and has guided data center GPU revenue of $2 billion worth in 2024, with capacity for significantly more should demand come in stronger than currently expected. Intel’s (INTC) Gaudi 2 accelerators also seem to be gaining a foothold, and Intel plans to launch Gaudi 3 accelerators in 2024. In-house efforts from cloud providers are also ramping up, as are offerings from chip startups like Cerebras.

Still, it is important to remember that the likely numbers around all these efforts will probably be dwarfed by Nvidia’s data center sales. Aside from Intel, the others do not seem to have anywhere near the capacity needed to compare against Nvidia. Last quarter, Nvidia’s data center revenue came in at $10.32b, and Nvidia’s implied guidance for Q3 is around $12b-13b. So even at run rate, Nvidia would have about $50 billion of data center revenue over the next year. However, given that they are still adding capacity, it seems likely that the figure could be higher than $60 billion, and perhaps closer to $70 billion depending on how well Nvidia does in terms of adding capacity (they have been outstanding so far).

And so despite the various new entrants, Nvidia will most likely still command the lion’s share (80%+ to 90%+) of data center accelerator revenue over the next year or so. Nvidia’s competitive position should also be further strengthened as it launches updates to its lineup and tries to accelerate its roadmap-for which it now has a lot of resources. The new entrants in the segment do not have an easy task ahead of them in terms of staying competitive generation after generation while Nvidia throws everything it has at the problem.

Hence, although Nvidia will certainly lose market share in data center accelerators-it is hard not to when you almost completely dominate the market-it is important to keep these share losses in perspective relative to how quickly worldwide investments toward AI are ramping up and how much of these investments will end up going to Nvidia.

Of course, the market share losses are a good thing-but for the time being they are also not going to slow Nvidia down much because the chipmaker will keep selling whatever it can make.

Concerns About Unsustainable Margins

Related to worries about potential new entrants are worries about declining margins as new entrants introduce competing products (potentially at cheaper prices), and as the current shortage of AI accelerators eases as supply expands to match demand.

These worries have merit from a long-term point of view. Nvidia’s margins are exorbitant and it is doubtful that they can be sustained indefinitely. Nevertheless, Nvidia’s position in the short term remains extremely strong.

As far as new entrants are concerned, as discussed, they are unlikely to capture much market share for the time being. Given this, it is unlikely that Nvidia would go for significant price cuts on its 80% or 90% of the market to try and win back a few percentage points of market share. Financially, it makes little sense and we should not expect Nvidia to compete on price for some time.

And as far as the current shortage of AI accelerators is concerned, this demand should also persist for some time given the length of the backlog. Moreover, as discussed above, in the meantime demand for AI accelerators could also potentially increase if early AI-based services are successful.

And so, although it is inevitable that Nvidia’s margins will decline at some point, that point is still some ways off-and Nvidia’s margins could potentially stay elevated for a year or more depending on exactly how demand for AI-powered services evolves and how quickly firms invest in AI infrastructure.

Concerns About China Export Restrictions

Finally, investors are rightly concerned about the U.S. government’s restrictions on AI chip exports to China. According to a report from SemiAnalysis, it seems that the cat-and-mouse game of Nvidia exporting chips to China without running afoul of increasingly stringent rules will continue for some time (it is difficult to say how long, but politics can sometimes be slow to catch up). As long as this state of affairs continues, there should be a limited impact on Nvidia’s China revenue.

However, in the long term, I would assign a high probability that Nvidia’s China AI revenues will suffer – at least for chips on advanced nodes. AI technology has the potential for enormous geostrategic relevance, and there is a lot of uncertainty surrounding the subject. Therefore, I would not expect the U.S. government to relent in these export controls. Anything is possible, of course, but to me, the likely scenario seems to be that Nvidia’s China sales will take a significant hit within a few quarters.

Still, it is important to keep the damage in perspective. On the last earnings call, management noted that “China’s demand was within the historical range of 20% to 25% of our data center revenue, including compute and networking solutions.” We can surmise that Nvidia could lose, say, 15%-20% of its data center revenue when export restrictions finally curb AI accelerator sales (assuming some sales are not subject to restriction). Considering that Nvidia is currently guiding a sequential data center revenue growth of about 16-26%, Nvidia’s ongoing gains could very well dwarf the impact of China in a few quarters.

Moreover, if excess demand persists and Nvidia keeps selling whatever it can make even after restrictions to China become effective at curbing sales, then the impact of these export restrictions on Nvidia’s financials could be delayed even further.

Don’t Lose Sight Of The Bigger Picture

Concerns about Nvidia’s long-term outlook certainly have merit. Nevertheless, stocks often climb a wall of worry, and Nvidia seems like a good candidate for this scenario to play out. Although the company will have to contend with various challenges in coming years, for the time being, Nvidia remains extremely well positioned for continued growth.

It seems to me that the most likely scenario is that, despite the challenges discussed here, Nvidia will continue to do better financially each quarter for quite some time due to the meteoric growth in demand for AI accelerators. Investors should watch carefully, but in my opinion, the worries discussed should not lead investors to lose sight of the simple fact that Nvidia is at the forefront of modern technology and likely to remain there for years (if not more).

Moreover, as I have discussed, by the time these worries significantly impact Nvidia’s financials – most likely 2025 onward – the overall growth in the market for AI accelerators could very well have more than offset the impact of market share losses, lost sales to China, and lower margins.

The upcoming earnings report should give us further clarity. But it seems to me that investors can probably hold Nvidia through earnings with confidence that the top and bottom lines will keep growing even as uncertainties about the future persist. And then they can evaluate how the AI revolution is playing out and how the industry is evolving.

---

Analyst’s Disclosure: I/we have a beneficial long position in the shares of NVDA, AMD 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.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

---