Near-term challenges for Nvidia's (NVDA) mainstay gaming GPU business spells a more compelling risk/reward for investors willing to ride out the storm.
Nvidia's Recent Challenges
Though its shares have rebounded a bit over the last two weeks, Nvidia is still down 42% from an early-October high of $292.76. The GPU giant was hammered during October's market correction, and it tumbled again in November after missing October quarter estimates and issuing a weak January quarter sales outlook that was blamed on a mid-range graphics card inventory overhang caused by a plunge in demand from cryptocurrency miners.
On Nvidia's earnings call, CEO Jensen Huang said the inventory overhang will take "one or two quarters" to correct, and expressed confidence that gamer demand for mid-range GPUs will improve now that prices (previously inflated due to the shortages caused by crypto demand) have stabilized. Consensus analyst estimates appear to have more than priced in this issue: Not only is Nvidia expected to see its Gaming segment revenue (it covers sales of PC gaming GPUs and console processors) drop 17% annually during the January quarter, it's expected to see annual drops in each of the following three quarters before returning to growth.
Overall, Gaming revenue, which still accounts for slightly over half of Nvidia's total revenue, is expected be down 3% in fiscal 2020 (ends in Jan. 2020) to $6.38 billion, following a 19% increase in fiscal 2019. In addition, Nvidia's OEM & IP segment, which (among other things) covers sales of GPUs meant specifically for crypto miners, is expected to see revenue drop 32% in fiscal 2020 to $525 million, following a modest 2% increase in fiscal 2019.
The estimates suggest a pretty high degree of analyst caution about the pace at which mid-range GPU sales, which should benefit next from the arrival of mid-range products based on Nvidia's recently-launched Turing architecture, will rebound. And -- though Huang insisted the ramp is off to a good start -- they also point to some caution about the pace at which Nvidia's high-end Turing gaming GPUs, which began shipping in September, will ramp in the near-term.
Why Next Year's Gaming Estimates Might Be Too Cautious
A lot of this caution likely stems from the fact that while Nvidia has made the ability of high-end Turing GPUs to enable real-time ray tracing (a feature that can deliver photorealistic game imagery) a major selling point, it will take time to flesh out the list of available games that can leverage the specialized processing cores (known as RT cores) used to support ray tracing. And, for that matter, the specialized cores (known as Tensor cores) used to power deep learning algorithms that improve GPU performance when doing traditional graphics rendering.
But it's worth keep in mind here that a number of marquee titles supporting ray-tracing will launch in the coming months, and that some major existing titles will be updated to support it. This fact won't be lost on gaming enthusiasts making upgrade decisions.
Some of the caution regarding the Turing ramp might also be related to the fact that initial benchmarks for the first major title to support ray tracing, Electronic Arts' (EA) Battlefield V, revealed performance hits of greater than 60% for Turing GPUs when ray-tracing was enabled at the game's "Ultra" setting, with performance hits increasing at higher resolutions.
However, it looks like this hit partly stems from the fact that it often takes developers a bit of time to get comfortable optimizing software for a new hardware architecture or platform. On Monday, Nvidia and EA announced that a Battlefield V update arriving on Tuesday will (when paired with a new Nvidia driver) improve ray-tracing performance by up to 50%.
Moreover, looking at this issue long-term, the fact that ray-tracing (only supported by Nvidia's gaming GPUs for now) is clearly very computationally demanding suggests it could be a major upgrade driver for some time, provided the image quality improvements it delivers are as good as advertised. In the near-term, high-end gamers might upgrade to play ray-traced games at a 1440p resolution. Farther down the line, they might do so to play them at a 4K resolution.
Other Businesses Are Still Doing Well
Though Gaming is facing near-term challenges, Nvidia's three other major product segments are humming along. The company's Datacenter segment, which now accounts for about a quarter of revenue, saw its sales rise 58% annually last quarter. Nvidia's dominant position in the market for accelerators used to train AI/deep learning algorithms remains a boon for this segment, as do its growth opportunities in the AI inference and traditional high-performance computing (HPC) markets. Nvidia recently launched a Turing inference GPU, and it wouldn't be surprising to see a Turing training GPU arrive in the spring or summer of 2019.
Automotive segment revenue rose 19% last quarter, while Professional Visualization revenue (driven by workstation GPUs) rose 28%. Automotive revenue, which for now depends heavily on infotainment processor sales, should start getting a bigger lift from Nvidia's numerous autonomous driving-related engagements in the second half of fiscal 2020. Professional Visualization revenue should benefit from the recent launch of Turing GPUs that (thanks to their integration of RT cores) are promised to enable the real-time rendering of photorealistic scenes.
Nvidia now trades for 21 times a fiscal 2021 EPS consensus of $8.20 -- an estimate that has been cut by nearly 20% since October even though Nvidia added $7 billion to its stock buyback authorization in November, and could easily be topped if Gaming demand proves better than expected. While Nvidia's valuation still doesn't exactly qualify as dirt-cheap, it looks pretty reasonable in light of gaming, server, workstation and automotive opportunities, not to mention the limited competition the company is still seeing in key markets such as high-end gaming GPUs and AI training accelerators.