Nvidia: The Most Important Q2 Earnings Release (NASDAQ:NVDA)

Nvidia Corporation (NASDAQ:NVDA) is set to release earnings on Wednesday, August 23. The release will likely be very closely watched, as it will give investors an idea about demand for artificial intelligence (“AI”) chips. Nvidia is the biggest company manufacturing chips used in AI data centers. Its A100 AI chips are industry-leading, boasting high performance that can handle demanding AI workloads. Other companies are working on competing chips, but for now, A100s and H100s are required if you want to run cutting edge AI apps online.

The indispensability of A100/H100 chips to modern AI app development has been a major boon to Nvidia. In its most recent quarterly release, NVDA guided for $11 billion in Q2 revenue, which would be a growth rate of 64% from the prior year quarter. Prior to the Q1 earnings release coming out, analysts expected the company to do $7 billion in Q2 revenue, so NVIDIA’s guidance was $4 billion ahead of expectations.

Nvidia’s upcoming release is very important, not only for NVDA shareholders, but for the markets as a whole. The reason it’s important is because it will show whether the AI craze that has swept the markets over the last 8 months is really delivering economic value. Although Alphabet (GOOG) (GOOGL) and Microsoft (MSFT) delivered positive earnings growth last quarter, they did not attribute their growing earnings to AI. Instead, they attributed it to rising earnings at their established businesses. MSFT’s “more personal computing” segment – which includes the new AI-powered Bing – saw its revenue fall 4% last quarter. Google’s search revenue increased last quarter, but it’s unlikely that Bard had much to do with that, as Google has not included Bard as a default search feature like Microsoft has with Bing.

So, if AI is going to start delivering real results for investors, Nvidia would be the company to deliver them. It sells the world’s most widely used AI chips, they cost $10,000 each, and tech companies are ordering them by the tens of thousands. Furthermore, analysts expect the company to do $2.07 in per share earnings in Q2, which would be 305% growth from the prior year quarter’s EPS ($0.51). On top of that, Nvidia recently launched the H100 GPU, which is even more powerful than the A100.

All of this bodes well for Nvidia as a company. The question is, “is the stock a buy even while trading at a nosebleed valuation?” According to Seeking Alpha Quant, Nvidia currently trades at 146 times adjusted earnings, 222 times GAAP earnings, 43 times sales, and 45 times book value. That’s a mighty steep valuation. Of course, Nvidia’s expected growth is sky-high, too. If the company hits its revenue guidance, then its revenue growth rate will be 64%. If it hits its earnings guidance, then its earnings growth rate will be 305%. If you grow at 305% CAGR for just a few years, you can rapidly catch up with the most extreme-looking valuation.

The question is whether Nvidia actually will keep up its growth. Google is already developing its own chips, it says that a system that uses 4,000 of them strung together was able to beat an equivalent system running A100 chips. That point is academic now with the H100 released to the market, but it goes to show that Nvidia’s lack of competition in AI chips won’t last forever. Eventually, competition will arrive. It’s for this reason that I consider Nvidia a ‘hold’ ahead of its upcoming earnings release. In the ensuing paragraphs, I’ll elaborate on that point in more detail, focusing on Nvidia’s competitive position and how the upcoming release could impact it.

Nvidia: Competitive Position

One of the things that Nvidia has going for it right now is its lack of competition in AI chips. Other companies are building AI chips, but Nvidia’s offerings beat them all in head-to-head performance benchmark contests. In fact, in MLCommons’ most recent inference datacenter benchmark contest, virtually all of the top performing systems ran on A100 chips. In a distant second were systems running Qualcomm’s (QCOM) AI 100 chips.

So, Nvidia is currently ahead of the competition in AI accelerator chips. That’s an important advantage, but it’s not guaranteed to last forever. Other companies are building AI accelerator chips, and Qualcomm’s offerings appear to be at least serviceable.

Then there’s Advanced Micro Devices, Inc. (AMD). So far, no AMD chips have been entered into MLCommons’ benchmarking tests, but if you look at the website copy for the AMD Instinct 2100 Series, it appears to describe a competitor to Nvidia’s A100. The chips are described as “AI data center accelerators.” They serve the same function that Nvidia’s A100 chips do: namely, optimizing the performance of the CPU by facilitating parallel processes. Finally, CEO Lisa Su mentioned AI many times on her company’s second quarter earnings call, indicating that she intends to prioritize AI chips.

All of these factors together suggest that Nvidia’s competitive position is strong but may weaken in the future. NVDA’s competitors see the massive market the company is tapping into, and are eager to break into it themselves. Based on the slow progress its competitors are making, Nvidia should enjoy a wide moat in AI chips in the near to medium term. However, the moat could deteriorate in the longer term. Nvidia’s moat in AI accelerator chips is not based on its brand identity or intellectual property, but the fact that its chips are simply technologically superior to what the competition offers. It follows from this that if a competitor spends enough money on R&D, it can catch up with Nvidia on AI.

Operational Indications

In estimating Nvidia’s long-term revenue and earnings trajectory, we need to look at how the company’s suppliers are doing. This lets us know how many orders the company is making to get its A100 chips built.

The best indicator we can go off here is Taiwan Semiconductor’s (TSM) most recent earnings release. Taiwan Semi is Nvidia’s biggest supplier, so its results can give us some hints about how NVDA itself is doing.

In its most recent quarter, TSM delivered:

• $15.68 billion in revenue, down 10%.

• $5.31 billion in net income, down 23.3%.

• $1.14 in diluted EPS, down 23.3%.

The release was a beat, but the growth was negative. Despite beating on earnings, Taiwan Semiconductor shares fell in the trading session after they came out. The reason was the guidance. Well below what analysts wanted to see, it sent shockwaves across the entire semi industry, sending even the mighty Nvidia itself into a spiral.

On a brighter note, TSM did have some positive things to share about its AI business

In the earnings call following its release, TSM said that AI accelerators account for 6% of its total revenue. The company said that it expected this “segment” revenue to grow at 50% CAGR over five years. From this, we have reason to think that Nvidia’s $11 billion Q2 revenue guidance will be met. If TSM’s AI revenue grows at 50% CAGR over the next five years, then 64% growth in a single year is quite doable. Growth typically declines over time, as large numbers in the base period make future growth hard to achieve. Therefore, we’d expect something like 64% growth in the earlier periods of a long-term period with 50% CAGR growth.

Earnings Forecast

On the whole, I expect that Nvidia will hit its Q2 revenue guidance. Its main supplier is expecting similar growth in its AI segment, and we have seen many news reports in the last 8 months saying that big tech companies are doing big orders of A100 and H100 chips. Therefore, there is no reason to doubt Nvidia’s Q2 guidance. I expect revenue will come in at $11 billion or better.

Earnings is a different story. Taiwan Semiconductor recently announced that it would raise its prices by 3% to 6%, and it certainly has the pricing power to do it. No other foundry has the manufacturing capacity that TSM has.

The TSM price hike news came out after Nvidia’s Q1 earnings release. The price hike won’t kick in until 2024, but it followed an earlier hike of 5% to 9% in 2023. The earlier hike was announced in May. For this reason, I believe there is a possibility that TSM will miss on earnings despite being in line, or better, on revenue. Manufacturing costs are trending upward, and NVIDIA is still heavily reliant on TSM, despite the strides Intel (INTC) and others have made in the foundry space.

The Bottom Line

Taking everything into account-valuation, competitive position and revenue/cost forecasts-I consider Nvidia stock a hold. It is without a doubt one of the most successful tech companies on earth right now, and AI chips will likely deliver it $11 billion in revenue in Q2. But when a company trades at 222 times earnings and 43 times sales, it’s hard not to think it’s overpriced. Given the conflicting signals from different factors, NVDA stock is probably safe enough for those who bought earlier this year, but not the best asset to deploy fresh capital into today.