We encourage you to read our previous post-ER write-up found here and also the pre-ER found here as it goes through the pros/cons of Marvell’s fundamental profile, and our motivation in adding the stock back to our portfolio.
Per our last write-up, the bull case is this:
“Marvell doubled its AI revenue from $400 million to $800 million. This means AI is now 14.4% of revenue, up from roughly 7% (on an annual run rate). This is bullish for our CY2024 thesis, and was not expected so soon. The most important statement on the call was this:
“Based on our latest demand outlook for our electro-optics products, we now expect revenue from AI to exit this year at over a $200 million quarterly revenue run rate or $800 million annualized. This is well above what we had outlined last quarter. Put this in perspective, this would put us at the run rate we had previously communicated for all of next year.”
However, the bottom line is in bad shape as it’s not an ideal time to have to access the debt capital markets. Per our last write-up:
“Where the report is concerning is the increasing net debt to EBITDA ratio, which has increased from 1.6X to 1.8X. You can expect us to risk manage this position depending on FED actions. It was stated in the call: “we will opportunistically explore accessing the debt capital markets to refinance our upcoming debt maturities.”
This is an important quarter for Marvell to step up and improve its bottom line as the market has overlooked this given the AI story is quite strong. The ingredients are there as revenue and EPS is expected to nicely rebound over the next few quarters, it’ll be up to management to prove they can give the market what it wants in terms of profits and cash flow margin.
Revenue and EPS
Q2 revenue declined by (-11.6%) YoY to $1.341 billion
Management Q3 revenue guidance and consensus is $1.4 billion, representing a YoY decline of (8.9%) at the mid-point. It’s expected that the revenue YoY decline will bottom in Q3 and a return to growth is expected in Q4.
GAAP EPS was (-$0.24) last quarter and is expected to be ($-0.07) +/- $0.05 this quarter. The negative to thin profit margin is one of the primary concerns with Marvell.
Last quarter, adjusted EPS was $0.33. Management’s Q3 guidance ranges from $0.35 to $0.45, mid-point of $0.40. This represents a YoY decline of (29.7%). The YoY decline in earnings will also bottom out in Q3 with a return to growth expected in Q4.
Margins
Management guidance for Q3 gross margin is 46.8%. Adjusted gross margin guidance is 60.8%. It was stated that adj. gross margin will reach 64% in Q4 helped by a recovery in data center storage. The gross margin is also expected to benefit from cost cutting initiatives like optimizing headcount and continuing to partner with the suppliers to drive more efficiency in the supply chain.
o The Q2 gross margin was 38.9% compared to 42.2% in Q1 and 51.8% in the same period last year. The gross margin was down due to lower percentage of data center revenues in the revenue mix.
Management has guided for GAAP operating margin of (-1%) compared to (-15.3%) in the previous quarter. Management guidance on adjusted operating margin is 29.6% compared to 25.2% in Q1.
The adjusted net margin improved 164 basis points sequentially to 21.64% and was down from 32% in the same period last year.
Cash Flow and Balance Sheet
The operating cash flow margin was 8.4% compared to 15.8% in Q1 and 21.8% in the same period last year. The operating cash flow margin was low primarily due to an increase in DSO (days sales outstanding) and severance-related cash restructuring charges. Management mentioned that they expect DSO to improve in the next quarter.
The CFO, Willem Meintjes, replied to an analyst’s question.
“Yes, so this quarter certainly DSO was impacted somewhat by linearity. We do expect a nice back — bounce-back in Q3 and some normalization.”
It is crucial for the company to improves its cash flows in the coming quarter. The free cash flow dropped to $1.2 million compared to $105.8 million in Q1 and $256.3 million in the same period last year. The lower operating cash flows and higher capex of $111 million led to the drop in the free cash flow.
The company has cash of $423.4 million compared to $1.03 billion at the end of Q1. Debt is $4.15 billion, which includes short-term debt of $1.02 billion. The company used $572 million to repay debt in the recent quarter. Due to the lower cash flows, the company had to repay its debt entirely from the cash balance. This was contrary to what management had indicated in the Q1 earnings call when they stated they would repay debt from free cash flow and cash balance.
They have resumed buybacks as indicated in the last earnings call and it doesn’t seem ideal the company would take this route when the net debt to EBITDA ratio has increased from 1.6x in Q1 to 1.83 in Q2. Per the earnings call, “we will opportunistically explore accessing the debt capital markets to refinance our upcoming debt maturities.”
This is our primary concern with Marvell in the near term given elevated interest rates.
Key Metrics
Data center revenue was down (-29%) and was up 6% QoQ to $459.8 million, which should be marking a bottom, as long as storage recovery doesn’t get pushed out further. This exceeded guidance of 0% QoQ growth. The beat was due to the AI networking products. We’ve covered additional datapoints on the storage recovery and memory rebound here. This compares to being down (-32%) YoY last quarter and (-12%) QoQ decline.
On a QoQ basis, data center is expected to accelerate to “mid-teens” growth. Per management: “Demand for our AI products continues to grow at an extraordinary rate and we are working very closely with our customers to meet rapidly evolving needs. On the other hand, enterprise on-premise is expected to continue to trend down. As a result, we are projecting overall data center revenue in the third quarter to grow in the mid-teens sequentially on a percentage basis.”
Carrier infrastructure end market was down (-3%) YoY and down (-5%) QoQ to $275.5 million due to wired networks whereas 5G was strong at 25% QoQ growth. The carrier end market is expected to grow in low single digit sequentially helped by wireless.
Enterprise networking declined (-4%) YoY and (-10%) QoQ to $327.7 million. This is expected to decline further into the low teens QoQ next quarter. Per management, enterprise networking will take a few quarters to normalize: “We expect this inventory re-normalization to take a few quarters to resolve as customer balance sheets get worked down over time.”
Consumer end market is up 2% YoY and up 18% QoQ to $167.7 million. Revenue is expected to grow sequentially in the low teens next quarter.
Automotive and industrial end market was up 32% YoY and 23% QoQ to $110.2 million driven by increased adoption of Ethernet in cars. This segment is expected to be up 30% YoY and flat sequentially.
Conclusion:
We are watching tonight’s report with anticipation as we hope to see the product story overcome the challenges seen in the bottom line, — if not this quarter than at least in the company’s guidance for next quarter. There is an incoming, material rebound, as detailed above. What we want to see is if the rebound is strong enough to result in a decent cash margin and GAAP profits. If so, we will have a win-win to where the fundamentals are improving and a nice product story is setting up for 2024. If not, we will go back to the drawing board to figure out how to risk manage in a way that instills persistence for the longer-term thesis.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.
The word “record” was emphasized in the opening remarks as CrowdStrike put up a record quarter in many regards: record net new ARR of $223 million, record non-GAAP subscription gross margin, record GAAP and non-GAAP operating profitability, and record free cash flow.
What is weighing on CrowdStrike after hours is the deceleration in billings. CrowdStrike prefers to focus on ARR and Net New ARR, yet the market is keeping an eye on billings, especially this earnings season, considering we’ve seen mixed results on billings from cybersecurity peers. We detail this for you below.
The other blemish, if you will, was when the CFO stated: “our dollar based net retention rate was slightly below our benchmark in Q3.” This means DBNRR was below 120. Looking back, the July 2022 quarter was at 120%. However, I believe this is the first time that DBNRR was below 120.
Beyond this, the company had a solid report. It was the first quarter the company was profitable from operations (as you’ll recall, CrowdStrike was profitable from interest income in the past). Net new ARR also accelerated nicely from (-10%) last quarter to +13% this quarter. This helps to set the stage for more growth in the future.
Key Takeaways:
CrowdStrike delivered a 1.1% revenue beat and 10.8% EPS beat relative to consensus estimates, and guided fiscal Q4 marginally above consensus; however, the quarter was relatively strong, as net new ARR rose to a record at $223 million. ARR growth decelerated slightly to 35%, but topped the $3 billion mark for the first time. CrowdStrike re-emphasized its goal to reach $10 billion in ARR over the next five to seven years. The company also stated “we are maintaining our net new ARR assumptions which call for in-line to modestly up net new ARR for the full year and double-digit year-over- year net new ARR growth in the second half.” This implies net new ARR will be strong again next quarter.
Revenue growth remained strong at +35%, but billings growth looked to decelerate to the high-single-digit range YoY, compared to prior growth rates above +20%. A key item in the report was that Q3 marked CrowdStrike’s first quarter with positive operating income. CrowdStrike now has to prove that it can continue to expand operating margin further into positive territory.
Financials:
Revenue and EPS:
Revenue of $786 million beat consensus estimates by $8.6M. This represented growth of +35% YoY
Subscription revenue was $733.5 million, up +34% YoY.
ARR increased +35% YoY to $3.15 billion, marking the first time that ARR has surpassed $3 billion.
Net new ARR reached a record at $223.1 million, and was +12.6% higher compared to $198.1 million in the year-ago quarter.
Adjusted EPS of $0.82 beat estimates by $0.08, or 10.8%. This represented YoY growth of +105%.
GAAP EPS of $0.11 compares to a GAAP loss of ($0.24) in the year-ago quarter.
Margins:
Gross margin of 75.2% increased ~240 bp YoY ~20 bp QoQ.
Subscription gross margin of 78.2% increased ~270 bp YoY and ~40 bp QoQ.
Operating margin of 0.4%, compared to an operating margin of (9.7%) in the year-ago quarter and (2.1%) in fiscal Q2.
Net margin of 3.4% expanded ~225 bp QoQ, and marked the third straight quarter with a positive net margin.
Cash & Debt:
Cash and short-term investments of $3.17 billion.
Total debt was $742.1 million.
Operating cash flow reached a record at $273.5 million, representing an increase of +12.6% YoY from $242.9 million. Operating cash flow margin was 34.8%.
Free cash flow reached a record at $239 million, an increase of +37.3% YoY from $174.1 million. Free cash flow margin was 30.4%.
Noteworthy:
Net new ARR growth and a first quarter with positive operating income were the two major positives from Q3’s report. Net new ARR rebounded to a record $223.1 million after falling to $174.2 million in fiscal Q1, a strong recovery and setting the stage for another possible record to close out FY24.
CrowdStrike also recorded its first quarter to generate operating income, albeit at a razor-thin 0.4% operating margin. However, this shift to a positive margin benefited the bottom-line, allowing net margin to expand ~225 bp QoQ to ~3.4%. This marked CrowdStrike’s third straight quarter of GAAP profitability, with sequential growth in each of the three quarters.
We had mentioned in the pre-ER write-up that while CrowdStrike had begun to post GAAP profitability, it was preferable that the company be GAAP profitable from operations – now, the next task is for CrowdStrike to show further growth in operating income. You can read our last earnings report write-up following Q2 earnings here.
Another interesting snippet was an increase in the number of customers deploying 7+ modules. Whereas customers deploying 5+ remained the same QoQ at 63%, the amount deploying 7+ increased from 24% last quarter to 26% this quarter. Those deploying 6+ modules also increased by 1 percentage point to 42%. CrowdStrike has done an excellent job of upselling existing customers to higher amounts of deployed modules, so this 2 percentage point increase was a healthy figure to see.
Billings:
However, there was one glaring negative from the report – billings growth has decelerated to the single digit range. Billings was calculated to have fallen (2%) QoQ and +9% YoY to $821.5M for Q3, a significant slowdown from the +13% QoQ and +22% YoY growth rate recorded in the prior quarter.
Pictured Above: I/O Fund calculations for CrowdStrike’s Billings growth/decline
This deceleration matches what peers are reporting:
Fortinet guided for billings to decline (-1%) to (-9%) in its upcoming quarter after reporting just +5.7% YoY growth.
Palo Alto lowered its full-year billings forecast while it reported a slowdown to +16% growth compared to +27% in its year-ago quarter.
Zscaler reported +34% YoY billings growth on Monday, but maintained its full year guidance calling for +24% to +26% YoY growth, suggesting that a deceleration is set for the next few quarters.
Earnings Call:
Billings:
Given Billings is where the potential weakness resides, there was a question from an analyst regarding the decline. Since this was the most important question on the call in regards to the price action, I’m quoting it below.
Q: “And then quarter was phenomenal. But I do see some weakness across the board of cyber companies with billings. In your case it was down about 2%. I also see some weakness in deferred revenues. How do I reconcile what I see with billings with deferred, with the underlying drivers that are very strong and your strong execution? Why is why are we seeing weakness not just with you, maybe with the entire space, but why are we seeing weakness with billings across the board? Thanks.”
A: CFO: I'm going to start with billings. Yeah. You're correct. For us specifically, we don't manage the business to billings. And we feel ARR gives you the absolute best proxy to revenue. And we felt that that's the right metric. As you know, since we went public to give you more transparency into the health of our business. And that's the metric that really guides you on health.
[…] We think that billings has certain things that just are not as relevant as a metric like ARR, you're comparing a balance sheet item to a P&L item and for us, the P&L is going to dictate the health of the business. So for us billings obviously is going to be impacted by duration and there are many things that go into that. And remember also that when you think about on a year-on-year basis, we're still up on billings. And I think that's the one thing that you want to take away. For us, when we think about how we want to continue to be transparent, ARR really gives you that notion of where we're going and how we're doing. And I think that that's the focus and it has been, by the way, since we've been public. Even as a private company, that's the one that we manage the business to, that's how we look at how to give out quotas to our reps, et cetera, et cetera. So for us that's not going to change. And, I hope that answers that question.”
Translation: CrowdStrike’s CFO did not really answer the question, such as perhaps seasonality contributed or some deferred revenue will be realized in Q4 that would have been realized in Q3 (these are hypothetical answers). Instead, the CFO answered that analysts should focus on ARR instead of Billings, but the problem is that ARR is not a GAAP metric and this is why Billings remains important for an apples-to-apples comparison with peers. This is something to monitor, yet given net new ARR accelerated, the market may conclude these two cancel each other out.
Macro Environment Weak:
The other takeaway was CrowdStrike’s discussions that the current environment is tough. CrowdStrike may be less susceptible, yet management made it quite clear they are facing challenges. Here is what the CEO said when asked if October was strong (given other cybersecurity peers have stated it was a weak month for them):
“Yeah, we certainly had a strong October. I think as I said in my prepared remarks, the macroenvironment is still is still challenging. And we make no mistake about that. Deals take longer, a lot more scrutiny a lot of sign-offs, and there's a lot more work that goes into these larger enterprise deals. Getting deals done, even like Falcon Flex, which are more enterprise-like in their nature, takes time. So, we had a great October, but in general, buyers are still cautious. And I think the fact that we're able to provide a real platform play that allows them to consolidate in other technologies and ultimately save money accrues values to us, but it certainly takes a lot of time and effort to get the deal over the goal line, but team did a great job, and October was strong for us.”
Management also stated they are not counting on a Q4 budget flush in their guide, which translates to a weaker environment: “As George outlined, strong demand for the Falcon platform is driving our pipeline to new heights. However, the macroenvironment remains challenging with continued increased budget scrutiny, and as a result, we are not expecting to see the typical Q4 budget flush.”
As redundant as it may sound, we will rely on technicals to manage this position. We tend to rely heavily on fundamentals during pullbacks/selloffs or when the risk/reward is favorable for another leg up in the market. However, we use technicals for risk management when the market appears overextended. There were some weak areas in the report that were canceled out by a few metrics that really matter in terms of a strong foundation, such as operating profitability and accelerating/return to growth in net new ARR. We continue to see CrowdStrike as a strong choice within cybersecurity and this earnings report does not change our view.
You can read the current technical setup here in terms of what we want to see in terms of price levels.current technical setup here in terms of what we want to see in terms of price levels.
Equity Analyst Damien Robbins contributed to this analysis
This article was originally published on Forbes on Nov 21, 2023,11:18am ESTForbes Forbes on Nov 21, 2023,11:18am EST
Nvidia has surged this year with 241% gains YTD, which has more than doubled the returns of the FAANGs. This is no small feat considering it’s widely understood Big Tech is holding up the broader market. Valuations are stretched and leadership is only narrowing; to say there’s pressure going into Nvidia’s report this evening is an understatement.
The outsized demand for the H100 has led to historic moments as Nvidia is expected to exit this fiscal year with quarterly data center revenue of $14 to $15 billion compared to $3.6 billion per quarter at FY2023 exit. Should these estimates be correct (we will get the official guide this evening), Nvidia will end the year with a bang with approximately 300% growth in the final fiscal quarter.
Wow, what a year. Investors may not truly appreciate what Nvidia accomplished given a global pandemic and shelter-in-place orders fueled triple digit growth in tech stocks three years ago. Yet, what Nvidia accomplished was entirely due to product-market fit and design prowess with no end of the world scenario needed. It’s rare what Nvidia did, which was to ignite demand of enormous magnitude.
It’s well known my firm was early to this move in Nvidia with a bold analysis that claimed Nvidia will surpass Apple in valuation by 2026. You can look forward to my firm updating the long-term thesis in the coming weeks with details on how Nvidia will close-in on the next trillion in market cap. But in the near-term, Nvidia investors face what makes or breaks a portfolio, which is the inevitable moment of when Nvidia will top and sell off, how to handle these enormous gains, and if Nvidia can surprise the market again now that it was the defacto leader in the Nasdaq’s historic rally this year.
My firm strongly believes that simply picking a stock is akin to playing a fantasy sport, whereas discussing how to manage the stock is what separates fantasy from the live game. On Nvidia, we’ve been quite clear that we were net buyers in 2022 and we have been trimming the position to take gains in 2023. Meanwhile, Nvidia has remained our largest position until very recently when we put a different stock as first place and Nvidia as second place. Although we typically reserve our trades for our research members, we’ve been open about our strategy of active portfolio management with this spectacular, winning position. Judging by filings by famous hedge fund managers, we are in good company with this strategy.
Going into this highly anticipated report, I’d like to provide my readers with more information on how we are managing our Nvidia position and what to expect from the earnings report. This is a near-term analysis whereas our long-term thesis that Nvidia will surpass Apple in valuation is still firmly intact.
Neck-Breaking Release Cycle: H200 is Hopping Ahead
Nvidia has a near-monopoly in data center GPUs, and one of its strategies to protect its moat is to upgrade GPUs quickly to where it’s hard for AMD, Intel or custom silicon to catch up.The release cycle from the H100 to H200 is neck-breaking, as a typical cycle is two years whereas the H200 will ship in volume one year following the H100. The B100 based on the Blackwell architecture is expected to hit the market at the end of calendar year 2024 with the X100 following soon after.
Source: NVIDIA INVESTOR’S PRESENTATION
If 2023 was the year AI accelerators made their importance known to Wall Street, then 2024 will be the year that memory and HBM3/HBM3E makes its importance known as the competition is going head-to-head at memory capacity and bandwidth per GPU rather than compute performance. This further translates to mean the AI race is more focused on inference for the next generation of GPUs as the neural network can be run entirely in memory without the need to move data back-and-forth with the external memory.The H200 is the first GPU with HBM3e for 141 GB of memory and 4.8 TB/s bandwidth. This will result in 1.6X to 1.9X better inferencing performance than the H100.
To drive the point further as to how important memory will be in the next generation of GPUs, the compute performance from the H100 to the H200 is not changing much. According to what the industry has seen so far from Nvidia’s GPU HGX 200 systems, there will be “32 PLOPS FP8” performance, which would be achieved through eight H100s with 3,958 teraflops of FP8 each. The translation is that Nvidia’s H200 upgrade is strategically focused on memory, which also translates to Nvidia feeling pressure from AMD as the MI300X will be the first GPU to hit the market with the memory capacity and bandwidth offering full utilization to increase LLM inferencing performance.
By adding HBM3 and HBM3e memory, the compute engines get a performance boost, albeit at a higher cost as HBM3 costs 5-6 times more than typical DRAM. Fewer GPUs will be needed so the cost does not translate to an equal increase in total cost of ownership. GPUs with HBM3 and HBM3E will run compute-intensive large language models with fewer GPUs than is required with the H100s due to offering roughly double the memory. The need for fewer GPUs is accomplished by running LLMs in the memory. The H200 with 141GB of memory compared to the H100’s 80GB will reduce the number of GPUs required for running popular large language models.
If you read between the lines on the H200, then Nvidia is a bit nervous about AMD’s MI300X with the H200 serving as an attempt to bridge the H100 and the B100. AMD’s design more than doubles the memory of the H100 with 192GB HBM3 memory and 5 TB/s of bandwidth, and most importantly, will be out a few months prior to the H200. The MI300X was the first to run a 40B parameter large language model on a single GPU.
AMD should feel satisfied that it forced the near-monopoly leader to hurry toward releasing the H200 with HBM3e as an answer to the MI300X. We covered this in a deep dive for our premium members in July and reiterated it again in August when we covered our favorite memory stock.
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What to Expect in the Upcoming Earnings Report:
The very quarter that Nvidia began reporting double digit negative revenue growth of (-16.5%) was the best buying moment. Near the bottom a year ago, our firm wrote for Forbes that Nvidia Was Ready to Rumble with the RTX 40 Series and the H100 GPUs. Notably, Nvidia is up 200% YTD yet is up over 300% since the October low, which is why timing matters.
One year later, and Nvidia is unrecognizable from where the company was exactly one year ago. For the October quarter, Nvidia is expected to report YoY growth of 169.6% to 171% for $16 to 16.1 billion and growth of 190.6% YoY growth for the December quarter. According to current estimates, the December quarter is peak growth.
Source: I/O FUND
Pictured Above: The very quarter that Nvidia bottomed in fiscal Q1 was the quarter that the stock was had its highest short interest since the Covid low as the product thesis was little understood at the time.highest short interest since the Covid low as the product thesis was little understood at the time.
A beat is very important for Nvidia given the spotlight on this company. Demand is certainly there, and what instead is in question (into the foreseeable future) is supply.
Here is what the CFO stated on the last earnings call:
“We expect supply to increase each quarter through next year” and also “Demand for our Data Center platform where AI is tremendous and broad-based across industries on customers. Our demand visibility extends into next year. Our supply over the next several quarters will continue to ramp as we lower cycle times and work with our supply partners to add capacity.”
Where the market was a tad disappointed last quarter was when the CFO declined to elaborate on what percentage increase in supply she was expecting to see. The translation is that these are hard comps to compete with, and without a substantial increase in supply, the growth rate may have an inherent constraint given supply has already increased triple digits YoY.
The soaring demand for GPUs is evident in Nvidia’s growth rate. Per the Financial Times, Nvidia is planning to ship 1.5M to 2M GPUs next year compared to a target of 500,000 this year. Given this outsized demand, the hiccup is more likely to happen on the supply side. For this reason, we detail Taiwan Semiconductor’s chart below.
When you strip out data center revenue, what you have is an even higher growth rate for the data center segment of 239% to $13 billion expected this quarter. So, the question remains —- can supply continue to grow at these elevated percentages?
Source: NVIDIA IR
The data center segment is clearly the thesis but it doesn’t hurt that gaming has rebounded, as well, with 22% growth last quarter.
Source: NVIDIA IR
Last quarter, the gross margin improved significantly to 70.1% compared to 64.6% in Q1 and 43.5% in the same period last year. This was the best gross margin in Nvidia’s history due to higher average sales prices and some contribution from the increased mix of software.
Per the CFO: “software is a part of almost all of our products, whether they're our Data Center products, GPU systems or any of our products within gaming and our future automotive products.” Separately, the standalone software business is worth “hundreds of millions of dollars annually.” As seen with our note on the H100 release from last year, its important investors are early to a tipping point. This is why we’ve been adamant that Nvidia’s true AI moment was in 2020 with the A100. If you bought the stock for the H100, you likely missed this year’s power move. The same will be true for Nvidia’s software revenue.
Regarding this quarter’s gross margin, management expects it to expand to 71.5% in the upcoming quarter. The operating income grew by an incredible 1,263% YoY to $6.8 billion, which shows the cyclical nature of semiconductors. The operating margin was 50.3% compared to 7.4% in the same period last year. The management guidance for the next quarter is 53.1%. Typically, Nvidia’s operating margin is in the 30% range.
Source: NVIDIA IR
This has flowed through to the bottom line with Nvidia’s adjusted EPS up 429% YoY for $2.70 compared to 481.3% growth expected this quarter for EPS of $3.37.
Source: SEEKING ALPHA
Nvidia has the strongest cash flow margins among mega cap stocks. The operating cash flow margin is 47% with a free cash flow margin of 44.8%. In addition to higher revenue helping the cash flow, there was also $1.25 billion in customer payments received ahead of the invoice date.
Source: YCHARTS
The company has cash and marketable securities of $16.02 billion with debt of $9.7 billion. Last quarter, there was $3.28 billion shares repurchased. The Board of Directors approved an additional $25 billion in stock purchases with $4 billion authorized remaining at the end of Q2.
Data Center Assumptions
I/O Fund Analyst Notes on Nvidia’s Data Center Segment
The magnitude of Q4 guidance will be very important given heighted expectations. Assuming Nvidia meets its Q3 guidance of $16B +/- 2%, we’ve put together a simple scenario analysis to parameterize the different outcomes anticipated based on Nvidia’s potential Q4 guidance.+/- indicates anticipated stock positive or negative price performance on the next trading day based on that scenario.
Source: I/O FUND
At $40,000 per H100, that equals $28B in H100 sales alone, and when you add the A100 and other data center sales at a current run rate of $14B, the Data Center segment could report total revenue of $42B in FY24 (CY23). When you equal this out across the upcoming quarters, it looks something like this based on our estimates and Piper Sandler estimates.
Nvidia's Data Center segment could report total revenue of $42B in FY24 (CY23)
Source: ESTIMATES FOR DATA CENTER REVENUE FOR Q3 AND Q4 FROM PIPER SANDLER
We believe the market will reactive negatively if Nvidia provides F4Q24 (Jan-Q) guidance that is in-line or lower than consensus growth of 11% Q/Q for the Jan-Q.
On the flip side, Nvidia will likely need to provide guidance of at least greater than 20% Q/Q growth for a significant positive reaction. This is because consensus will need to make upward revisions to their earnings for the remainder of FY24 (CY23) and FY25 (CY24). This is critical to support the current valuation with NVDA trading at ~45x NTM Non-GAAP P/E in-line with its 5 year average of ~45x NTM Non-GAAP P/E as of Monday November 21, 2023.
Our base case assumption is that Nvidia’s F4Q24 (Jan-Q) guidance will estimate Q/Q growth of at least +20%. Recall, H100 was only introduced to the market toward end of CY22. The Apr-Q was the very first quarter when Nvidia was beginning to see the impact of AI and demand for the H100. Piper Sandler believes Nvidia will close out the year with data center revenue of $42B and 2H23 Data Center revenue ~88% greater than 1H23 revenue.
Furthermore, we believe if Nvidia maintains its ~35% beat that it had for the Jul-Q for the rest of FY24 (CY23), Nvidia can potentially do $52B in Data Center revenue for FY24 (CY23).
Looking ahead to FY25, we believe Nvidia can do ~$92B in Data Center revenue based on our estimates for % beats for Actual Data Center revenue vs. Estimates for Data Center Revenue (Piper Sandler).
Source: I/O FUND
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Exploring Scenarios for the Upcoming Earnings Report:
The neutral-case scenario is that Nvidia reports in line, but can’t give the Street what it wants, which is a raise on already impressive growth to help sustain the market leader’s gains this year.
If investors are being realistic, a raise is best left to next quarter when the company typically offers a fiscal year outlook. The question is not whether Nvidia is a top AI stock, and has a promising future (of course it does). The question at hand is whether Nvidia can produce a report that pushes buyers off the sidelines. These are two different matters, and are often in opposition after a large run-up in price.
The best-case scenario is that Nvidia’s been downplaying its supply (just a touch) and there will be a beat for the fiscal Q4 guide. Nvidia’s story is quite clear, which is that the data center segment is producing historic growth and the bottom line is so beautiful, you have to squint to make sure it’s real. If this happens, we could see the price go into the mid-$500s before technicals are predicting that buyers will be exhausted. As a reminder, that’s only a 7% move from where the stock is trading now.
Piper Sandler has a data center estimate for fiscal year 2024 of $42 billion, which translates to $14.9 billion in data center revenue if we assume $13 billion this quarter. We detail below the price targets we are eyeing to take more gains should Nvidia report a beat on Q4FY24.
The topping-out scenario is that Nvidia’s buying is exhausted, and there isn’t one fundamental analyst on earth that can help investors figure out when this will happen. That is best left to somewhat-esoteric technical analysis. As you’ll note, I am not calling this the bear-case as there is not a bear case for Nvidia. Even if the company loses China entirely due to restrictions, it’s likely that demand gets absorbed. However, there is a bear case for the semiconductor sector, of which Nvidia is exposed to, and I detail this for you below.
Regarding the topping-out scenario, it’s unlikely Nvidia has a major negative surprise to the downside as semiconductors have strong visibility compared to, say, an ad-tech company. The management team should be going to great lengths to be consistent and accurate with Wall Street given the long golden roadway in front of them. Therefore, the topping-out scenario is aptly named as a 200% gain means you’ve got to impress the Street to keep those gains, and Nvidia may need to refuel for a quarter or so until we can get to a new fiscal year guide next quarter.
The Red Scare
What’s not to be forgotten in the excitement of the product road map is China, which has been the predominant risk for semiconductor stocks dating back to 2018. Last year, the government restricted Nvidia from selling its two most powerful chips to China, the A100 and H100. To circumvent these restrictions, Nvidia designed slightly less powerful chips called the A800 and H800. As reported by Reuters, the H800 has as much computing power as the H100 in certain settings. For the United States, these chips are important to block as they strengthen China’s military.
Last month, the U.S. Department of Commerce announced updated rules focuses on computing performance by removing the bandwidth parameter and focusing exclusively on how powerful a chip is, as well as performance density, which will prevent companies from working loopholes. According to an official who spoke to Reuters, “the U.S. will require companies to notify the government about semiconductors whose performance is just below the guidelines before they are shipped to China.”
Although this is a medium-term issue for Nvidia, analysts believe the demand is high enough today that the company shouldn’t have any issues absorbing the 20% to 25% loss in its data center segment from tighter export restrictions to China. Looking further out for FY2025, Keybanc sees a $5 impact to Nvidia’s $25.62 EPS estimate, and up to a $20B impact to its data center segment with current estimates at $101B for the data center in FY2025.
Eventually, demand may settle – especially as more competitors step up – and investors should pencil-in losing China revenue as a risk that is materializing now, with the revenue impact likely to be felt in FY2025.
Nvidia continues to push to all-time highs, which is a scenario that was outlined in our prior free report on NVDA in September of this year. In the last analysis, the I/O Fund Portfolio Manager stated: “as long as we hold $340, Nvidia has the potential for one more swing higher into year-end/early next year.”
The primary scenario presented had the $545-$574 region as the target for the next swing higher. As of today, we are about 7% away from this target in what appears to be the final 5th wave in an uptrend off the October 2022 low.
I have laid out two scenarios that I continue to see playing out in the coming weeks-months:
The topping-out scenario has NVDA in a complex topping pattern. We would see a sharp reversal from current levels that would ultimately break below $435-$419 support region. This would signal that the top is in, and we would then setup our downward targets to start accumulating again.
The bull scenario has us already in the final swing higher. Our targets are between $545 – $575 for this move. If we end up seeing a gap and continuation higher from the earnings report, then we would get a direct path to these targets. We would use this strength to continue to trim. The other scenario is that we see a slight pullback that holds the $435-$419 region, which would set us up for a push into higher targets in the coming months.
Source: I/O FUND
Semiconductor Industry May Be the Achilles Heel
Nvidia could certainly miss, yet it’s less likely given the company has outsized demand and visibility on supply. Within this context, it is easier to see the level of risk with interrelated stocks. One chart that is quite concerning, which has ramifications for all of tech, is Taiwan Semiconductor (TSM)
Source: I/O FUND
The bounce from the October, 2022 low is clearly an overlapping and messy move higher. This is common of B waves. What’s concerning is that the drop from the July high is a 5 wave pattern that broke through the major trendline. This would be wave 1 of the larger (C) wave.
What followed is a 3 wave retrace, so far, which would be wave 2. If the next drop is a 5 wave pattern that takes us below $89, it will be a strong warning. On the other hand, if we can see a vertical move over $104, then it will shift the odds away from the red count above, and suggest that we could see a larger swing higher into early 2024, which would be the green count.
We do not own TSM as we closed this position, yet one reason we are watching this chart is to help manage our semiconductor positions as a break below $89 is concerning enough to have a read-through to our other positions. In this case, we will likely hedge the semiconductor stocks that we have identified as those we want to own in a downturn.
A break below $89 could also be concerning given TSM is in the crosshairs with China, and the United States recently tightened export restrictions to effectively cutoff AI chips. China has made it known they are pursuing domestic silicon, and if so, TSM may become stuck in a tug-o-war on which country gets 3nm, 4nm and 5nm supply.
The Broader Semiconductor Sector (PHLX)
The PHLX Semiconductor Index is a popular index of the broader semiconductor sector. It currently has the same downside setup that we are seeing in TSM. However, it is moving up into major resistance and into a cycle that suggests a reversal is likely to follow.
Source: I/O FUND
The fan placed at the October, 2022 low represents a series of important angles that the PHLX has been using in its push higher. The red 1×1 line is a true 45 degrees off the low, and is the most important angle in defining an uptrend. Note how price broke below it and is now testing this angle as resistance.
Furthermore, those symbols above price represent cycles that we see within the PHLX. Note how price tends to reverse the trend that is moving into them. So, regarding these cycles, how we trend into them is the most important thing. We are currently trending up, into the current cycle, while testing the major angle in red.
It is likely that the broader semi sector sees a reversal soon, and until the PHLX can retake the red 1×1 angle, the pressure and risk remain to the downside.
Conclusion:
Nvidia’s earnings outcome is not easy to read in the tea leaves. This is because the fundamentals are the best in the S&P 500 and the CFO has been clear that she has strong visibility for this quarter and into next year. It’s possible the company misses, but not probable (outside of something China related). Rather, Nvidia’s issues are sector-wide as semiconductor indexes and the bellwether TSM are looking weak on technicals. This would signal even if Nvidia beats/raises and the stock goes up, that its peer group may weigh on the company’s price action in the near-term. There’s also immense pressure that Nvidia raises, which may not be realistic given constraints on supply.
We’ve been crystal clear in both August and September that Nvidia has a move to $545 to $570 and this could mark the top. We continue to believe this is the price target where our firm will again take gains. If we don’t get there this evening, and price breaks down, then we will also take gains. In our opinion, this is the only way to procure a win-win scenario with a stock that holds a leading allocation in a portfolio that has extended 200% in one year.
Meanwhile, you can look forward to an update on how, exactly, Nvidia will surpass Apple’s valuation by 2026 in the coming weeks.
Our premium members will receive our post-earnings analysis this evening after hours. If you own Nvidia stock, or are looking to own NVDA, we encourage you to attend our weekly premium webinars, held every Thursday at 4:30 pm EST. Next week, we will discuss our plan following NVDA’s earnings, as well as a handful of other AI plays for 2024 – what our targets are, where we plan to buy as well as take gains.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in NVDA at the time of writing and may own stocks pictured in the charts.
Nvidia’s Fiscal Q3 earnings report was spectacular on all accounts. The data center growth for this quarter was bonkers againbonkers again with growth of 279% year-over-year. The FQ4 guide implies data center growth that will accelerate to roughly 370% next quarter.
Overall revenue beat by $2 billion this quarter for $18.12B in revenue, up 206%. For next quarter, the guide beat by another $2 billion for guidance of $20B compared to $17.9B expected.
EPS of $4.02 compares to $3.39 expected. Gross margin grew to 74% compared to 71.5% expected.
Yet, the stock is down 1.5% after hours. In our pre-earnings write-up that was published this morning in our free newsletter, I had stated: “The topping-out scenario is that Nvidia’s buying is exhausted, and there isn’t one fundamental analyst on earth that can help investors figure out when this will happen.” I explained this is best left to technical analysts as there are many forces which weigh on a stock. It was unlikely Nvidia missed due to the CFO’s visibility on supply, yet the win-win scenario is that we don’t need the market to continue to reward Nvidia. It already has rewarded Nvidia, and if the market is getting tired of Nvidia’s exceptional results, then we will simply take gains and buy again lower.
Essentially, what we are seeing after hours has nothing to do with the company’s financials. When buyers become exhausted, it means a story is well-known. It’s not logical, it’s merely what makes a market.
The flaw in Nvidia’s report is the loss of China revenue. It can be deceiving because demand is so high, that Nvidia will absorb those losses in the upcoming quarter. However, there are implications in the medium-term, which we had also written about in our pre-earnings report.
The long-term thesis is very much intact, which is that Nvidia is on its way to become the world’s most valuable company someday. Data center GPUs are only part of the story. Automotive has the potential to exceed data center GPUs, and there’s also software which we covered here.
In the near-term, Nvidia investors should keep an eye on the broader semiconductor sector, which looks weak, and there’s a chance the China impact drags on FY2025/FY2026 estimates until we get a new fiscal year guide next quarter. I also touch base on a few positives that are important to keep an eye on.
Revenue and EPS:
Nvidia reported revenue of $18.1B, up 206% Y/Y and well above consensus of $16.1B and above guidance of $16B. However, the magnitude of the revenue beat of 12% was smaller than the 22% beat in the July quarter. Non-GAAP EPS was $4.02, well above consensus of $3.39.
Revenue Segments:
Data Center revenue of $14.5B, up 279% YoY and up 41% QoQ
Gaming revenue of $2.9B, up 81% YoY and up 15% QoQ
Pro Visualization revenue of $416M, up 108% YoY and up 10% QoQ
Automotive revenue of $261M, up 4% YoY and up 3% QoQ
OEM & Other Revenue of $73M, flattish YoY and up 11% Q/Q
Nvidia provided revenue guidance of $20B +/- + 2% above consensus of $17.9B with adjusted GM guidance of 75.5% and Non-GAAP Operating Margin guidance of 64.5%.
More on Data Center Segment:
Our pre-earnings report highlighted the release of the H200. Major cloud players such as AWS, Google Cloud, Microsoft Azure, and Oracle cloud will be among the first CSPs to offer H200 inferences starting in Q2 of 2024. The H200 is likely to come with a higher ASP than the H100 due to HBM3e memory. The H100 has an ASP in the $30,000 to $40,000 range. The higher ASP may not contribute to margins necessarily, as HBM3e is costly.
At $40,000 per H100, that equals $29B in H100 sales alone, and when you add the A100 and other data center sales at a current run rate of $15B, the Data Center segment could report total revenue of $44B in FY24 (CY23). When you equal this out across the upcoming quarters, it looks something like this based on our estimates and Piper Sandler estimates.
Nvidia is expected to report approximately $16.5B in revenue for the January quarter. Keybanc has data center revenue at $101 billion for next year. If we assume China is $20 billion of this (and worst case, doesn’t get absorbed) then it will look something like this:
Scenario 1:
Q1 FY25: $18B
Q2 FY25: $19.5B
Q3 FY25: $21B
Q4 FY25: $23B
However, it’s likely the China revenue does get absorbed even if analysts are forced to revise estimates for now. This means that estimates may go down this quarter, and then be revised up again when management discusses the fiscal year guide. If so, it would look more like this:
Scenario 2:
Q1 FY25: $20B
Q2 FY25: $24B
Q3 FY25: $27B
Q4 FY25: $30B
That’s based on Keybanc’s fairly optimistic estimate of over $100B next year in data center revenue. Here are data center revenue numbers that are more conservative from Piper Sandler. Due to the QoQ growth in this model, next quarter’s fiscal year guide is paramount for us Nvidia bulls.
Scenario 3:
My opinion is that Scenario 1 is a safe assumption as it combines continued growth in the data center with some China impact.
Margins:
Gross margin of 74% beat guidance of 71.5%. As stated in our pre-ER write-up, these are historic margins for Nvidia.
The company reported an operating margin of 57.5% for income of $10.4 billion. The adjusted operating margin of 63.8% compares to a margin of 26.4% last quarter.
Net income of $9.2 billion represents a margin of 51% compared to 11.5% net margin in the year ago quarter. This is a combination of data center strength and being at the cyclical trough last year for gaming.
Cash:
Cash flow margins are the best in the Mag 7 at 40.5% operating cash flow this quarter and 38.9% in free cash flow margin. Meta has the second best FCF margin at 34.7% followed by Apple at 29.7%.
Nvidia had $18.3B in cash and marketable securities, up from $16.0B last quarter and debt of $9.7B in-line with the July quarter of $9.7B.
The company utilized cash of $3.91 billion towards shareholder returns, including $3.81 billion in share repurchases and $99 million in cash dividends. Last quarter, an additional $25 billion was authorized for share repurchases.
Earnings Call:
The China Impact:
We had written the following in our pre-earnings report:
“The Red Scare:
What’s not to be forgotten in the excitement of the product road map is China, which has been the predominant risk for semiconductor stocks dating back to 2018. Last year, the government restricted Nvidia from selling its two most powerful chips to China, the A100 and H100. To circumvent these restrictions, Nvidia designed slightly less powerful chips called the A800 and H800. As reported by Reuters, the H800 has as much computing power as the H100 in certain settings. For the United States, these chips are important to block as they strengthen China’s military.
Last month, the U.S. Department of Commerce announced updated rules focuses on computing performance by removing the bandwidth parameter and focusing exclusively on how powerful a chip is, as well as performance density, which will prevent companies from working loopholes. According to an official who spoke to Reuters, “the U.S. will require companies to notify the government about semiconductors whose performance is just below the guidelines before they are shipped to China.”
Although this is a medium-term issue for Nvidia, analysts believe the demand is high enough today that the company shouldn’t have any issues absorbing the 20% to 25% loss in its data center segment from tighter export restrictions to China. Looking further out for FY2025, Keybanc sees a $5 impact to Nvidia’s $25.62 EPS estimate, and up to a $20B impact to its data center segment with current estimates at $101B for the data center in FY2025.
Eventually, demand may settle – especially as more competitors step up – and investors should pencil-in losing China revenue as a risk that is materializing now, with the revenue impact likely to be felt in FY2025.”
It’s tempting to shrug off the loss of revenue given Nvidia beat/raised next quarter, which is the quarter when 20% to 25% of revenue from China and other restricted countries will be cut off. However, the Street is likely to be cautious tomorrow because FQ4 will be seen as an outlier where demand can absorb the 20% to 25%. Basically, the outsized demand will be transitory whereas the U.S. Department of Commerce is cutting off 20% to 25% permanently. There was some talk about Nvidia serving these countries with a less powerful chip, but the restrictions are blacklisting Nvidia’s AI chips (specifically) so this workaround won’t be an easy feat.
By the time Nvidia comes up with a workaround, even if it’s acceptable, those countries will have designed their own domestic silicon. Even if this eventually does get absorbed, analysts will likely revised down their estimates for a few quarters out in FY2025 or next fiscal year FY2026. This may, in turn, impact Nvidia’s valuation. Per the CFO: “The export controls will have a negative effect on our China business, and we do not have good visibility into the magnitude of that impact even over the long term.”
This does not derail Nvidia’s thesis by any means and the timing could not have been better with the restrictions happening during a period of outsized demand. As pointed out on the call, Nvidia will be tapped by many countries that are not blacklisted into the foreseeable future: “National investment in compute capacity is a new economic imperative, and serving the sovereign AI infrastructure market represents a multibillion-dollar opportunity over the next few years.”
InfiniBand up 500% YoY:
We covered InfiniBand a few years back when our site covered the Mellanox acquisition. Mellanox was an important acquisition as it helped Nvidia align its architecture with speed by supporting Virtual Protocol Interconnect (VPI), which allows the ubiquitous Ethernet to provide bandwidth as cheap as possible, and InfiniBand to deliver higher throughput and fewer bottlenecks during high loads. Today, this acquisition is paying off.
Per the opening remarks: “Networking now exceeds a $10 billion annualized revenue run-rate. Strong growth was driven by exceptional demand for InfiniBand, which grew fivefold year-on-year […] Azure uses over 29,000 miles of InfiniBand tabling, enough to circle the globe.”
InfiniBand growing five-fold exceeds overall data center revenue given the $15B in total data center revenue last fiscal year is expected to grow 200% to $45 billion at the exit of this fiscal year. Networking revenue tripled and data center compute grew four-fold.
The discussion on the call is that companies are standardizing with InfiniBand as the “computing fabric” increases the effectiveness of AI infrastructure by 20% to 30%. InfiniBand is nearly ubiquitous in supercomputing and is becoming popular with AI/Big Data applications on a large scale for high performance clusters. The benefits of the software defined fabric is that it’s low latency, high bandwidth and low management cost.
Recurring Software Revenue at $1 Billion:
Going off what we know, recuring software revenue may have doubled over the past few quarters CFO had stated: “hundreds of millions of dollars annually” and it’s now being stated the standalone software business will be worth $1 billion next quarter: “We are on track to exit the year at an annualized revenue run-rate of $1 billion for our recurring software support and services offerings.”
Keep an eye on this as it’s likely to be the leading story over the next few years – especially as automotive ramps.
AI Factories:
This was probably the most important question in terms of Nvidia’s growth potential. There’s nothing revelatory being said, per se, but it’s nice to hear some of the bigger picture repeated.
Question: “Because when I just look at the trajectory of your Data Center, it will be close to nearly 30% of all the spending in Data Center next year. So what metrics are you keeping an eye on to inform you that you can continue to grow? Just where are we in the adoption curve of your products into the generative AI market?” -Vivek Arya, Bank of America
Answer: “Generative AI is the largest TAM expansion of software and hardware that we've seen in several decades. At the core of it, what's really exciting is that what was largely a retrieval-based computing approach – almost everything that you do is retrieved off of storage somewhere – has been augmented now, added with a generative method. And its changed almost everything. […]
And one of the areas that is really impactful is the software industry, which is about $1 trillion or so, has been building tools that are manually used over the last couple decades. And now, there's a whole new segment of software called co-pilots and assistants. Instead of manually used, these tools will have co- pilots to help you use it, and so instead of licensing software – we will continue to do that of course, but we will also hire co-pilots and assistants to help us use the software. […]
But there's a new class of data centers, and this new class of data centers, unlike the data centers of the past, where you have a lot of applications running used by a great many people that are different tenants that are using the same infrastructure, and that data center stores a lot of files. These new data centers are very few applications, if not one application, used by basically one tenant, and it processes data. It trains models, and it generates tokens. It generates AI. And we call these new data centers AI factories.”
Translation: If you separate AI from traditional data centers (and where data centers are headed), then Nvidia represents far more than 30%.
Conclusion:
We are tracking TSM, semiconductor indexes, and Nvidia’s chart for signs of exhaustion as outlined here. We are seeking a win-win scenario where we can lock-in gains, and then use that cash to buy Nvidia again at lower levels. As stated, Nvidia’s thesis is firmly intact. Rather, the issue is the market is seeing very narrow leadership and Nvidia is the defacto leader within that narrow leadership. The saying in Wall Street is that pigs get slaughtered. That’s a rough way of saying 200% gains YTD should be approached carefully as the goal is to make real money, not paper money. Of course, 200% will be nothing by the time we are done with this position. But for this year, it’s good enough.
Nvidia’s Fiscal Q3 earnings report was spectacular on all accounts. The data center growth for this quarter was bonkers againbonkers again with growth of 279% year-over-year. The FQ4 guide implies data center growth that will accelerate to roughly 370% next quarter.
Overall revenue beat by $2 billion this quarter for $18.12B in revenue, up 206%. For next quarter, the guide beat by another $2 billion for guidance of $20B compared to $17.9B expected.
EPS of $4.02 compares to $3.39 expected. Gross margin grew to 74% compared to 71.5% expected.
Yet, the stock is down 1.5% after hours. In our pre-earnings write-up that was published this morning in our free newsletter, I had stated: “The topping-out scenario is that Nvidia’s buying is exhausted, and there isn’t one fundamental analyst on earth that can help investors figure out when this will happen.” I explained this is best left to technical analysts as there are many forces which weigh on a stock. It was unlikely Nvidia missed due to the CFO’s visibility on supply, yet the win-win scenario is that we don’t need the market to continue to reward Nvidia. It already has rewarded Nvidia, and if the market is getting tired of Nvidia’s exceptional results, then we will simply take gains and buy again lower.
Essentially, what we are seeing after hours has nothing to do with the company’s financials. When buyers become exhausted, it means a story is well-known. It’s not logical, it’s merely what makes a market.
The flaw in Nvidia’s report is the loss of China revenue. It can be deceiving because demand is so high, that Nvidia will absorb those losses in the upcoming quarter. However, there are implications in the medium-term, which we had also written about in our pre-earnings report.
The long-term thesis is very much intact, which is that Nvidia is on its way to become the world’s most valuable company someday. Data center GPUs are only part of the story. Automotive has the potential to exceed data center GPUs, and there’s also software.
In the near-term, Nvidia investors should keep an eye on the broader semiconductor sector, which looks weak, and there’s a chance the China impact drags on FY2025/FY2026 estimates until we get a new fiscal year guide next quarter. I also touch base on a few positives that are important to keep an eye on.
Revenue and EPS:
Nvidia reported revenue of $18.1B, up 206% Y/Y and well above consensus of $16.1B and above guidance of $16B. However, the magnitude of the revenue beat of 12% was smaller than the 22% beat in the July quarter. Non-GAAP EPS was $4.02, well above consensus of $3.39.
Revenue Segments:
Data Center revenue of $14.5B, up 279% YoY and up 41% QoQ
Gaming revenue of $2.9B, up 81% YoY and up 15% QoQ
Pro Visualization revenue of $416M, up 108% YoY and up 10% QoQ
Automotive revenue of $261M, up 4% YoY and up 3% QoQ
OEM & Other Revenue of $73M, flattish YoY and up 11% Q/Q
Nvidia provided revenue guidance of $20B +/- + 2% above consensus of $17.9B with adjusted GM guidance of 75.5% and Non-GAAP Operating Margin guidance of 64.5%.
More on Data Center Segment:
Our pre-earnings report highlighted the release of the H200. Major cloud players such as AWS, Google Cloud, Microsoft Azure, and Oracle cloud will be among the first CSPs to offer H200 inferences starting in Q2 of 2024. The H200 is likely to come with a higher ASP than the H100 due to HBM3e memory. The H100 has an ASP in the $30,000 to $40,000 range. The higher ASP may not contribute to margins necessarily, as HBM3e is costly.
At $40,000 per H100, that equals $29B in H100 sales alone, and when you add the A100 and other data center sales at a current run rate of $15B, the Data Center segment could report total revenue of $44B in FY24 (CY23). When you equal this out across the upcoming quarters, it looks something like this based on our estimates and Piper Sandler estimates.
Nvidia is expected to report approximately $16.5B in revenue for the January quarter. Keybanc has data center revenue at $101 billion for next year. If we assume China is $20 billion of this (and worst case, doesn’t get absorbed) then it will look something like this:
Scenario 1:
Q1 FY25: $18B
Q2 FY25: $19.5B
Q3 FY25: $21B
Q4 FY25: $23B
However, it’s likely the China revenue does get absorbed even if analysts are forced to revise estimates for now. This means that estimates may go down this quarter, and then be revised up again when management discusses the fiscal year guide. If so, it would look more like this:
Scenario 2:
Q1 FY25: $20B
Q2 FY25: $24B
Q3 FY25: $27B
Q4 FY25: $30B
That’s based on Keybanc’s fairly optimistic estimate of over $100B next year in data center revenue. Here are data center revenue numbers that are more conservative from Piper Sandler. Due to the QoQ growth in this model, next quarter’s fiscal year guide is paramount for us Nvidia bulls.
Scenario 3:
My opinion is that Scenario 1 is a safe assumption as it combines continued growth in the data center with some China impact.
Margins:
Gross margin of 74% beat guidance of 71.5%. As stated in our pre-ER write-up, these are historic margins for Nvidia.
The company reported an operating margin of 57.5% for income of $10.4 billion. The adjusted operating margin of 63.8% compares to a margin of 26.4% last quarter.
Net income of $9.2 billion represents a margin of 51% compared to 11.5% net margin in the year ago quarter. This is a combination of data center strength and being at the cyclical trough last year for gaming.
Cash:
Cash flow margins are the best in the Mag 7 at 40.5% operating cash flow this quarter and 38.9% in free cash flow margin. Meta has the second best FCF margin at 34.7% followed by Apple at 29.7%.
Nvidia had $18.3B in cash and marketable securities, up from $16.0B last quarter and debt of $9.7B in-line with the July quarter of $9.7B.
The company utilized cash of $3.91 billion towards shareholder returns, including $3.81 billion in share repurchases and $99 million in cash dividends. Last quarter, an additional $25 billion was authorized for share repurchases.
Earnings Call:
The China Impact:
We had written the following in our pre-earnings report:
“The Red Scare:
What’s not to be forgotten in the excitement of the product road map is China, which has been the predominant risk for semiconductor stocks dating back to 2018. Last year, the government restricted Nvidia from selling its two most powerful chips to China, the A100 and H100. To circumvent these restrictions, Nvidia designed slightly less powerful chips called the A800 and H800. As reported by Reuters, the H800 has as much computing power as the H100 in certain settings. For the United States, these chips are important to block as they strengthen China’s military.
Last month, the U.S. Department of Commerce announced updated rules focuses on computing performance by removing the bandwidth parameter and focusing exclusively on how powerful a chip is, as well as performance density, which will prevent companies from working loopholes. According to an official who spoke to Reuters, “the U.S. will require companies to notify the government about semiconductors whose performance is just below the guidelines before they are shipped to China.”
Although this is a medium-term issue for Nvidia, analysts believe the demand is high enough today that the company shouldn’t have any issues absorbing the 20% to 25% loss in its data center segment from tighter export restrictions to China. Looking further out for FY2025, Keybanc sees a $5 impact to Nvidia’s $25.62 EPS estimate, and up to a $20B impact to its data center segment with current estimates at $101B for the data center in FY2025.
Eventually, demand may settle – especially as more competitors step up – and investors should pencil-in losing China revenue as a risk that is materializing now, with the revenue impact likely to be felt in FY2025.”
It’s tempting to shrug off the loss of revenue given Nvidia beat/raised next quarter, which is the quarter when 20% to 25% of revenue from China and other restricted countries will be cut off. However, the Street is likely to be cautious tomorrow because FQ4 will be seen as an outlier where demand can absorb the 20% to 25%. Basically, the outsized demand will be transitory whereas the U.S. Department of Commerce is cutting off 20% to 25% permanently. There was some talk about Nvidia serving these countries with a less powerful chip, but the restrictions are blacklisting Nvidia’s AI chips (specifically) so this workaround won’t be an easy feat.
By the time Nvidia comes up with a workaround, even if it’s acceptable, those countries will have designed their own domestic silicon. Even if this eventually does get absorbed, analysts will likely revised down their estimates for a few quarters out in FY2025 or next fiscal year FY2026. This may, in turn, impact Nvidia’s valuation. Per the CFO: “The export controls will have a negative effect on our China business, and we do not have good visibility into the magnitude of that impact even over the long term.”
This does not derail Nvidia’s thesis by any means and the timing could not have been better with the restrictions happening during a period of outsized demand. As pointed out on the call, Nvidia will be tapped by many countries that are not blacklisted into the foreseeable future: “National investment in compute capacity is a new economic imperative, and serving the sovereign AI infrastructure market represents a multibillion-dollar opportunity over the next few years.”
InfiniBand up 500% YoY:
We covered InfiniBand a few years back for our premium members. Mellanox was an important acquisition as it helped Nvidia align its architecture with speed by supporting Virtual Protocol Interconnect (VPI), which allows the ubiquitous Ethernet to provide bandwidth as cheap as possible, and InfiniBand to deliver higher throughput and fewer bottlenecks during high loads. Today, this acquisition is paying off.
Per the opening remarks: “Networking now exceeds a $10 billion annualized revenue run-rate. Strong growth was driven by exceptional demand for InfiniBand, which grew fivefold year-on-year […] Azure uses over 29,000 miles of InfiniBand tabling, enough to circle the globe.”
InfiniBand growing five-fold exceeds overall data center revenue given the $15B in total data center revenue last fiscal year is expected to grow 200% to $45 billion at the exit of this fiscal year. Networking revenue tripled and data center compute grew four-fold.
The discussion on the call is that companies are standardizing with InfiniBand as the “computing fabric” increases the effectiveness of AI infrastructure by 20% to 30%. InfiniBand is nearly ubiquitous in supercomputing and is becoming popular with AI/Big Data applications on a large scale for high performance clusters. The benefits of the software defined fabric is that it’s low latency, high bandwidth and low management cost.
Recurring Software Revenue at $1 Billion:
Going off what we know, recuring software revenue may have doubled over the past few quarters CFO had stated: “hundreds of millions of dollars annually” and it’s now being stated the standalone software business will be worth $1 billion next quarter: “We are on track to exit the year at an annualized revenue run-rate of $1 billion for our recurring software support and services offerings.”
Keep an eye on this as it’s likely to be the leading story over the next few years – especially as automotive ramps.
AI Factories:
This was probably the most important question in terms of Nvidia’s growth potential. There’s nothing revelatory being said, per se, but it’s nice to hear some of the bigger picture repeated.
Question: “Because when I just look at the trajectory of your Data Center, it will be close to nearly 30% of all the spending in Data Center next year. So what metrics are you keeping an eye on to inform you that you can continue to grow? Just where are we in the adoption curve of your products into the generative AI market?” -Vivek Arya, Bank of America
Answer: “Generative AI is the largest TAM expansion of software and hardware that we've seen in several decades. At the core of it, what's really exciting is that what was largely a retrieval-based computing approach – almost everything that you do is retrieved off of storage somewhere – has been augmented now, added with a generative method. And its changed almost everything. […]
And one of the areas that is really impactful is the software industry, which is about $1 trillion or so, has been building tools that are manually used over the last couple decades. And now, there's a whole new segment of software called co-pilots and assistants. Instead of manually used, these tools will have co- pilots to help you use it, and so instead of licensing software – we will continue to do that of course, but we will also hire co-pilots and assistants to help us use the software. […]
But there's a new class of data centers, and this new class of data centers, unlike the data centers of the past, where you have a lot of applications running used by a great many people that are different tenants that are using the same infrastructure, and that data center stores a lot of files. These new data centers are very few applications, if not one application, used by basically one tenant, and it processes data. It trains models, and it generates tokens. It generates AI. And we call these new data centers AI factories.”
Translation: If you separate AI from traditional data centers (and where data centers are headed), then Nvidia represents far more than 30%.
Conclusion:
We are tracking TSM, semiconductor indexes, and Nvidia’s chart for signs of exhaustion as outlined here. We are seeking a win-win scenario where we can lock-in gains, and then use that cash to buy Nvidia again at lower levels. As stated, Nvidia’s thesis is firmly intact. Rather, the issue is the market is seeing very narrow leadership and Nvidia is the defacto leader within that narrow leadership. The saying in Wall Street is that pigs get slaughtered. That’s a rough way of saying 200% gains YTD should be approached carefully as the goal is to make real money, not paper money. Of course, 200% will be nothing by the time we are done with this position. But for this year, it’s good enough.
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The current theme for us within the broad market is caution. It is our belief that we are completing a cyclical bull market within a secular bear market. We are seeing narrow leadership while many unpopular stocks and sectors are now testing their October, 2022, lows. The resiliency of the US economy has kept this market trending up, but we are starting to see some cracks within the employment data, which is typically the last shoe to drop before stocks.
This is one of the primary themes within our Advanced service, which is really tailored to the more active investors. However, at times, we think it is important to share the broad risks with all of our subscribers. Based on our analysis, we believe that a bigger top was either put in in July, or we may have one more push into Q1 2024 before putting in a top. We manage this risk by hedging as well as through raising cash based on our interpretation of the macro economic backdrop and where we are within the business cycle. While we are still net long, we continue to raise cash into strength, and patiently wait for better prices on some choice AI names.
Every Thursday at 4:30 pm Eastern, our Portfolio Manager Knox Ridley holds a webinar for Advanced Signals Members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. Learn more here.here.
This article was originally published on Forbes on Nov 16, 2023,05:19pm ESTForbes Forbes on Nov 16, 2023,05:19pm EST
Apple’s Services segment was one of the brightest spots in a relatively in-line earnings report at the beginning of November, topping an $85 billion run rate as growth jumped back to the high double-digits after a string of single-digit growth. Services demonstrated that its growth flywheel continues to strengthen with multiple outlets of opportunity in sight — from AI, to further growth in the installed base, to price hikes across different Services bundles.
Services Growth Outpaces iPhone, Apple
Since fiscal 2018, Services has become increasingly important to both the top and bottom lines for Apple. The segment has seen its share of revenue rise from under 15% five years ago to 22.2% at the end of September. Since then, Services has seen its annual run rate increase from ~$40 billion to over $85 billion, on track to surpass a $100 billion run rate potentially as early as the second half FY24.
FY21 was a breakout year for Services – the segment recorded greater than 24% YoY growth and generated more than $10 billion in gross profit each quarter, as its gross margin neared 70%. Gross margin has continued to stay above the 70% range, rising as high as 72.6% in Q2 FY22.
Source: I/O Fund
FY23 ending in September saw a full year growth rate of 7.1% YoY for $85.2 billion outpacing both iPhone and company-wide growth, with Q4 being the strongest quarter of the fiscal year with a growth rate of 16.3% YoY. The I/O Fund recently covered Apple’s earnings report more in-depth following fiscal Q4 here.
Since FY18, Apple has grown revenue at a 7.6% CAGR, meanwhile, Apple’s company-wide gross profit has grown at a 10.1% CAGR over the same period with profits partly impacted by Services’ rising contribution and expanding margin.
Compared to Apple, Services is seeing revenue and gross profit grow at much quicker rates – more than 9 percentage points higher for both metrics. Since FY18, Services revenue has grown at a 16.5% CAGR, outpacing Apple’s 7.6% growth rate as well as the iPhone’s 4.0% CAGR, due to the unevenness in revenue in between upgrade cycles – iPhone delivered YoY revenue declines in FY19, FY20, and FY23.
Services’ gross profit has expanded at a 20.1% CAGR, rising around 150% since FY18, from $24.2 billion to $60.3 billion as gross margin has expanded 10 percentage points, from 60.8% to 70.8%. This strong revenue and gross profit growth over the past five years has seen Services gain importance to Apple’s margins and its bottom line.
Source: Apple
In FY18, Services contributed 23.7% of Apple’s gross profit, whereas today, Services contributes 36% of gross profit.
The breakdown looks like this:
As Services’ share of revenue rose from 15% to 22.2%, it helped pull Apple’s gross margin ~580 bp higher in just five years. Product gross margin – iPhone, Mac, iPad, etc. – increased just 210 bp, meaning this expansion in gross margin is primarily coming from Services.
FY21 was a breakout year for Apple’s gross margin, expanding from 38% to more than 42% because of that growth in Services. Apple is guiding for gross margin to expand further in fiscal Q1 next year, to the 45% to 46% range – an expansion of 200 to 300 bp YoY, with Services’ growth rate forecast to be in the high-teens again.
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Services Seeing Multiple Growth Outlets
Services growth has been broad based, with new revenue records across a range of different offerings, and the segment has multiple growth outlets to lever in the future, from growth in paid subscribers, AI, and price hikes.
CEO Tim Cook explained on Apple’s Q4 earnings call that the Services segment “achieved all-time revenue records across App Store, advertising, AppleCare, iCloud, payment services, and video, as well as the September quarter revenue record in Apple Music.” CFO Luca Maestri added that Services “reached all-time revenue records in the Americas, Europe and rest of Asia-Pacific and a September quarter record in Greater China.”
What is driving these record levels across multiple Services offerings and in every geography worldwide is solid growth in active devices and strong growth in paid subscriptions. Paid subscriptions have risen at more than 27% annually over the past five years to 1 billion by the end of FY23.
Source: APPLE
Apple has surpassed 2 billion installed devices, and “continues to grow at a nice pace and establishes a solid foundation for the future expansion of the ecosystem.” Thus, the organic growth flywheel for Services remains soundly intact – growth in installed devices driving growth in paid and transacting accounts at a higher degree.
At the start of FY18, Apple reported that it had an installed active device base of 1.3 billion devices, meaning it had a ratio of about 0.18 paid subscriptions per 1 active device. Since then, installed devices have grown more than +50% to over 2 billion, while paid subscriptions have grown nearly +360% to almost 1.1 billion, or a ratio of about 0.5 paid subscriptions per active device.
Reaching new all-time highs in its installed device base signals further growth lies ahead for Services, especially as the ratio of paid subscriptions per active device continues to rise. Other outlets of growth arise from Apple’s recent price hikes and potential monetization opportunities from AI.
Additional Levers
Apple recently enacted some price hikes for News+, Arcade, and its One bundles, with the hikes ranging from $2/mo to $5/mo. As a whole, the price hikes could generate an additional ~$5 billion in annual revenue with just a 15% attach rate to Apple’s more than 1 billion paid subscriptions — however, the price hikes could incur a small amount of churn, among more price-sensitive consumers.
In terms of AI, Apple is not releasing any details about projects in development, though it is rumored that some of the AI products Apple is working on would improve Siri and Messages’ capabilities, or add features to Keynote, Pages, and Apple Music. Apple’s large language model ‘Apple GPT’ is reportedly under development, but a commercialization route is still undetermined. The next-generation of Apple’s software, iOS 18, macOS 15, and watchOS 11, are poised to bring AI features to Apple’s devices next year, as it works to catch up in the generative AI deployment race against OpenAI and Google.
For any of its AI products, there are three routes that could boost Services revenue – adding AI features for free in an aim to boost engagement across offerings, charging a subscription fee for AI features, or increasing prices of current bundles that incorporate AI. For example, if Apple charged for a stand-alone AI subscription at a $2.99/mo price point, it could rake in ~$10.8 billion in annual revenue at a 15% attach rate to its more than 2 billion active devices; boosting the prices of all of its subscription bundles by $0.99/mo could also add more than $10 billion annually.
In a previous Forbes article “AI Could Be Apple’s Next Chapter,” my firm pointed out that: “although Apple is tight-lipped about the progress of its AI projects, the so-called Apple GPT chatbot is rumored to be more powerful than Open AI’s GPT 3.5 model, according to The Verge. Apple is spending millions of dollars a day training the large language model Ajax on more than 200 billion parameters.”
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iPhone Demand Uncertain, China Risks Remain
Analysts have expressed concern over the holiday launch trajectory of Apple’s new iPhone 15, hinting that supply shortages, lower levels of consumer spending, and shorter wait times suggest weaker demand. The iPhone remains Apple's main source of revenue, and a conservative fiscal Q1 guide from the company along with heightened concerns over iPhone 15 demand add to risks that iPhone revenue growth in the near-term will remain depressed, after growing just +2.6% YoY in Q4.
Other concerns arise from Apple’s concentration in China, in regard to its iPhone supply base. Bank of America warned that Apple’s iPhone “supplier base remains largely in China,” which could “create many headwinds including around production, demand, [and] competition,” given that it is “hard to move all elements out of China.”
Services remains strong and a segment to watch, but we need the iPhone to participate and come in strong too, with a lingering risk to watch around China. Without the iPhone participating, Services is not enough to carry Apple’s stock alone, especially given its current valuation trading at levels hard to sustain.
Source: YCHARTS
Apple is currently trading at a 7.76x P/S ratio, above its 5-year median P/S ratio of 6.59x, with the 8.0x a level that Apple has struggled to hold on to since spiking to it in 2020. Apple is also trading at a nearly 28.8x forward P/E ratio, again another valuation level that it has struggled to hold on to – since late 2021, Apple has generally pulled back to below 24x forward P/E after trading above the 28 range.
Source: YCHARTS
However, another risk to watch is Alphabet’s antitrust trial, as it could have direct implications for Apple in the event of a negative ruling. Alphabet’s multi-billion dollar payments to Apple for Google to be the primary search engine on Safari across Apple’s devices is at the center of the trial, and that payment is rumored to be ~$19 billion this year – a key witness mentioned during the trial that Google is paying Apple 36% of search advertising revenue it generates via Safari. Should the scale of those payments constitute monopolization of the search market, Apple could be set to lose on a lucrative Services revenue stream.
Conclusion
Services is rapidly becoming one of Apple’s most important top-line segments, and arguably is the most important for Apple’s bottom-line, given its outsized role in boosting Apple’s gross margin. Organic growth has been a strong driver of Services’ +16.5% 5-year revenue CAGR and its +20.1% 5-year gross profit CAGR, both of which outpace Apple’s growth rates by more than 9 percentage points.
Should Services continue to grow in the teens for the next five years, such as at a 14% 5-year CAGR through FY28, it would be generating approximately $164 billion in revenue, or slightly more than 30% of Apple’s projected $538.6 billion in revenue. Price hikes, introduction of AI features, or finding ways to increase engagement and boost the ratio of paid subscriptions per active device all support this long-term revenue growth outlook for the segment.
Damien Robbins, Equity Analyst at the I/O Fund, contributed to this article.
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The focus of our recent AMD deep dive in July helped emphasize how memory has become a point of fierce competition among AI accelerators.
“The MI300X requires more power than its predecessor MI250X at 750 watts, and this is higher than Nvidia’s H100 at 700 watts. However, it’s not an apples-to-apples because what the MI300X promises to deliver is running compute-intensive large language models with fewer GPUs than is required with the H100s due to offering roughly double the memory.”due to offering roughly double the memory.”
“The impetus is AI acceleration, which is in a stage where it’s fiercely competing on memory […] In fact, according to Lam, AI servers use 8X DRAM and 3X NAND compared to an enterprise class server […]according to Lam, AI servers use 8X DRAM and 3X NAND compared to an enterprise class server […]
Point being, memory is becoming an important component in the AI arms race, and Lam is a major equipment supplier and beneficiary of capital intensity that follows each new generation of HBM.memory is becoming an important component in the AI arms race, and Lam is a major equipment supplier and beneficiary of capital intensity that follows each new generation of HBM.
In the analysis, we touched on the GH200 super chip from Nvidia, which “combines the H100 GPU with Grace 72-core Arm CPUs for an increase of memory capacity by 3.5X and memory bandwidth by 3X. Per the press release: HBM3e memory, which is 50% faster than current HBM3, delivers a total of 10TB/sec of combined bandwidth, allowing the new platform to run models 3.5x larger than the previous version, while improving performance with 3x faster memory bandwidth.”
Since then, more information has been revealed about Nvidia’s H200 GPUs, which will have 141GB total of HBM3e memory with 4.8 TB/s of bandwidth across six HBM3e stacks. This compares to the H100 with 80GB of HBM3 and 3.35 TB/s of bandwidth. To see how this compares to the MI300X from AMD, you can read more here.
If 2023 was the year AI accelerators made their importance known, then 2024 will be the year that memory and HBM3/HBM3E makes its importance known as the competition is going head-to-head at memory capacity and bandwidth per GPU rather than compute performance. This further translates to mean the AI race is more focused on inference for the next generation of GPUs as the neural network can be run entirely in memory without the need to move data back-and-forth with the external memory.
In fact, to drive the point further as to how important memory will be in the next generation of GPUs, the compute performance from the H100 to the H200 is not changing much. According to what the industry has seen so far from Nvidia’s GPU HGX 200 systems, there will be “32 PLOPS FP8” performance, which would be achieved through eight H100s with 3,958 teraflops of FP8 each. The translation is that Nvidia’s H200 upgrade is strategically focused on memory, which also translates to AMD having a strong sense of direction on design as it forced Nvidia to answer to the MI300X’s memory capacity and bandwidth. It’s also quite strategic for AMD to go directly toward competing on LLM inferencing performance as these are the workloads that will be most in demand.
Memory is Tough
As we review the memory market, and also segue to the PC market in this analysis, it bears mentioning that the memory is a tough market. It can often be a race to the bottom on pricing, there are rollercoaster-like cyclical patterns, it’s heavily exposed to consumer devices, and it has many global leaders not trading on the Nasdaq. Memory leaders are concentrated in APAC and so any United States stock needs to be measured against overseas competitors.
With that said, over the past year, the memory, smartphone, and PC markets have been going through inventory corrections, but these markets are close to bottoming based on recent earnings commentary from several semiconductor companies such as Samsung, Microsoft, AMD, Intel and others. Sometime in the medium term, PCs will go through a super cycle driven by AI. We want to look more closely at the timing of this and who the major players might be.
In the Lam Research analysis, it was stated that the pummeled consumer market is deceiving as eventually hybrid AI will bring AI processing capabilities to the edge, including consumer devices. Memory is a key component in the competitive AI race both inside and outside the data center. Although the introduction to this analysis emphasized data center AI accelerators, we want to start to turn our focus toward the edge.
It's also important to point out that what matters most for determining a good stock is dollar content per chip. For example, HBM3e is priced five to six times higher than typical DRAM. This means that if the shipment volume is 2% of total DRAM, then its sales ratio reaches 12%. Our goal is to find the semiconductors that can charge more for their chips in the AI super cycle for PCs rather than simply PC players.
Memory Rebound
HBM3 sales are expected to explode. According to Trend Force, HBM3 could grow to $8.9 billion in 2024 for a 127% YoY increase.
SK Hynix is projecting 100% growth in HBM demand this year and next, revised up from 50% growth. According to SK Hynix, the AI chip boom will drive an 82% CAGR for HBM3 by 2027. SK Hynix has reclaimed its spot as the number two memory company globally due to HBM sales, and was the preferred supplier of HBM3 for Nvidia’s H100 GPUs.
Samsung, the world’s largest manufacturer of DRAM and NAND by revenue, has shown a trend of QoQ improvements in revenue and operating profits since 4Q22. As long as this trend continues, then it’s likely the memory market has bottomed. According to the Korea Economic Daily, Samsung executives stated at a conference: “Our customers’ current (HBM) orders have more than doubled from last year.”
Micron shows something similar to where the company was reporting deeply negative growth and is rebounding significantly on revenue. This is easily seen on a QoQ basis pictured below.
As a percentage of revenue, Micron’s QoQ Profit Improvement is also quite clear with a recovery by the second half of 2024.
Although HBM3 will participate, the major memory suppliers are primarily rebounding from lapping a trough in a consumer cycle that had peaked following Covid. Typically, memory stocks would be on a deep discount given the steep cycle, yet SMH returns are > QQQ returns. This has lifted the tide of all boats, and memory stocks such as Micron and Lam are not trading where they’d typically trade, which makes a near-term buy less likely for the I/O Fund until we see a pullback. This is where the I/O Fund is unique, not only do we strive to be early in our research, such as to the importance of memory in the next release of AI accelerators, but we are also careful with our timing.
PC Rebound
Similar to the memory and smartphone markets, the PC market is in the process of normalizing inventory. Silicon Motion, one of the largest manufacturers of NAND flash controllers, which go into PCs and smartphones, commented in its recent earnings call that inventory for the PC and smartphone markets is normalizing and these markets are poised to return to growth in CY24.
“We saw inventory level begin to normalize across the majority of end markets and OEM order activity pick up in the third quarter leading to a strong revenue growth in the quarter. We expect this trend to continue and are confident they will lead to strong sequential growth in the fourth quarter. While the first half of 2023 was challenging due to the global macro economy weakness and excess inventory in the channels the inventory level across our end market is normalizing and OEM demand continue to improve.” -Silicon Motion, Q3 Earnings Call Nov 2023
“By end market standpoint, excess inventory in the PC and smartphone markets have plagued the industry since late 2022, when the global economy weakened and demand slowed. It has taken nearly a year where we believe the inventory level in both the PC and smartphone markets are normalizing. We are seeing more consistent order pattern from our customers and better visibility that are more closely aligned with end market demand. We are optimistic that this trend will continue and that the industry is well positioned to return to growth in 2024.” -Silicon Motion, Q3 Earnings Call Nov 2023
This commentary by Silicon Motion was also supported by AMD in its recent earnings call, in which management commented that it expects growth for the PC market in CY24, and the PC market will return to normal seasonality levels in demand.
“Year-over-year, we expect revenue for the Data Center and the Client segments to be up by strong double-digit percentage, the Gaming segment to decline, given where we are in the console cycle, and the Embedded segment to decline due to additional softening of demand in the embedded market.
Sequentially, we expect Data Center segment to grow by strong double-digit percentage, Client segment revenue to increase and the Gaming and Embedded segment to decline by double-digit percentage […]
Sales of our Ryzen 7000 processors featuring our industry-leading Ryzen AI on-chip accelerator, grew significantly in the quarter as inventory levels in the PC market normalized and demand began returning to seasonal patterns.” –AMD Q3 2023 Earnings Call
For the PC market, HP believes AI can help double the PC market’s growth over the next 3 years.
“The biggest opportunity we see is with in Personal Systems. The ability to run generative AI applications on a PC will enable personalized experiences, improved latency, provide better security and privacy protections, and reduce costs. And as we begin commercializing AI-enabled devices, we believe the overall PC category growth rate can double over the next three years.” -HPQ Analyst Day
Intel has ambitious plans to take advantage of the AI opportunity in PCs. Through its AI PC Acceleration Program, Intel is focused on having AI on more than 100M PCs by 2025. Intel is working with over 100 independent software vendors on more than 300 accelerated AI features, including well-known companies such as Adobe, Webex, and Zoom.
On December 14th, Intel will launch the Core Ultra Processors. The new processors are a 7nm chiplet design which makes updates easier, and allows for the most efficient use of the chip tiles. Especially for AI purposes, chiplets are replacing monolithic circuits, where the overall system is divided into smaller parts so that 3nm or 5nm nodes can be replaced when needed. This avoids having to replace all of the components as nodes shrink and design companies otherwise battle Moore’s Law. With chiplets, AI platforms can scale by adding computing power and reduce total cost of ownership.
The Meteor Lake architecture will come with a neural processing unit (NPU) to execute AI workloads. The goal of AI edge devices (PCs, mobile devices, and edge servers) is to diversify AI execution for both speed and power efficiency. By running the workloads across NPUs, GPUs and CPUs, the Core Ultra will drive better efficiency.
“Built on Intel 4, the Intel Core Ultra has been shipping to customers for several weeks and will officially launch on December 14 alongside our 5th Gen Xeon. The Ultra represents the first client chiplet design enabled by Foveros Advanced 3D packaging technology, delivering improved power efficiency and graphics performance.
It is also the first Intel client processor to feature our integrated neural processing unit, or NPU, that enables dedicated low-power compute for AI workloads. Next year, we will deliver Arrow Lake as well as Lunar Lake, which offers our next-gen NPU, ultra-low power mobility and breakthrough performance per watt.”
Intel and also Qualcomm are set to release WiFi 7 in Q4. WiFi 7 will be two to four times faster than WiFi 6 and will have twice as many data streams. Although AI applications are not mainstream yet, WiFi 7 makes it possible to develop and distribute AI applications due to the high capacity, low latency, and extended range. The high bandwidth consumption that AI applications require, along with moving AI workloads to AI devices means WiFi 7 will be instrumental for AI-powered PCs.
Note: We will discuss Qualcomm again when we look more closely at the mobile rebound.
2024 Refresh: Windows 12
“We actually think 2024 is going to be a pretty good year for client, in particular because of the Windows refresh. We still think that the install base is pretty old, and does require a refresh. We think next year may be the start of that given the Windows catalyst.” -Intel, Citi Analyst Conference, Sept 6th
In September, a CoPilot update was rolled-out for Windows 11 with over 150 features such as CoPilot in Windows, which is a toolbar that allows generative AI to be used across any task across the Windows operating system. The new update also added AI-powered Bing search to the taskbar.
Windows 11 was an exciting update, yet the next Windows release is expected to make a much bigger impact. The Intel statement was the first to hint at the Windows refresh, which is generally understood to be Windows 12, due to come out in 2024.
We had noted that AMD also referenced a Windows refresh in the last earnings call. Per management’s opening remarks noted in our Post-ER writeup: “Looking forward, we are executing on a multiyear Ryzen AI road map to deliver leadership compute capabilities built on top of Microsoft's Windows software ecosystem to enable the new generation of AI PCs that will fundamentally redefine the computing experience over the coming years.”
It's likely that Intel and AMD are leaking the next Windows refresh because Microsoft is working closely with hardware partners to optimize chips to handle the AI workloads. The Ryzen 7000 mobile processors are the first x86 chips to contain a dedicated AI engine to support Microsoft’s Windows Studio Effects. Typically, this requires Arm-based hardware with a dedicated neural processing unit (NPU).
AI-powered PCs will ultimately change the trajectory for AI, to where more people can access AI-powered applications, which in turn, will help AI developers be able to build a bigger ecosystem. There is a major bottleneck right now for AI applications to where client devices are not powerful enough or energy efficient enough to leverage AI capabilities.
Look for Windows 12 to be a major release for 2024, and to be the official moment AI-powered PCs kickoff.
What Industry Analysts are Saying:
Gartner:
Per Gartner, “The global PC market is expected to rebound in the fourth quarter of 2023 as the beleaguered industry begins a return to growth. Worldwide PC shipments totaled 64.3 million in the third quarter of 2023, according to analysis from Gartner, marking a 9% decrease compared to the same period last year and the eighth consecutive quarterly decline.”
Additional Management Commentary:
AMD:
“Sales of our Ryzen 7000 processors, featuring our industry-leading Ryzen AI on-chip accelerator, grew significantly in the quarter as inventory levels in the PC market normalized and demand began returning to seasonal patterns.” -AMD, Q3 Earnings
“Question – Blayne Curtis: Thanks. And then I just wanted to ask on the PC market, I think you and Intel have seen you were under-shipping in the first half. Maybe you're kind of over-shipping a little bit now, restocking. I'm just kind of curious your perspective of what that normalized run rate is in terms of the size of the PC market and kind of any perspective, if inventory levels are starting to move back up.
Answer – Lisa T. Su: Yeah, I would say again, Blayne, when we look at sort of the third quarter and sort of the environment that we're on now, I think inventory levels are relatively normalized, and so the sell-in and consumption are fairly close. We were building up for holiday season that is a strong season for us overall. When I think about the size of the market, I think from a consumption standpoint, this year is probably somewhere like 250 to 255 million units or so.”
“Jean Hu
Yeah. Hi, Stacy. I'll say the first thing is, if you look at 2023, it's a very unusual year for the industry, right, especially the PC market. It's one of the worst down cycles during the last 3 decades. So during that kind of a down cycle, definitely, we had headwinds on gross margin side, on our Client business, which we have made significant progress in Q3 and Q4 in second half.”
Microsoft:
“In our consumer business, PC market unit volumes are returning to pre-pandemic levels.”
“Windows OEM revenue increased 4% year-over-year, significantly ahead of expectations driven by stronger-than-expected consumer channel inventory builds and the stabilizing PC market demand noted earlier, particularly in commercial.”
Previous Cyclical Behavior
According to Deutsche Bank, past semiconductor cycles have lasted on average of ~28 months (2 years, 4 months).
If we look at the beginning of 2018 to the end of Feb 2020, the last down cycle, the SOXX was down 14% off of its high due to the US and China trade war, which included bans on Huawei and ZTE. Semiconductor companies were negatively impacted by these bans. By the end of February 2020, semiconductor stocks were down the following from their highs:
QRVO: down 15%
HP: down 21%
SWKS: down 22%
QCOM: down 18%
DELL: down 42%
Conclusion:
As we look toward 2024, memory and PCs are shaping up to be a predominant theme. This broad analysis looks at management commentary across a range of companies that all seem to point toward the bottom being in for PCs and memory. In the coming weeks, we will look closer at specific companies that will participate as we narrow our focus for 2024.
Big Tech capex is a leading indicator for AI semiconductor companies and has been a secular tailwind for our holdings, such as Nvidia and AMD. The combined capex of Big Tech companies has increased from $41.4 billion in 2017 to $150.6 billion in 2022, growing at a CAGR of 29.5%. In the recent earnings calls, management teams from big tech companies are indicating they will continue to invest in AI.
On a side note, increased capex related to AI does not mean AI stocks will move in a linear fashion, rather we track data like this to help us determine what to buy during selloffs, and at the bottom of selloffs.
Semiconductor Market Update
According to the Semiconductor Industry Association (SIA), global semiconductor sales were up 1.9% MoM and down (-4.5%) YoY in September to $44.9 billion. Q3 global semiconductor sales were up 6.3% QoQ and down (-4.5%) YoY to $134.7 billion.
John Neuffer, SIA President and CEO said, “Global semiconductor sales increased on a month-to-month basis for the seventh consecutive time in September, reinforcing the positive momentum the chip market has experienced during the middle part of this year,”increased on a month-to-month basis for the seventh consecutive time in September, reinforcing the positive momentum the chip market has experienced during the middle part of this year,” he further said, “The long-term outlook for semiconductor demand remains strong, with chips enabling countless products the world depends on and giving rise to new, transformative technologies of the future.”
Meanwhile, South Korean exports rose in October as semiconductor exports reported the smallest drop since August 2022 of (-3.1%) YoY in October. Chip sales helped the rise in the country’s exports for the first time in about a year.
Management Commentary on Big Tech Capex
Meta
Meta spent $32.04 billion in capex in 2022, up 66.5% YoY. 2023 has been a ‘Year of Efficiency’ and reducing capex was a priority for the company. Reduced spending in 2023 was possible due to cost savings, particularly in non-AI servers and the capex shift to 2024.
Susan Li, CFO of Meta, said in the recent earnings call. “Capital expenditures were below the prior year levels primarily due to lower server and data center construction spend as we prepared to shift to our new data center design, as well as payment timing.”to lower server and data center construction spend as we prepared to shift to our new data center design, as well as payment timing.”
The management during Q3 results lowered the upper range of the 2023 capex. It is expected to be $27 billion to $29 billion from the earlier reduced estimate of $27 billion to $30 billion, representing a YoY decline of (12.6%) at the mid-point. However, they expect higher capex for next year in the range of $30 billion to $35 billion, representing a YoY growth of 16.1% at the mid-point. The CFO said in the earnings call, “With growth driven by investments in servers, including both non-AI and AI hardware, and in data centers as we ramp up construction on sites with the new data center architecture we announced late last year.”With growth driven by investments in servers, including both non-AI and AI hardware, and in data centers as we ramp up construction on sites with the new data center architecture we announced late last year.”
Microsoft
Microsoft spent $28.40 billion in capex in 2022, up 3.3% YoY. YTD September 2023, the company has already spent $29.7 billion and therefore will see a significant jump in capex for the year 2023, helped by investments in cloud and AI.
Amy Hood, CFO of Microsoft, said in the recent earnings call. “Capital expenditures, including finance leases were $11.2 billion to support cloud demand, including investments to scale our AI infrastructure. Cash paid for PP&E was $9.9 billion.” including investments to scale our AI infrastructure. Cash paid for PP&E was $9.9 billion.” She further added, “We expect capital expenditures to increase sequentially on a dollar basis, driven by investments in our cloud and AI infrastructure. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure buildout.”driven by investments in our cloud and AI infrastructure. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure buildout.”
Nvidia had announced last year that they have a multi-year collaboration with Microsoft to build a giant AI supercomputer using thousands of Nvidia GPUs, Nvidia Quantum-2 InfiniBand, and full stack of Nvidia AI software to cater to the growing demand for AI.
Alphabet
The company spent $31.49 billion in capex in 2022, up 27.8% YoY. In the recent quarter, the company’s capex grew by 10.7% YoY to $8.06 billion. YTD September 2023, the capex was $21.3 billion down (-11.1%) YoY. However, the company will see an increase in Q4 and continue to grow in 2024.
Ruth Porat, CFO of Alphabet, said in the recent earnings call. “Finally, our reported CapEx in Q3 was $8 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers, followed by data centers, reflecting a meaningful increase in our investments in AI compute.reflecting a meaningful increase in our investments in AI compute.
The growth in reported cash CapEx in Q3 is somewhat muted due to the timing of supplier payments, which can cause variability from quarter-to-quarter. We continue to invest meaningfully in the technical infrastructure needed to support the opportunities we see in AI across Alphabet and expect elevated levels of investment, increasing in the fourth quarter of 2023 and continuing to grow in 2024.” We continue to invest meaningfully in the technical infrastructure needed to support the opportunities we see in AI across Alphabet and expect elevated levels of investment, increasing in the fourth quarter of 2023 and continuing to grow in 2024.”
She further clarified to an analyst that “2024 aggregate CapEx will be above the full year 2023.”“2024 aggregate CapEx will be above the full year 2023.”
The main takeaway is that the investment in technical infrastructure is growing and will continue to grow in 2024. There is an increasing shift in investment in technical infrastructure (i.e., AI and cloud) compared to other capex like office facilities, which is of prime importance for our portfolio. Ruth had clarified the change in shift in the Q4 2022 earnings call, “We're increasing our investments in technical infrastructure. And that's not just for AI. That's to support investments across Alphabet, in particular in Cloud as well. And at the same time, we're meaningfully decreasing our CapEx for office facilities.”we're meaningfully decreasing our CapEx for office facilities.”
Amazon
The company spent $58.62 billion in capex in 2022, down (-2%) YoY. The key takeaway is the company’s technological infrastructure spend is increasing. To understand the breakup of Amazon’s capex, we looked at some of the other previous earnings calls and understand technology infrastructure spend to be over 50% of the total capex. Brian Olsavsky, CFO of the company said in the Q2 2022 earnings call, “In 2021, we incurred approximately $60 billion in capital investments. About 40% of that is comprised of technology infrastructure, primarily supporting AWS as well as our worldwide stores business. Another 30% of the $60 billion was fulfillment capacity and a little less than 25% was for transportation, remaining 5% was comprised of things like corporate space and physical storesAbout 40% of that is comprised of technology infrastructure, primarily supporting AWS as well as our worldwide stores business. Another 30% of the $60 billion was fulfillment capacity and a little less than 25% was for transportation, remaining 5% was comprised of things like corporate space and physical stores.” He further said, “We expect infrastructure to represent a bit more than half of our total capital investments in 2022.”“We expect infrastructure to represent a bit more than half of our total capital investments in 2022.”
The guidance for 2023 capex is $50 billion, down (14.7%) YoY. However, technology infrastructure continues to grow. Brian said in the recent earnings call. “Now, let's turn to our capital investments. We define our capital investments as a combination of CapEx plus equipment finance leases. These investments were $50 billion for the trailing 12-month period ended September 30, down from $60 billion in the comparable prior year period. For the full year 2023, we expect capital investments to be approximately $50 billion compared to $59 billion in 2022. We expect fulfillment and transportation CapEx to be down year-over-year, partially offset by increased infrastructure CapEx to support growth of our AWS business, including additional investments related to generative AI and large language model efforts.”We expect fulfillment and transportation CapEx to be down year-over-year, partially offset by increased infrastructure CapEx to support growth of our AWS business, including additional investments related to generative AI and large language model efforts.”
We will be listening closely for 2024 capex discussions next quarter.
Conclusion
We continue to monitor Big Tech capex commentary and are encouraged by Meta’s recent guide for FY2024. Meta is the only company that has provided this level of visibility. In addition to a potential increase in capex from Big Tech, we are hearing across the board that a higher allocation of capex is going toward AI infrastructure.
With that said, it’s normal for cloud IaaS to go through periods of optimization. Given Meta’s guide, we are hopeful a period of optimization will not happen in 2024. Meanwhile, we will continue to closely monitor Big Tech capex comments closely as an important proxy for AI accelerators.
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Royston Roche, Equity Analyst at the I/O Fund, contributed to this analysis.
This article was originally published on Forbes on Nov 9, 2023,09:23pm ESTForbes Forbes on Nov 9, 2023,09:23pm EST
BYD more than doubled Tesla’s China sales in October as Tesla’s sales slipped on a month-over-month basis, while NEV startups showed strong sales numbers across the board. China’s new energy vehicle (NEV) industry continues to exhibit solid momentum, with September seeing NEV sales rise about +22% YoY and October estimated to see around +34% YoY growth. As a whole, China is expected to once again be the primary driver of global EV sales this year, with volumes forecast to reach or exceed 8.5 million units, or more than 60% of the projected 14 million global volume.
Tesla has been in the spotlight recently — its margins have contracted significantly over the past few quarterscontracted significantly over the past few quarters as it prioritizes price cuts. China is Tesla’s most important market as it currently represents the highest remaining total addressable market (TAM), therefore the recent weakness is not something to ignore, especially as domestic rivals pick up their pace of growth.
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BYD Trumps Tesla in China as Sales Stagnate
BYD’s delivery numbers have shown tremendous growth in Q3 and the start of Q4, as opposed to Tesla’s stagnation as consumer demand looks to be shifting in favor of local OEMs. XPeng and Li Auto both posted record October numbers with ~300% YoY growth, while NIO saw +60% YoY growth. BYD’s increased dominance in China is more visible with sales data by model: 5 of the top 6 highest selling models in October were BYD, combining for nearly 214,000-unit volume, compared to the Model Y’s 53,249 volume for the month.
Source: I/O Fund
BYD has seen steady growth in NEV and purely BEV sales since May, and since June, BYD has posted five straight record months for NEV deliveries, rising from 253,046 in June to close out Q2 to more than301,000 in October June to close out Q2 to more than301,000 in October to kick off Q4. Deliveries grew +39% YoY in October, the slowest growth rate so far this year, where monthly sales have averaged +77% YoY growth. In terms of BEV sales, for a more apples-to-apples comparison to Tesla, BYD recorded +60% YoY growth to 165,505 deliveries and exports of China-made vehicles in October – more than double Tesla’s total . At that rate, BYD is set to overtake Tesla in terms of quarterly BEV deliveries, being on track to surpass 500,000 BEVs in Q4, whereas Tesla is forecasting a volume of at least 449,000 vehicles in Q4 to reach its1.8 million target for 2023.
Source: I/O Fund
On the other hand, Tesla’s China sales peaked in June at 93,680 vehicles, with September seeing a nearly (12%) MoM and (11%) YoY decline to 74,073 vehicles, including exportspeaked in June at 93,680 vehicles, with September seeing a nearly (12%) MoM and (11%) YoY decline to 74,073 vehicles, including exports. October saw a fractional YoY increase of just +0.6% while registering a consecutive MoM decline of (2.6%), as the OEM continues to lag the growth of the broader NEV industry.
The Profitability Picture
NIO and XPeng are struggling to find a shift to profitability with elevated levels of R&D and losses piling up, whereas Tesla is facing margin troubles, exacerbated by its reliance on China. The reason here is simple: Tesla continues to sell vehicles in China below its average cost, from Q4 2022 through Q3 2023. Currently, the base Model Y is priced around $36,200, and the revamped Model 3 saw a 12% increase in its base price to $35,800 – both still below Tesla’s average cost of ~$37,487 per vehicle in Q3.
The recently announced Model Y price hikes may help alleviate the issue, given the Model Y is accounting for just over 70% of monthly sales in China, but the past four quarters have seen China’s ASP trail average cost per vehicle by (3%) or more.
Source: I/O Fund
Q1 saw Tesla deliver 137,429 vehicles in China (excluding exports) for an average ASP of $35,589.
Q2 saw China’s ASP rise ~$1,000 to $36,578 on a +14% QoQ rise in deliveries to 156,676 vehicles. ASP was aided by a price increase in May and a higher mix of Model Y sales.
Q3 saw ASP decline once more to $35,953, as deliveries slipped (12.2%) QoQ to 139,624
Although Tesla has made progress in bringing its cost per vehicle lower over the past four quarters, ASP has declined at a quicker rate due to extensive price cuts. However, the sheer volume that China contributes – just under 33% of YTD deliveries at 433,729 vehicles – combined with ASP trailing average COGS means that Tesla’s margins will likely not recover above 20% until China’s ASP shifts back above average COGS. It is important for cost of goods sold (COGS) to be below average selling price (ASP), as the difference between the two is the gross profit. In Tesla’s case, China’s ASPs being below average COGS are weighing negatively on gross profit.
We previously discussed how Tesla will likely continue to lower prices to increase its leading EV market share to stave off competition which will intensify over the next few years. In a competitive analysis framework, we projected Tesla’s Q3 operating margins to decline to a level between Honda and VW, or to 7.8% compared to most recent 9.6%. Operating margin for Q3 was 7.6%, just below our base case and above our bearish case model. For a deeper dive into Tesla’s margin story is evolving, read more here and here.to 7.8% compared to most recent 9.6%. Operating margin for Q3 was 7.6%, just below our base case and above our bearish case model. For a deeper dive into Tesla’s margin story is evolving, read more here and herehere and here.
Source: I/O Fund
This is increasingly evident when looking at Tesla’s automotive gross margins. Automotive margin saw a pinch in Q2 2022 as COGS rose, before falling below 20% in Q4 2022 as China ASPs shifted below the COGS curve. Margins have fallen each quarter this year as China ASPs remains below the curve, dragging on global ASP which continues to slide as a result of price cuts.
However, BYD is showing strength in margins this year – BYD’s automotive gross margins surpassed 25% in Q3, rising from 20.7% in Q1 and from 22.8% in the year ago quarter. Automotive gross margin has also markedly improved from 15.6% in Q1 2022, an expansion of 1010 bp, while Tesla’s margins have contracted 1390 bp since peaking that same quarter at 29.65%. BYD has cut prices of some of its popular models, but not to the degree that it has become detrimental to margins.
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China’s Importance to Tesla
Tesla’s weaker sales numbers in China in September and October do raise some demand concerns, as these two months typically are the start of seasonal strength lasting through December. It also raises broader concerns within its margins and revenue growth, due to the outsized influence China has on Tesla’s production and deliveries.
Gigafactory Shanghai accounts for slightly more than half of Tesla’s current installed production capacity of ~1.85 million vehicles, with the plant capable of operating at a ~0.95 million annual run rate. Tesla noted in Q3 that the “Shanghai factory has been successfully running near full capacity for several quarters, and we do not expect a meaningful increase in weekly production run rate.” In Q3, Tesla sold 222,517 China-made vehicles, with 82,893 exported. On a YTD basis, Tesla sold 699,056 China-made vehicles, with 265,327 exported. That means China accounted for ~51.1% of Q3’s total deliveries and ~52.1% of the 1.32 million total deliveries YTD.
Shanghai is essentially maxed out in terms of the volume of vehicles that it can churn out, so October’s stagnation raises more questions about how Tesla will regain market share in China. With BYD’s strong growth in Q3 and Tesla’s slide in September, the American EV maker saw its market share fall more than 300 bp QoQ from 12.98% in Q2 to 9.89% in Q3.
While September’s MoM weakness could be chalked up to a production line upgrade in anticipation of the revamped Model 3, October’s MoM stagnation either points to a slowdown in production off full capacity at Giga Shanghai (annualized rate of ~0.86M vs ~0.95M max), or a build-up in China-made inventory. Neither scenario would be much of a positive for Tesla heading into China’s seasonally strong Q4, as both could suggest more demand weakness through the end of the year.
Conclusion
The main story for Tesla investors at the moment is when margins will bottom, as automotive and gross margin continues to deteriorate. China offers a major clue for when and where margins will bottom, given that Tesla relies on the country for about one-third of its deliveries and just over 20% of its revenues.
BYD is excelling at executing during this price-competitive time, with deliveries reaching a new monthly record while margins expand. On the other hand, Tesla has seen monthly sales in China stagnate, with ASP in the country sliding again in Q3. With China’s ASP currently going on five quarters below Tesla’s average COGS, the bottom for margins is still not in sight.
I/O Fund Equity Analyst Damien Robbins contributed to this report.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
