With a rotation into value names underway, it would be easy to discard all of tech and move towards the sectors that are working. However, as we discussed last week, one specific tech sector is currently outperforming most value names – semiconductors.
This week, we provide a brief video taken from our weekly webinar where we offer a more macro context around why we like semiconductors going forward. Some markets appear to be closer to new highs than lows, and we believe that semiconductor stocks are signaling that they are ready to resume their leadership role going into 2023.
On November 8th, 2008, the NASDAQ-100 put in a low in the largest bear market since the 1929 crash. On March 9th, 2008 the S&P 500 put in its low, as the tech heavy NASDAQ-100 made a higher low. This was the first indicator that the next bull cycle would be tech driven. More times than not, the new leadership will bottom first, and lead us out of the bear cycle.
The following bull cycle led to some of the greatest gains in tech’s history. At the time of the 2009 low, companies like Amazon, Google, Facebook, and Netflix were either not public companies, or obscure tech names with uncertain business models. These names came to provide some of the greatest gains over the last decade, as they rose to become some of the most valuable companies in the world.
Big Tech, as encompassed by the Nasdaq-100, was the most popular winner in the last bull market. From its 2008 low to the November 2022 high, it returned an astounding 1545%, compared to the S&P 500’s 622% returns within the same cycle.
However, few are aware that there was a sector within tech that not only performed better than the FAANG driven NASDAQ-100, but also led the market – semiconductors. Like the NASDAQ-100, the popular VanEck Semiconductor ETF (SMH) bottomed on November of 2008. However, during the same cycle it returned 2105%.
The FAANGs revolutionized the lives of the consumer, making them popular choices in most portfolios. Underneath these consumer products, was the need for semiconductors to drive forward smartphones and cloud data centers.
Leadership develops in two ways: 1) relative performance, or who is performing better than the others; 2) who bottoms first. Semis have been notable winners, and we believe are showing signs of continuing that leadership into 2023, along with the noticeable rotation into value stocks. Tech investors must be more discerning in this market, but the outsized gains are showing up for those that are watching the seismic shift within the markets.
Since the 2022 bear market began, semiconductors have been leading the broad market once again, except on the way down. When the leaders of a bull market continue to lead on the way down, it becomes a big warning that the predominant bull market is shifting. On November 22, 2021, SMH put in its high. On January 4th, 2022 the S&P 500 put in its high, as the semiconductors made a lower high. This was the same pattern we saw in 2008/2009, except in reverse.
Since then, we have seen 4 major bounces in this bear market. The above chart shows the VanEck Semiconductor Index (SMH) in the black bars, and the S&P 500 in blue. Each time, you’ll note how the SMH continued lower as the S&P 500 tried to rally. This was a warning of more downside to come.
On September 30th, new leadership emerged within the value sector, as many tech names continued lower. Darlings like TSLA, MSFT, AMZN, GOOGL continued to make new lows well into October. Meanwhile, many names in the boring Dow Jones Industrial Average (DJI) bottomed first, and have outperformed the S&P 500 since this recent bounce began.
As it appears that value is now leading, many have discarded tech, which is unfortunate. Though you must be discerning in this market, there are several tech names, like Netflix and Enphase, to name a few, that bottomed before the S&P 500, and are more than double the returns of the Dow Jones Industrial Average off the low.
What this rotation is signaling is twofold: 1) what the market wants to see is earnings, cash flow and stable profits. The old tech themes prior to 2021, which is growth at any cost, is over; 2) Even though it did not bottom before the broad market, one of the key leaders in this bounce is the semiconductor sector, which is a clue to what area of tech will likely lead in the next bull cycle.
Off the October 13th low, SMH climbed 40%, compared to the S&P 500 that climbed +17.45%. Even with the obvious rotation into value oriented names, SMH is still a leading sector off the October 13th low, where the Dow is up 21%.
As long as the October lows hold any additional weakness, it’s worth acknowledging that this trend could morph into semis being a (quiet) leader for when a bull market resumes. At the very least, SMH may not see new lows. If DJI and SMH, being notable leaders in this bounce, and do break their lows, I’d take this as a clear sign bear market will continue. This helps to illustrate the importance of SMH’s leadership.
In conclusion, with the information we have now, semis are most likely to lead the next bull cycle. Whether this bull cycle starts in 2023 or 2024 is unclear at this time. The catalyst within the burgeoning AI/Machine Learning tech trend, as well as the growth of EVs/automotive, and cloud, will cement their dominance. This also lines up with what the market is looking for in terms of profitability, as most semis are cash efficient companies with many offering dividends. Even though semiconductor stocks are not as exciting as owning a FAANG, we will look to add to our semiconductor positions on any weakness as we enter a new year.
Taiwan Semiconductor Manufacturing has attracted a lot of attention lately after Berkshire Hathaway invested $4.1 billion in the company. This is surprising since Warren Buffet avoids technology stocks. Yet, given TSM’s expanding margins and strong bottom line, it makes sense a value investor would be attracted to the stock.
Our thesis is that the company has developed market leadership in the foundry industry particularly with advanced nodes, which are nodes defined as 7nm and below. The advanced nodes have strong demand by top design companies, such as Apple and Nvidia, particularly in high-performance computing and smartphones. The company has started the production of 3nm process technology and currently this is the most advanced chip production technology. Samsung is a competitor that has begun production using 3nm technology. However, in the past TSMC has been able to win the business from Samsung due to better yields and economies of scale.
The company’s fundamentals are also strong and that makes it an ideal bet in the current market environment. Along with the top-line growth the company’s bottom line has sharply improved. For example, the company’s net profit margin has improved from 37.7% in Q3 2021 to 45.8% in Q3 2022. This is on a large net profit base of $20 billion and is headed toward $30 billion. Many companies have struggled with rising costs while TSM has successfully navigated these challenges with cost controls and negotiating better prices with its customers.
Notably, part of the company’s success has been in developing a niche as a pure-play foundry. Its focus has been manufacturing for its customers, and its success has been built on the principle of not designing or manufacturing semiconductor products under its own name. It counts leading companies like Apple, AMD, Nvidia, Qualcomm, and Intel as its customers. Samsung lost much of its business from Apple as Samsung is a direct competitor to Apple on smartphones. The growing use of smartphones, PCs, Internet of Things, Artificial Intelligence, automotive, and 5G are tailwinds for the company in the long term as TSM has mastered advanced node output.
Market Opportunity
According to Fortune Business Insights, the semiconductor market size was $528 billion in 2021. The market is expected to grow at a compound annual growth rate of 12%, from $573 billion in 2022 to $1.4 trillion in 2029. According to Verified Market Research, the semiconductor foundry market was valued at $102 billion in 2022 and is expected to reach $183 billion by 2030, growing at a compound annual growth rate of 6.5% from the year 2023 to 2030.
TSMC is expected to grow faster than its industry. C.C. Wei, said in the Q3 earnings call, “We expect strong demand for our leading node technologies, driven by both smartphone and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.”to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.”
Similarly, McKinsey predicts that the semiconductor industry will be a trillion-dollar industry by the end of this decade. The article highlights the impact of the chip industry in our daily lives and how this industry is critical to the functioning of the modern economy. It predicts that the market could grow at an average of 6-8% from 2021 to 2030, growing from $590 billion to $1.07 trillion in 2030. About 70% of the growth is expected to be driven by automotive electronics, computation and data storage, and wireless communication.
Market leadership
According to TrendForce research, TSMC is the leading global foundry in terms of revenue. It has a market share of 56.1% in Q3 2022, up from 53.4% in Q2 2022. Samsung ranks a distant second with 15.5%, followed by UMC with 6.9%, and GlobalFoundries with 5.8%. The report suggests that TSMC was able to withstand the slowdown in the global economy and the impact from the China Covid-19 outbreak. The report states the company benefitted from strong demand from the new iPhone models.
Product and business model
Fabless semiconductor companies benefit from outsourcing their fabrication of chips to companies like TSMC. They hereby save the high costs of building and maintaining facilities for chip manufacturing. The fabless companies instead spend their resources on R&D for designing chips. There is a third category of semiconductor companies which are called integrated device manufacturers (IDMs), who design and manufacture chips like Samsung and Intel.
TSMC was founded by Morris Chang in 1987. He is known as the father of Taiwan’s chip industry and is credited to the concept of the foundry business. The company successfully developed a business model that ensures it will not compete with its customers as it does not manufacture under its own name. The company was able to win Apple’s business from Samsung since the latter is a direct competitor of Apple. . The company’s chips are mainly used in five platforms: smartphones, high-performance computing, Internet of Things, Automotive, and Digital Consumer Electronics.
Smaller nanometer technology nodes refer to a smaller size for each transistor, allowing more transistors to be squeezed in a given die area, and thereby providing better power efficiency and performance.
TSMC’s 5nm (N5) technology process follows the 7-nanometer process node. The company began volume production in Q2 2020 and experienced a strong ramp in the 2H 2020. TSMC’s 5-nanometer technology is the company’s second available EUV process technology, which enabled the company to win orders for smartphones and high-performance applications. 5-nanometer process technology provides about 20% faster speed than N7 technology or about 40% power reduction. The company also launched an enhanced version of the 5nm called 4nm technology. Apple’s A16 chip is made using 4nm technology.
TSMC’s 3nm technology (N3) will be the next die size following 5nm technology (N5). The company claims that the 3 nm will offer up to 70% logic density, gain up to 15% speed improvement at the same power and up to 30% power reduction at the same speed as compared with the 5nm technology. 3nm technology will be used for the production of chips for mobile and high-performance computing applications. The company also plans to make N3 chip production in the Arizona plant. Currently, the 3nm chips are made in Taiwan.
The company’s CEO, C.C. Wei, said in the Q3 earnings call, “Our N3 is on track for volume production later this quarter with good year. We expect a smooth ramp in 2023, driven by both HPC and smartphone applications. Our customers' demand for N3 exceeds our ability to supply partially due to the ongoing tool delivery issues, and we expect N3 to be fully utilized in 2023.
We expect N3 revenue in 2023 to be higher than N5 revenue in its first year in 2020 and for N3E to contribute mid-single-digit percentage of our wafer revenue in 2023, as our overall revenue base is much larger today than in 2020. N3E will further extend our N3 family with the enhanced performance, power and yield, and offer complete platform support for both smartphone and HPC applications. N3E development is progressing ahead of plan, and volume production is now scheduled for second half 2023.”We expect N3 revenue in 2023 to be higher than N5 revenue in its first year in 2020 and for N3E to contribute mid-single-digit percentage of our wafer revenue in 2023, as our overall revenue base is much larger today than in 2020. N3E will further extend our N3 family with the enhanced performance, power and yield, and offer complete platform support for both smartphone and HPC applications. N3E development is progressing ahead of plan, and volume production is now scheduled for second half 2023.”
Financials
The company’s revenue growth has been strong. Along with the top-line growth the margins have also improved. The October and November monthly figures suggests that the revenue might accelerate in the Q4 2022.The company’s Q3 2022 revenue grew by 36% YoY and 11% QoQ to $20.23 billion. Wendell Huang, CFO of the company, said, “Our third quarter business was supported by strong demand for our industry-leading 5nm technologies.” The company’s revenue grew 37% in Q2 2022 and 36% in Q1 2022.
The company releases monthly revenue figures in the local currency. The U.S dollar figures for the quarter and full year results will be released in mid-January.
For October 2022, revenue was approximately NT$210.27 billion, an increase of 1% MoM and 56.3% YoY. For November 2022, revenue was approximately NT$222.71 billion, an increase of 5.9% sequentially from October 2022 and a YoY increase of 50.2%. Revenue from January to November 2022 was NT$2,071 billion, a YoY growth of 44.6% compared to the same period in 2021. This marks an acceleration in revenue from the previous quarter when we look at the October & November monthly figures and helps to substantiate TSM’s comments that they will withstand a semiconductor slowdown better than competitors.
The advanced technologies, which are defined as 7-nanometer and below, accounted for 54% of Q3 wafer revenue with 5nm process technology contributing 28% and 7nm process technology contributing 26%. In Q2, 5nm contributed to 21% of wafer revenue, and 7nm contributed to 30%. This means 5nm is gaining market share sequentially.
Smartphone revenue accounted for 41% of Q3 revenue, high-performance computing accounted for 39%, Internet of Things accounted for 10%, automotive accounted for 5%, Digital Consumer Electronics accounted for 2%, and others accounted for 3%. The management has reiterated in the earnings call that HPC and Smartphone will be the growth drivers for the company in the long-term.
Another reason for the strong revenue is that the HPC and automotive business is still steady. The company’s CEO, C.C. Wei said in the earnings call. “Okay, let me answer this one. Of course, we say that so far, our customers give us their demand forecast — so the data center and automotive related are still steady. But now the market becomes solved and will take a more conservative way in our planning for 2023. And that's why we say that we don't rule out the possibility. They might have some correction also, but we did not see it right now, to be frank with you.”so the data center and automotive related are still steady. But now the market becomes solved and will take a more conservative way in our planning for 2023. And that's why we say that we don't rule out the possibility. They might have some correction also, but we did not see it right now, to be frank with you.”
The company’s gross profit was $12.2 billion, with a gross margin of 60.4%, up from 51.3% in the same period last year and 59.1% in Q2 2022. This was higher than the management guidance of 57.5% to 59.5% as the company benefited from favorable foreign exchange and cost improvements. The margin improvement is very good in spite of the inflationary pressures.
The company’s operating income was $10.2 billion compared to $6.1 billion in the same period last year. The operating margin improved to 50.6% from 41.2% in Q3 2021 and 49.1% in Q2 2022. It was higher than the management guidance of 47% to 49%.
The net profit was $9.3 billion compared to $5.6 billion in the same period last year. The net profit margin was 45.8% compared to 37.7% in Q3 2021 and 44.4% in Q2 2022. The EPADR (Earnings per American Depository Receipt) was $1.79 compared to $1.08 for Q3 2021 and $1.55 for Q2 2022.
The return on equity was 42.9%, up from 39.4% in Q2 2022 and 30.7% in the same period last year. The strong margins also highlight that the company has been able to negotiate better prices with its customers and also grow its revenues.
The free cash flow in Q3 was $4.8 billion, with a free cash flow margin of 24%, compared to a free cash flow of $4.7 billion (31% of revenue) in Q3 2021 and $4.1 billion (23% of revenue) in Q2 2022. The company generated a total of $18 billion in free cash flow in the last four quarters.
TSM has a stable balance sheet. The company had cash and marketable securities of $47.2 billion and debt of $27.3 billion at the end of Q3 2022.
Guidance
Management Q4 guidance given during Q3 results is $20.3B at the mid-point, representing a YoY growth of 29% and QoQ growth of 0.4%. The gross margin guidance is 59.5% to 61.5% and operating margin is 49% to 51%.
Below is the analyst consensus revenue estimates as per Seeking Alpha. Notably, the company discussed in detail that the first half of 2023 is likely to be weaker than the second half
C.C. Wei, CEO of the company, said in the Q3 earnings call that 2023 will be a growth year for the company, “Looking ahead to 2023 with the successful ramp up of N5, N4P, N4X and the upcoming ramp of N3, we're continue to expand our customer product portfolio and increase our addressable market. While the ongoing semiconductor inventory correction will affect the first half 2023 utilization rate we expect our business to be supported by stronger demand for our differentiated and leading advanced and specialty technologies, and for 2023 to be a growth year for TSMC.”While the ongoing semiconductor inventory correction will affect the first half 2023 utilization rate we expect our business to be supported by stronger demand for our differentiated and leading advanced and specialty technologies, and for 2023 to be a growth year for TSMC.”
The inventory correction that has impacted the entire semiconductor industry will result in a tough 1H 2023. However, the company’s technological leadership, strong relationship with the customers, and also a strong portfolio of HPC business will help the company fare better than the overall industry. The CEO said in the earnings call, “And for the inventory correction in 2023, all we want to say is like that. We expect probably 2023, the semiconductor industry were likely to decline. But TSMC also is not immune, we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”But TSMC also is not immune, we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”
Note: The revenue numbers will not match since we used company IR's revenue figures. The above figures differ, probably due to the currency conversion. However, we use the above estimates to understand the growth rate estimates.
The company reduced Capex for the full year 2022. The CFO said in the earnings call, “Three months ago, we said our 2022 CapEx will be closer to the lower end of our $40 billion to $44 billion range. Now, we are further tightening up this year's capital spending and expect our 2022 CapEx to be around $36 billion. About half of the change is due to capacity optimization based on the current medium term outlook. And the other half is still to continue to delivery challenges.”
The management continues to be optimistic about the long-term outlook. C.C. Wei, said in the Q3 earnings call, “We expect strong demand for our leading node technologies, driven by both smartphone and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.”
Valuation
The company is currently trading at a P/E ratio of 13.2 and fwd P/E ratio of 12. It has a P/S ratio of 5.6 and a fwd P/S ratio of 5.4. It is trading lower than the 5-year P/E ratio of 23.3 and a 5-year P/S ratio of 8.5.
Source: YCharts
The company has a better free cash flow margin when compared to its peers.
Source: YCharts
Risks
The geopolitical tensions related to China might negatively impact the stock. The company has been reducing this risk by setting up fabs outside of Taiwan. However, this could also lead to lower profits. For example, manufacturing in the US will be expensive compared to Taiwan. Some of the cost burden could be reduced by the benefits of the CHIPS Act of 2022.
The global economy's overall slowdown and delays caused by Covid-19 might negatively impact the company's 2023 revenues and the other semiconductor companies. The analysts expect revenue to grow single digits in 2023. However, the company has managed the slowdown better in the past and its results in the past few quarters have proved it. The analysts expect full year revenue to grow 30% in 2022, 7% in 2023, and 19% in 2024. Similarly, full-year EPS is expected to grow 57% in 2022, decline 9% in 2023, and grow by 27% in 2024.
Conclusion
The company has good long-term revenue growth potential due to its leadership in advanced technology nodes. Advanced nodes and a strong HPC presence will drive outsized market share of 15% to 20% — or nearly 3X more than the overall semi-market is expected to grow. The company has been able to negotiate prices with its customers, make cost improvements, and improve the profit margins, along with generating industry-leading free cash flow. We expect H1 to be weaker than normal, but the market will reward any incremental strength from TSM compared to peers.
TSMC reported an unexpectedly strong November, per a press release today which stated:
TSMC today announced its net revenue for November 2022: On a consolidated basis, revenue for November 2022 was approximately NT$222.71 billion, an increase of 5.9 percent from October 2022 and an increase of 50.2 percent from November 2021. Revenue for January through November 2022 totaled NT$2,071.33 billion, an increase of 44.6 percent compared to the same period in 2021.
This has been on the top of our list in portfolio meetings for some time and this press release may mark an impetus to enter the stock. We will have a deep dive in the next 1-2 weeks. Royston covered the earnings report on the forum in October here.
TSMC preannounced its Q3 2022 results on Oct 13. The company’s leadership position in advanced nodes has helped the company to continue to deliver strong results in a current tough macro environment.
Revenue growth was strong as it grew by 36% YoY and 11% QoQ to $20.23 billion.
The company’s gross margin improved to 60.4% compared to 59.1% in Q2 2022 and 51.3% in the same period last year.
This was higher than the management guidance of 57.5% to 59.5% as the company benefitted from favorable foreign exchange and cost improvements.
The operating margin was also strong as it came at 50.6% compared to 49.1% in Q2 2022 and 41.2% in the same period last year. It was higher than the management guidance of 47% to 49%.
The company’s net profit grew by 80% YoY to NT$280.87 billion (US$9.26 billion) with a net profit margin of 45.8% compared to 44.4% in Q2 2022 and 37.7% in Q3 2021.
EPS was NT$10.83 compared to NT$6.03 in Q3 2021. EPADR (Earnings per American Depository Receipt) is $1.79, beating estimates by $0.11.
The company had a free cash flow of NT$146.73 billion (US$4.84 billion) with an excellent free cash flow margin is 24%.
The average exchange rate used is $1= 30.32 Taiwan Dollars
The key trends from the earnings call:
The company has reduced the Capex for 2022 to $36 billion from last quarter’s guide to being at the lower end of the previous guidance of $40 billion to $44 billion range. The CFO said in the earnings call, “About half of the change is due to capacity optimization based on the current medium term outlook. And the other half is still to continue to delivery challenges.”
The company’s CEO, C.C.Wei, said, “On the demand side, we continue to observe softness in consumer end market segment. Other end market segments such as data center and automotive related remain steady for now for TSMC. But we start to see the possibility of adjustment unrolled.”On the demand side, we continue to observe softness in consumer end market segment. Other end market segments such as data center and automotive related remain steady for now for TSMC. But we start to see the possibility of adjustment unrolled.”
He further gave more information when an analyst asked the outlook down the road.
“Of course, we say that so far, our customers give us their demand forecast — so the data center and automotive related are still steady. But now the market becomes solved and will take a more conservative way in our planning for 2023. And that's why we say that we don't rule out the possibility. They might have some correction also, but we did not see it right now, to be frank with you.They might have some correction also, but we did not see it right now, to be frank with you.
And for the inventory correction in 2023, all we want to say is like that. We expect probably 2023, the semiconductor industry were likely to decline. But TSMC also is not immune, we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”
Guidance:
The company expects Q4 2022 revenue to be $20.3 billion at the mid-point of the guidance, representing a YoY growth of 29%. Gross profit margin is expected to be in the range of 59.5% to 61.5% and operating profit margin is expected to be in the range of 49% to 51%.
Below are the consensus revenue estimates for the next few quarters.
Source: Seeking Alpha
The company has reiterated the long-term guidance. “We expect strong demand for our leading node technologies, driven by both smartphone and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.
We are going to cut our Marvell position until next year. The company missed across the board on every line item and we think there are stronger horses in the stable (for now).
While I have your attention and before I lose anyone on the mundane numbers: Marvell is an exceptionally strong product story. That is hard to see right now … but it’s a top 5G semi and a top AI semi and has a solid entry into automotive and CXL. By 2024, the words “CXL” will be similar to 2022’s words “silicon carbide” for buzz and stock returns. I’m not wavering on conviction; I’m wavering on timing. Also, per the earnings call, 5G is closer than one might think as Nokia is expanding into India and Marvell is the exclusive infrastructure supplier.
So, Marvell is taking a commercial break in our portfolio and we will be back soon.
Q3 Earnings Report:
The current quarter came in slightly below expectations but the fiscal Q4 guide had a larger, unexpected miss.
Marvell reported revenue of $1.53 billion for growth of 27%. This compares to estimates of $1.56 billion and growth of 28.5%.
For fiscal Q4, Marvell is guiding for revenue of $1.4 billion compared to $1.61 billion expected. This will represent growth of 4.5% down from 20% expected.
GAAP EPS of $0.02 this quarter missed estimates of $0.05-$0.13 that was provided by management. Adjusted EPS of $0.57 was reported compared to $0.59 expected. Adjusted EPS guidance for next quarter at $0.46 missed estimates of $0.61, at the midpoint.
On average, there was a one point miss across the top line and bottom line margins. GAAP gross margin of 50.6% compared to 51.1% guidance. Adjusted gross margin of 64% compared to 65% guidance.
The GAAP operating income of 6.9% compares to 8% expected. The adjusted operating margin of 36.7% compared to 37% guided. This resulted in $105.8 million in GAAP operating income and $561 million in adjusted operating income.
The company has operating cash flow of $411 million and free cash flow of $363 million. There is $723 million on the balance sheet.
Revenue Segments:
Marvell beat/met on data center and carrier infrastructure and missed on enterprise networking and automotive.
Data center grew 25% for revenue of $627M compared to 20% growth expected.
Carrier infrastructure was in line and grew 26% for revenue of $271M compared to mid-20% growth expected.
Enterprise networking missed with growth of 52% for revenue of $376M compared to 70% expected.
Consumer declined (2%) compared to (10%) for revenue of $178 million
Automotive missed for growth of 26.6% and revenue of $84.2 million compared to 40% growth expected.
Additional Notes:
China greatly impacted Marvell’s guide for next quarter, especially the enterprise networking segment. Per the opening remarks:
“Just to give you a sense of the magnitude of that change, we estimate that our revenue in the fourth quarter from our OEM customers based in China will decrease by over 1/3 compared to the second quarter. We expect revenue from China OEMs will account for less than 10% of our total company revenue in the fourth quarter.”
Despite the beat, storage weighed on the data center segment yet cloud was robust, per management:
“Our storage products, including fiber channel, HDD and SSD, all saw demand decline during the quarter. However, our cloud business continued to grow sequentially, driven by strength in our electro-optics and switch products.”
There is a disappointing guide for data center though for Q4:
“We are seeing the growth rate of the data center end market decelerate and customers have started adjusting their inventory to address the changing demand picture. As a result, for the fourth quarter of fiscal 2023, we are expecting our data center revenue to decline year-over-year approximately in the mid- to high teens on a percentage basis and sequentially decline in the mid-20% range [..] In particular, we are projecting a very large reduction in shipments of our HDD controllers and preamps, as HDD OEMs deal with a broad-based inventory correction.”
Carrier infrastructure is an area where Marvell is likely to positively surprise investors next year. Nokia is beginning to ramp using Marvell’s OCTEON 10 DPU, which we have covered in the past. In addition, Marvell helped pioneer OpenRAN for Layer-1 processing capabilities. Nokia/Vodafone and Samsung/Vodafone are partnering on OpenRAN with Marvell and using the company’s accelerator chip, the OCTEON Fusion processors.
Next quarter, automotive is expected to be strong with 30% YoY growth and mid-20% QoQ growth.
Carrier infrastructure is expected to grow mid-teens next quarter and to grow low single digits sequentially.
Marvell continues to provide clues on when it could possibly become a semiconductor leader again in the market. In addition to CXL ramping at some point next few years, the company also stated: “We expect that our cloud optimized silicon programs will build from the initial ramp that started in the second half of this fiscal year and continue to grow approximately $400 million in aggregate revenue in fiscal 2024 and $800 million in fiscal 2025 […] In addition to our cloud optimized programs, we expect that our 5G products in our automotive business will drive strong year-over-year revenue growth in fiscal 2024. Offsetting this growth to an extent, we expect a few quarters of inventory adjustments in some of our businesses as customers realign their demand.”
My translation: Give Marvell one to three quarters through Q2 of next year at the latest and come back to the stock somewhere in that window.
Marvell also gave us a good gauge on what to expect next year on Big Tech CapEx:
“Matt Murphy
Yes. Great question. So let me take it from the top. So, first point would be that if you look over the last few years, cloud CapEx has been on fire. It's been growing 30% kind of plus for the last few years. This year, if you look at reports and kind of what we see is probably something in the 15% range for '22 and then it depends on who you talk to, but probably down in the low to mid-single digits or maybe mid-single digits for next year.”
Conclusion:
We will revisit Marvell again sometime next year. To understand why we like the company in the face of lumpy earnings reports, please reference our last deep dive here. Perhaps it’s because I know the stock well at this point, but it’ll be a top pick for us on 5G in the near term. They spoke about Nokia expanding into India, as well as Europe. Given we may see few growth stories next year, Marvell may be one that finds a new growth trajectory from deep telecom pockets. The other segments are also to not be overlooked, especially if the China headwinds clear.
This article was originally published on Forbes on Nov 23, 2022,12:52pm ESTForbes on Nov 23, 2022,12:52pm EST
Nvidia has overcome strong headwinds over the past few years, including United States-China tensions, supply chain disruptions spanning many components, tough comps on the data center, tough comps on gaming, and a less-than-rosy macro environment. However, the most impactful of all has been Ethereum’s merge to Proof of Stake (POS), which led to a $2.5 billion cumulative miss in revenue.
In September, we made a prediction in the analysis entitled “Nvidia Stock Is Ready to Rumble with RTX 40 Series and H100 GPUs” that Nvidia’s new gaming release would soften the blow when we said the following:
“First, Nvidia is restricting supply on its current gaming model. Per the CFO: ‘Across those two quarters, the Q2 of ‘23, the Q3 of ‘23, we have likely undershipped gaming to our end demand significantly.’
[…] We estimated for our premium members that the amount undershipped is a minimum of $1 billion. The reason behind this is to help keep prices stable and to increase demand for the RTX 40 Series.
Second, Nvidia announced its GeForce RTX 40 Series at the GTC 2022 Conference this week.
The new Ada Lovelace architecture uses 76 billion transistors and a 4nm production process. In the keynote, the CEO stated: ‘Nvidia engineers worked closely with TSMC to create the 4N process optimized for GPUs. This process let us integrate 76 billion transistors and over 18,000 CUDA cores, 70% more than the Ampere generation.’
The improvement from 8nm to 4nm means more transistors on the GPU, which results in better performance as the 4nm processes data faster.
In the gaming world, this much anticipated release is expected to be 2-4X faster than the RTX 3090 Ti. The flagship AD102 GPU model will have 144 individual streaming multiprocessors (SMs) in one die compared to 84 SMs in the Ampere architecture. As stated, the AD102 will also have a 70% increase in CUDA cores over the RTX 3090 Ti […]
The popularity of this release will help determine if Nvidia can stage a comeback in the gaming segment.” You can read the full analysis here. Fast-forward and not only was the GeForce RTX 40 Series with Ada Lovelace architecture popular, management stated “the Ada launch was a homerun.” Below, we look at the most recent earnings report and then we break out additional details that support Nvidia’s Q3 reaching a gaming bottom.
Sign up for I/O Fund's free newsletter with gains of up to 221% – Click HereSign up for I/O Fund's free newsletter with gains of up to 221% – Click HereClick Here
What Q3 Earnings Results Says About a Gaming Bottom
First, I’ll provide a general overview of Nvidia’s earnings results before I discuss what to expect in the gaming segment specifically.
Nvidia reported as expected for Q3 ending in October with revenue of $5.93 billion for growth of (17%) which matched management guidance of $5.90 billion. Analyst consensus for revenue was $5.85 billion, or (17.7%) growth.
Fiscal Q4 ending in January was a slight miss with guidance of $6 billion compared to analyst consensus of $6.17 billion. This represents growth of (21%).
Nvidia reported adjusted EPS of $0.58 which missed adjusted EPS estimates of $0.71. This compares to the July quarter of $0.51 adjusted EPS.
Management indicated that profitability will increase from here: [GAAP and non-GAAP operating expenses were] primarily due to higher compensation expenses related to headcount growth and salary increases and higher data center infrastructure expenses. Sequentially, both GAAP and non-GAAP operating expense growth was in the single-digit percent, and we plan to keep it relatively flat at these levels over the coming quarters.”
In Q3, the GAAP gross margin was 53.6% and the adjusted gross margin 56.1%. This was a miss from management Q3 guidance of 62.4%. The reason for the miss related to China: “Gross margins reflect $702 million in inventory charges largely related to lower data center demand in China, partially offset by a warranty benefit of approximately $70 million.”
Nvidia is signaling that gross margin will return to normal next quarter with a guide for GM of 63.2%.
For the most part, Nvidia’s bottom line showed signs that last quarter was a bottom for the company with marginal, yet crucial improvement sequentially. As long as the company does not increase operating expenses, which the CFO stated the opex would be flat and not increase, then these margins should improve from here.
The company reported GAAP operating profit of $601 million for an operating margin of 10.1%. This compares to an operating margin of 7.44% last quarter. Nvidia’s typical OM is in the 37%-38% range.
The adjusted operating profits of $1.56 billion with a margin of 25.9% in Q3 compares to an adjusted operating margin of 19.76% in Q2. This is down from Nvidia’s typical adjusted OM of 47%.
The adjusted net margin of 24.5% in Q3 compares to an adjusted net margin of 19.27% last quarter.
The free cash flow margin was (2.6%) for free cash flow of ($156) million compared to a 12% margin last quarter for free cash flow of $824 million. The company has $13.14 billion in cash and $10.95 billion in debt.
The company returned $3.75 billion to shareholders with share repurchases and cash dividends. with $8.3 billion remaining under the share repurchase authorization through December 2023.
The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.Learn more about about our premium membership here.
Evidence that Gaming Bottomed in Q3
Gaming revenue was down (51%) for revenue of $1.57 billion. Admittedly, even if Q3 is the bottom, there is still quite a ways to go before the company returns to growth in this segment. The reason it’s important to identify a fundamental bottom is because it typically correlates with a bottom in the stock price.
Nvidia Management Points Toward Q3 as the Bottom in the Earnings Callas the Bottom in the Earnings Call
In addition to saying “the Ada launch was a homerun,” management expects gaming to grow sequentially from Q3 to Q4. Management also stated “our new Ada Lovelace GPU architecture had an exceptional launch” and “we sold out quickly in many locations and are working hard to keep up with demand.”
Most importantly, management stated gaming will return to sequential growth in Q4 and that channel inventory will “approach normal levels” as the company exits Q4 to where the company can more adequately match supply with demand.
On the call, Kress discussed that the sell-through rate across two quarters for gaming is $5 billion total, which helps prove the popularity of Nvidia’s RTX 40 series. The CEO also stated: “That 4090 — we shipped a large volume of 4090s because as you know, we were prepared for it. And yet within minutes, they were sold out around the world. And so, the reception of 4090 and the reception of 4080 today has been off the charts.”
The first release date for the RTX4090 models was October 12th with a starting price of $1,599. There was a second release date in November for the RTX4080 models with prices of $1,199 and $899. Notably, the mid-range RTX 40 series outperforms the previous generation’s high-end models, which also helps to drive demand because customers receive an upgrade at the $899 and $1,199 level. This is due to the Ada Lovelace architecture which offers 1,400 Tensor TFLOPs versus 320 Tensor TFLOPs which means the DLSS is superior and the high-end RTX 30 Series cannot compete with the mid-range RTX 40 series.
Deep learning super sampling (DLSS) refers to using AI to predict the next pixel. The new DLSS 3.0 not only predicts pixels but will also use AI to predict frames. This results in “up to four times” better performance over traditional rendering.
In addition to this, Nvidia released a new feature powered by Shader Execution Reordering (SER) which will improve ray-tracing performance by 3X with 25% faster frame rates. Rather than deliver workloads sequentially, the GPUs are able to reorder the workloads to process more workloads at once which results in more power and better performance.
Conclusion:
Despite a historic revenue miss, Nvidia is rising to the occasion with the perfectly timed Ada Lovelace architecture. As we said in our previous analysis, Nvidia is flexing their product muscles by meeting head-on the wave of negative sentiment on the stock. Investors should keep in mind, that despite enormous headwinds, Nvidia has been the best performing mega cap stock over the past few years (reference our analysis here for more details).
The company’s swift and concise answer to the crypto mining selloff helps illustrate why Nvidia stands apart from its peers – primarily, that its products are superior, end-market demand remains strong, and management has many levers it can pull to quickly reverse a bottom.
The I/O Fund targeted NVDA on October 13th for a price of $108. After a 50% gain in less than a month, we trimmed some NVDA around $162 with real-time trade alerts. We did this to raise cash, so that we can buy more at lower levels. Please join us next week, Thursday, 12/1, at 1:30 PST, for our premium webinar. We will discuss NVDA in depth and lay out our targets for adding to this position.
If you would like notifications when my new articles are published, please hit the button below to "Follow" me. You can also sign up for my newsletter here to receive weekly tech stock analysis for free.
We covered AMD’s pre-announcement in “The One Critical Reason I’m Still Feeling Zen.” The company has a lot of lost ground to recover and I believe it has enough horse power in its product line up to do so.
This was a stronger report than first glance because by guiding flat from Q3 to Q4 for 14% revenue growth,AMD stated data center and embedded will grow sequentially to absorb PC weakness. One analyst mentioned working with a number between $800M to $900M on Client Revenue for Q4, which would be down from $1 billion in Q3. It was also directly stated gaming revenue would be flat sequentially.
Rough Idea of Q4:
$850M Client Segment, at midpoint (hinted at)
$1,600 Gaming (confirmed)
$1,750 Data Center (rough estimate)
$1,350 Embedded (rough estimate)
This would mean sequential data center growth of 9% from Q3 to Q4 compared to 6.6% sequential growth from Q2 to Q3. Embedded was flat sequentially from Q2 to Q3.
I believe the timing of the Genoa product and the glimpse of Meta’s capex means we are setting up for a strong 2023 with data centers. I believe the analysts fully understood this point on the call as PCs were certainly discussed but was not the main focus. Data center discussions had more air time in the Q&A.
Note: we go into more specs and a great detail on AMD’s products on I/O Fund Advanced. Below is a summary.I/O Fund Advanced. Below is a summary.
Q3 Financials
Most notable from the Q3 report is that the company missed on Q4 revenue guidance with $5.97 billion for growth of 23.8% expected versus $5.5 billion reported for actual growth of 14%. The market shrugged this off as AMD stated data center and embedded would grow year-over-year and sequentially. I believe this was a solid reaction as AMD is becoming a leading AI company and holding the stock hostage to cyclical PC sales is missing the larger picture.
This brought the full year estimates down by $300 million from $23.8 billion to $23.5 billion. This will represent growth of 43% down from 44.9% expected. We can see that PCs will have a $2.8 billion drag on revenue this year as originally revenue was expected to be $26.3 billion.
Adjusted EPS of $0.67 missed estimates of $0.76 adjusted EPS. GAAP EPS was $0.04.
Where AMD had some positive surprises was in the adjusted margins and cash flow. The adjusted GM of 50% is higher than the year ago quarter at 48%. This is also true for Q4’s guide of 51% adjusted GM, which is higher than the year ago quarter at 50%.
The adjusted operating margin was also higher than what we had for expectations. It came in at 23% versus 13% expected and is flat from the year ago quarter. This led to adjusted operating income of $1.3 billion for 20% growth YoY and adjusted net income of $1.1 billion compared to $893 million a year ago for 23% growth YoY. Notably, this is down from $1.7 billion in Q2.
The GAAP GM was at 42% and GAAP OM was at ($64) million and both are lower than usual due to PCs/Client Segment.
The operating cash flow of $916 million is up from $849 million in the year ago quarter and free cash flow of $842 million helped maintain a steady FCF margin of 15%.
Apples-to-apples, I think this was a stronger report than Microsoft’s – a tech titan exposed similarly to PCs – because AMD’s other segments are so strong the company is able to maintain double digit growth of 14% next quarter compared to Microsoft’s low guide of 2%.
Data Center Strength:
This was an important comment regarding cloud spending specifically within the data center segment:
“Cloud revenue more than doubled year-over-year and increased sequentially as multiple hyperscalers expanded deployments of EPYC processors to power their internal properties and more than 70 new AMD instances were launched by Microsoft Azure and Amazon, Tencent, Baidu and others in the quarter.”
Analysts pressed AMD on if they expect 20% to 30% growth in the data center next year but management declined to comment “precisely” this early. Instead, AMD went on to call out North America hyperscale spending as a key driver for next year and mentioned China will not see a significant recovery (similar to 2022).
“Now it varies by segment, and so if I go through each of the segments, what we are seeing is I think North America cloud is, probably, the most resilient out of the segments within the Data Center market and this is where AMD is the strongest […] As we go into 2023, we expect growth in that market, particularly customers moving more workloads to AMD, just given the strength of our product portfolio, and overall, Genoa coming forward.
“Moving more workloads to AMD” = That’s a comment on Intel losing market share. Woohoo! Let’s gooooo!
Below is a notable conversation about how analysts are viewing Big Tech capex and cloud infrastructure growth as a leading indicator for AMD:
Harlan Sur
Great. Thank you. And despite the macro concerns, and as you mentioned, some near-term workload optimization, your North American cloud customers, I mean, they are still growing their cloud services business at a strong 30%, 40% year-over-year growth rate and I assume that these types of growth rates like the consumption of compute networking, storage workloads and therefore, installed utilization, like, this is all quite strong in driving the need to build out more compute capacity. Is this what’s driving the team’s sort of strong mid-term outlook for this segment or is it more a function of your strong product lineup with Genoa and continuing to capture greater compute share or both?
Dr. Lisa Su
Yeah. Right. Harlan, I would say, it’s a little bit of both and I think you said it well. In the very near-term, there is a little bit of optimization that each cloud vendor is doing. But in the medium-term, what our customers are telling us is they need more compute.
And the more compute is for additional workloads building out. It’s also for upgrade of, let’s call it, older compute, given our new products have very strong TCO, power efficiency, given the cost of power and energy around the world. We are actually seeing that also be a driver for some of the conversion to AMD in the cloud as we go into 2023.
Notably, one analyst stated the company missed their model and estimate for data center revenue. The CEO replied this is due to GPUs having a tough comp from last year due to the timing of a high-performance computing release – Frontier Exascale Supercomputer. She also pointed toward lower enterprise revenue.
In addition to Data Center, Embedded was strong and AMD called out 5G infrastructure specifically. I’m hoping this translates well for Marvell.
Information on PC Market for 2023
The data center may be resilient but certainly PCs are weighing on this company. I think this question and answer was important for AMD investors to hear so I’m quoting the conversation.
“Vivek Arya
[…] what does client recovery look like, do you get back to the $2 billion quarterly rate, do you get to $1.5 billion? And I asked that because your competitor was suggesting that next year the PC TAM would only be down 4% or 5%, which seems a little bit optimistic. What do you think AMD is kind of — what kind of PC TAM does AMD have in mind for next year so that we get a sense for how this de-risk the model is from a PC perspective?
Dr. Lisa Su
Yeah. So, a couple of different points, Vivek. Let me just answer the sort of the expectations around Q4. I would say, we are guiding, let’s call it, modestly down for Client and Gaming, and obviously, we are coming off of what is already a low base in Q3. We want to do that to correct the sort of the inventory situation as quickly as possible, and as a result, we are going to under ship consumption again in the fourth quarter to do that.
As it relates to next year, I think, there are a lot of factors. I mean this year PCs will be down quite a bit, let’s call it, high-teens, close to 20%. As we go into next year, I think, the industry is calling mid-single digits. I think that would be a good case. I think we should model down to minus 10%.
And again, within our PC business, we expect as we get through this inventory correction, I mean, we have very good products, and I feel very good about our product portfolio and very good about our platforms overall. So I do think the PC business will recover as we go into 2023, but we will have to work through these dynamics over the next quarter or so.
My translation: Perhaps I am being optimistic but I believe AMD is saying the recovery will happen earlier in 2023 (H1) rather than later in 2023 (H2) per the language chosen and that AMD plans to be on the earlier side within H1 by under shipping in Q4.
Conclusion:
AMD had a better earnings report than Microsoft and a better report than Nvidia is expected to have. These companies are comparable because of the one-time event hitting a non-thesis segment. Where they are not comparable is that AMD’s strongest segments are keeping the company in double digit growth territory.
I like Microsoft and Nvidia very much but it is uncanny how AMD continually finds a way to unexpectedly have a good report. I get to call this stock The Dark Horse for a little longer until it surpasses Intel on the data center; which means the name will likely be retired by 2024.
There's a lot to look forward to. If you’re looking for more than I/O Fund Essentials is providing, learn more about becoming an advanced member today.
At I/O Fund, we provided deep dive research and two 1-hour webinars that predicted AMD would take away a huge chunk of Intel’s market share to have double-digit market share in the data center. At the time, AMD had only 4% market share. The prediction was bold as Intel is the 800 lb. gorilla — yet the prediction fully materialized and AMD today has “low 20 percent” market share in the data center.
AMD’s comeback is nearly unheard of, with only Apple posting a comeback of this proportion in the history of the tech industry.
If you’re interested in hearing more beyond this write-up, I recommend our exclusive webinar provided to I/O Fund Members where we discussed in great detail AMD’s “EPYC” improbablecomeback:AMD Webinar
The abbreviated version is that AMD plans to take even more market share from Intel — and then will take this new lead over Intel to help fill the role of duopoly in AI accelerator chips.
Note: by the time you’re reading this, AMD comeback over Intel is more evident than when we first discussed it as we began discussing this and built a leading position with real-time alerts when AMD had 4% share in the CPU-data center and the company has grown this market share over 5X since our original prediction. In fact, the strategic comeback was so little recognized by industry analysts that we nicknamed AMD “the Dark Horse” which means an unexpected competitor who secures victory.
How Did “The Dark Horse” Get Here?
AMD’s Zen architecture was introduced in 2017. The company proved it wasn’t down for the count by offering a chipset-free design, resulting in energy-efficient processors capable of executing more tasks per cycle and more cores than Intel.
AMD’s first-gen Zen architecture helped prove AMD had a pulse and a heartbeat— however faint it may have been with a tiny 2% CPU market share— but it was circa 2020 when the company found its wings again. In that phase, it grew by 400%, catapulting to 8% of the CPU market. Today, its share stands at an estimated 20%-24% and while the company is unlikely to increase six times over again, with continued excellent management, market dominance of 50% market share or greater is very much in the real realm of possibilities. This is the move we want to capture in 2023/2024.
Second Gen
Note: we go into more specs and a great detail on AMD’s products on I/O Fund Advanced. Below is a summary.I/O Fund Advanced. Below is a summary.
When the company released the second generation of its Zen architecture, AMD showed it was outpacing Intel in terms of computing power, memory and energy use. More importantly, it was doing all this at a lower cost, thanks to multi-chip modules that combine a 7nm with a 14nm to use the most advanced technology when and where it’s needed most by leveraging the more mature process node.
At the time, Intel was still producing a 14nm chip, although it promised that a 10nm was on the way. Essentially, AMD leapfrogged their competitor with a more power-efficient product, and one that allows for more cores per chip.
Interestingly enough, Intel was expected to catch-up with a comparable 10nm release planned for Q2 or Q3 2020 called the Ice Lake Xeon Scalable. Then, at the height of the pandemic, just four months before Intel’s expected release, the I/O Fund covered AMD, calling it “the one that got away” in 2019. “It’s estimated that for every $1.00 in Rome chip sales, Intel loses $2.25 on average in Intel Xeon SP sales,” we noted. "The savings are then deployed to buy more Rome chips, which can further depress Intel’s revenue.”
The Milan EPYC Series announced in August of 2020 was officially launched in March of 2021. The Milan is built on 7nm technology and has up to 64 cores and 128 threads with increased clocks compared to the Rome series. At the time of launch, Milan had a 100% advantage over Intel’s Sky Lake on server processor scores, according to Geekbench.
This was the momentthe moment Intel was expected to go gangbusters but instead Intel drove into a brick wall. Ice Lake’s release was delayed for two years, finally launching with 40 cores, up from 28 cores, versus a whopping 68 cores for AMD.
“We won’t rehash the delay, denial, and begrudging admittance cycle that is Ice-SP’s gestation, just be aware that it was a 2019 CPU and is now a mid-2021 CPU. We know it launches today and Intel is officially claiming, ‘We have shipped over 200,000 Ice Lake CPUs for revenue’ and the shipping parts are the D-2 stepping […] let’s do the math and assume those 200K Ice-SPs shipped in three months or about 66K CPUs/month. If the server market is about 30M CPUs/year, let's call it 32M for the sake of round numbers, that would be 8M/quarter for normal production. = or about 2.28 days worth of production. This is not a figure I would be mentioning in public if I was aiming to boost confidence.”just be aware that it was a 2019 CPU and is now a mid-2021 CPU. We know it launches today and Intel is officially claiming, ‘We have shipped over 200,000 Ice Lake CPUs for revenue’ and the shipping parts are the D-2 stepping […] let’s do the math and assume those 200K Ice-SPs shipped in three months or about 66K CPUs/month. If the server market is about 30M CPUs/year, let's call it 32M for the sake of round numbers, that would be 8M/quarter for normal production. = or about 2.28 days worth of production. This is not a figure I would be mentioning in public if I was aiming to boost confidence.”
In my world, that’s the equivalent of a good Comedy Central Hollywood roast!
Why 2023 will be AMD’s Year
When we first covered AMD, it had a 4% share of the data center; now, it sits at roughly mid-20% of the CPU data center over Intel, a spectacular comeback.
However, the move we want to capture is when AMD goes from owning “mid-20%” of the CPU data center to owning 40% to 50% of the market— and this is entirely possible due to Intel’s most recent stumble.
AMD has the 5-nanometer line scheduled for release in Q4, which includes Zen-4 architecture, and Zen-5 architecture planned for 2024 (reference our AMD Q3 2022 earnings update provided for you in the Blog updates).
The company also stated that the Zen-3 Milan Series is still outstripping supply with visibility six quarters out, implying for full year 2023. Zen-2 was CEO Dr. Lisa Su’s comeback, while Zen-3 is responsible for the current move in data center market share.
Pictured Above: AMD has grown from 2% market share to “mid 20-percent market share”
AMD’s Dominance Over Intel Has Never Been More Obvious
AMD reported an 83% year-over-year increase in data center revenue for Q2 2022. Meanwhile, Intel dropped 16%. AMD appears to have gained 6% market share, which, one analyst noted, is “the highest share gain in the data center business that [AMD] has reported even going back to 2005.”
We began covering AMD when it had 4% total market share versus 96% Intel and the recent gains places AMD now in the “mid 20%” total market share for the data center against Intel. When asked if this was the correct math, Su stated to the analyst: “I think your math is in the ZIP code from our point of view.”
We have been quite thrilled to see the team at AMD led by Lisa Su and Forrest Norrod overtake Intel at times. However, what happened last quarter with Intel’s stumble is an exponentially greater mistake than the last stumble that we prepared for in March of 2020, which later materialized that July.
Meta: You say Capex, I think AMD
You may have seen tech commentators poking fun at Meta’s recent keynote. Zuckerberg demonstrated adding legs to Metaverse avatars, “progress” that doesn’t quite match up with the company’s mammoth investment. Most investors look at Facebook’s cash and think “this will make a great stock,”— yes, the FCF margin has been impressive. Many of Meta’s newfound critics are wondering: “Will the Metaverse succeed?”
What we want as investors is second-level thinking. Where is Big Tech capex going? Regardless of whether or not Meta succeeds, AMD stands to greatly benefit.
Other Factors
Meanwhile, we have to consider that outside of cybersecurity, there are going to be very few growth markets in tech in 2023, and of the growth markets we are tracking, very few will hit double digits.
Note: for more information on cybersecurity stocks and growth trends, please upgrade to I/O Fund’s full service where we also provide real-time trade alerts.upgrade to I/O Fund’s full service where we also provide real-time trade alerts.
Big Tech capex is important as it’s the one catalyst that can raise revenue estimates for next year for AMD, which subsequently raises bottom line estimates. We covered this in a free analysis going into earnings here:
“The news has been in an uproar about crypto mining and the consumer-related PC markets. However, it has been our stance for some time that Big Tech capex is the true leading indicator for AI semiconductor companies. Despite an enormous increase in Big Tech capex primarily driven by data centers, this line item does not get the attention it deserves in terms of follow-through to the semiconductor industry. Below, we look at FY2022 budgets to draw the conclusion that H2 spending on data center chips is equal if not greater than the first half of 2022 […] The Data Center Systems segment, however, is expected to grow fastest among all the segments. It is expected to grow 11% YoY to $212 billion, higher than the 6.4% growth in 2021.”
Where AMD Is Headed
Artificial Intelligence and Machine Learning Will Exceed the Mobile Economy
Smartphones had a 10-year cycle of maturation beginning with the iPhone in 2008 and the app economy proved to have a similar maturation for digital advertising. Following a decade-long run.
· The smartphone market was valued at $720 billion in 2019 and the global mobile application size was $155 billion.
· The mobile advertising market was valued at $60 billion — Facebook
The mobile market is worth roughly $2 trillion yet the combined market cap of these companies is $4 trillion. Meanwhile, PricewaterhouseCoopers is predicting the AI market will reach $15.7 trillion, which some experts believe will put its impact on par with the advent of electricity.
Semiconductors will not comprise the entire $15.7 trillion but according to McKinsey, they will “capture 40 to 50 percent of the total value from the technology stack.
“These diverse solutions, as well as other emerging AI applications, share one common feature: a reliance on hardware as a core enabler of innovation, especially for logic and memory functions.”
The artificial intelligence economy will be four times larger than the mobile economy. Picture this: if mobile gave us companies with $2 trillion market caps, it makes sense that AI will give us businesses with $8-$10 trillion market caps.
Breakdown
There’s also a lot to look forward to. Should you choose to upgrade to become a I/O Fund Premium member, you’ll receive AMD’s next five-year thesis, which will include Xilinx, long before anyone else know what they’re up to. This acquisition is more offensive for growth rather than defensive (along the lines of how YouTube impacted Google or Instagram impacted Facebook).
Our premium site owns two lesser-known semiconductor names. The first is centered in an important shift for electric vehicles and is up 58% in our portfolio this year. The second is an up-and-coming AI stock that doubles as a 5G infrastructure stock. There is something very big on the horizon for the AI/5G semi company in H2 2023 and we believe now is the time to look more closely as this company. We reserve these stock picks for our Premium I/O Fund Members, which you can learn more about here.
We covered AMD’s pre-announcement in “The One Critical Reason I’m Still Feeling Zen.” The company has a lot of lost ground to recover and I believe it has enough horse power in its product line up to do so.
This was a stronger report than first glance because by guiding flat from Q3 to Q4 for 14% revenue growth,AMD stated data center and embedded will grow sequentially to absorb PC weakness. One analyst mentioned working with a number between $800M to $900M on Client Revenue for Q4, which would be down from $1 billion in Q3. It was also directly stated gaming revenue would be flat sequentially.
Rough Idea of Q4:
$850M Client Segment, at midpoint (hinted at)
$1,600 Gaming (confirmed)
$1,750 Data Center (rough estimate)
$1,350 Embedded (rough estimate)
This would mean sequential data center growth of 9% from Q3 to Q4 compared to 8% sequential growth from Q2 to Q3. Embedded was up 4% sequentially from Q2 to Q3.
I believe the timing of the Genoa product and the glimpse of Meta’s capex means we are setting up for a strong 2023 with data centers. I believe the analysts fully understood this point on the call as PCs were certainly discussed but was not the main focus. Data center discussions had more air time in the Q&A.
Q3 Financials
Most notable from the Q3 report is that the company missed on Q4 revenue guidance with $5.97 billion for growth of 23.8% expected versus $5.5 billion reported for actual growth of 14%. The market shrugged this off as AMD stated data center and embedded would grow year-over-year and sequentially. I believe this was a solid reaction as AMD is becoming a leading AI company and holding the stock hostage to cyclical PC sales is missing the larger picture.
This brought the full year estimates down by $300 million from $23.8 billion to $23.5 billion. This will represent growth of 43% down from 44.9% expected. We can see that PCs will have a $2.8 billion drag on revenue this year as originally revenue was expected to be $26.3 billion.
Adjusted EPS of $0.67 missed estimates of $0.76 adjusted EPS. GAAP EPS was $0.04.
Where AMD had some positive surprises was in the adjusted margins and cash flow. The adjusted GM of 50% is higher than the year ago quarter at 48%. This is also true for Q4’s guide of 51% adjusted GM, which is higher than the year ago quarter at 50%.
The adjusted operating margin was also higher than what we had for expectations. It came in at 23% versus 13% expected and is flat from the year ago quarter. This led to adjusted operating income of $1.3 billion for 20% growth YoY and adjusted net income of $1.1 billion compared to $893 million a year ago for 23% growth YoY. Notably, this is down from $1.7 billion in Q2.
The GAAP GM was at 42% and GAAP OM was at ($64) million and both are lower than usual due to PCs/Client Segment.
The operating cash flow of $916 million is up from $849 million in the year ago quarter and free cash flow of $842 million helped maintain a steady FCF margin of 15%.
Apples-to-apples, I think this was a stronger report than Microsoft’s – a tech titan exposed similarly to PCs – because AMD’s other segments are so strong the company is able to maintain double digit growth of 14% next quarter compared to Microsoft’s low guide of 2%.
Data Center Strength:
This was an important comment regarding cloud spending specifically within the data center segment:
“Cloud revenue more than doubled year-over-year and increased sequentially as multiple hyperscalers expanded deployments of EPYC processors to power their internal properties and more than 70 new AMD instances were launched by Microsoft Azure and Amazon, Tencent, Baidu and others in the quarter.”
Analysts pressed AMD on if they expect 20% to 30% growth in the data center next year but management declined to comment “precisely” this early. Instead, AMD went on to call out North America hyperscale spending as a key driver for next year and mentioned China will not see a significant recovery (similar to 2022).
“Now it varies by segment, and so if I go through each of the segments, what we are seeing is I think North America cloud is, probably, the most resilient out of the segments within the Data Center market and this is where AMD is the strongest […] As we go into 2023, we expect growth in that market, particularly customers moving more workloads to AMD, just given the strength of our product portfolio, and overall, Genoa coming forward.
“Moving more workloads to AMD” = That’s a comment on Intel losing market share. Woohoo! Let’s gooooo!
Below is a notable conversation about how analysts are viewing Big Tech capex and cloud infrastructure growth as a leading indicator for AMD:
Harlan Sur
Great. Thank you. And despite the macro concerns, and as you mentioned, some near-term workload optimization, your North American cloud customers, I mean, they are still growing their cloud services business at a strong 30%, 40% year-over-year growth rate and I assume that these types of growth rates like the consumption of compute networking, storage workloads and therefore, installed utilization, like, this is all quite strong in driving the need to build out more compute capacity. Is this what’s driving the team’s sort of strong mid-term outlook for this segment or is it more a function of your strong product lineup with Genoa and continuing to capture greater compute share or both?
Dr. Lisa Su
Yeah. Right. Harlan, I would say, it’s a little bit of both and I think you said it well. In the very near-term, there is a little bit of optimization that each cloud vendor is doing. But in the medium-term, what our customers are telling us is they need more compute.
And the more compute is for additional workloads building out. It’s also for upgrade of, let’s call it, older compute, given our new products have very strong TCO, power efficiency, given the cost of power and energy around the world. We are actually seeing that also be a driver for some of the conversion to AMD in the cloud as we go into 2023.
Notably, one analyst stated the company missed their model and estimate for data center revenue. The CEO replied this is due to GPUs having a tough comp from last year due to the timing of a high-performance computing release – Frontier Exascale Supercomputer. She also pointed toward lower enterprise revenue.
In addition to Data Center, Embedded was strong and AMD called out 5G infrastructure specifically. I’m hoping this translates well for Marvell.
Information on PC Market for 2023
The data center may be resilient but certainly PCs are weighing on this company. I think this question and answer was important for AMD investors to hear so I’m quoting the conversation.
“Vivek Arya
[…] what does client recovery look like, do you get back to the $2 billion quarterly rate, do you get to $1.5 billion? And I asked that because your competitor was suggesting that next year the PC TAM would only be down 4% or 5%, which seems a little bit optimistic. What do you think AMD is kind of — what kind of PC TAM does AMD have in mind for next year so that we get a sense for how this de-risk the model is from a PC perspective?
Dr. Lisa Su
Yeah. So, a couple of different points, Vivek. Let me just answer the sort of the expectations around Q4. I would say, we are guiding, let’s call it, modestly down for Client and Gaming, and obviously, we are coming off of what is already a low base in Q3. We want to do that to correct the sort of the inventory situation as quickly as possible, and as a result, we are going to under ship consumption again in the fourth quarter to do that.
As it relates to next year, I think, there are a lot of factors. I mean this year PCs will be down quite a bit, let’s call it, high-teens, close to 20%. As we go into next year, I think, the industry is calling mid-single digits. I think that would be a good case. I think we should model down to minus 10%.
And again, within our PC business, we expect as we get through this inventory correction, I mean, we have very good products, and I feel very good about our product portfolio and very good about our platforms overall. So I do think the PC business will recover as we go into 2023, but we will have to work through these dynamics over the next quarter or so.
My translation: Perhaps I am being optimistic but I believe AMD is saying the recovery will happen earlier in 2023 (H1) rather than later in 2023 (H2) per the language chosen and that AMD plans to be on the earlier side within H1 by under shipping in Q4.
Conclusion:
AMD had a better earnings report than Microsoft and a better report than Nvidia is expected to have. These companies are comparable because of the one-time event hitting a non-thesis segment. Where they are not comparable is that AMD’s strongest segments are keeping the company in double digit growth territory.
I like Microsoft and Nvidia very much but it is uncanny how AMD continually finds a way to unexpectedly have a good report. I get to call this stock The Dark Horse for a little longer until it surpasses Intel on the data center; which means the name will likely be retired by 2024.
This article was originally published on Forbes Oct 14, 2022,09:31am EDTForbes Oct 14, 2022,09:31am EDT
Semiconductors have been rocked this year due to slower consumer spending on PCs, mobile and also slowing enterprise budgets that further affect hardware purchases, including PCs, notebooks and servers. The silver lining is Capex spending by Big Tech companies, which we’ve covered in the past for our premium members, when we stated that the increased Capex from companies like Google, Microsoft and Amazon and other big tech companies greatly benefit the semiconductor market.
The news has been in an uproar about crypto mining and the consumer-related PC markets. However, it has been our stance for some time that Big Tech capex is the true leading indicator for AI semiconductor companies. Despite an enormous increase in Big Tech capex primarily driven by data centers, this line item does not get the attention it deserves in terms of follow-through to the semiconductor industry. Below, we look at FY2022 budgets to draw the conclusion that H2 spending on data center chips is equal if not greater than the first half of 2022.
Market Opportunity
According to Gartner, the overall IT spending is expected to grow 3% to $4.5 trillion in 2022. It is lower than the 10% growth in 2021. The slowdown was mainly due to the cutdown in spending on personal computers, tablets, and printers.
The Data Center Systems segment, however, is expected to grow fastest among all the segments. It is expected to grow 11% YoY to $212 billion, higher than the 6.4% growth in 2021.
Hyperscale data centers, which are very large data centers primarily operated by Amazon, Microsoft and Google, are expected to outpace overall data center systems.
According to data from Allied Market Research, the global hyperscale data center market is expected to grow from $59 billion in 2020 to $585 billion by the year 2030, representing a Compound Annual Growth Rate of 26% from 2021 to 2030.
Similarly, the Artificial Intelligence chip market is expected to grow from $8.02 billion in 2020 to $194.90 billion by the year 2030, representing a CAGR of 37% from 2021 to 2030.
According to a report published by Dell’Oro Group, the global data center Capex is expected to be $377 billion by the year 2026 – which implies the majority of the growth noted by Allied Market Research will occur in the next few years.
The private markets are also signaling growth will continue as there has been quite a bit of deal activity in data centers.
According to data from Synergy Research Group, 87 data center focused merger and acquisition deals were closed in the first half of 2022, worth $24 billion. There is an additional $18 billion of pending deals in the pipeline that are agreed and are yet to be officially closed. The research group mentioned that 209 deals were closed in 2021 for over $48 billion, up 41% from 2020.
One of the more significant deals this year that was completed is the acquisition of CyrusOne for $15 billion by KKR and Global Investment Partners. John Dinsdale, Chief Analyst at Synergy Research Group, said, “There is an ever-increasing demand for data center capacity, driven by rapidly growing cloud markets, aggressive expansion of hyperscale operator networks and continued growth of data-rich digital services.”
Earnings season kicked off this week and our premium members are receiving deep-dive tech earnings analysis straight to their inbox each week. We also offer real-time trade notifications, weekly webinars, a completely transparent portfolio of 20+ positions and more. Learn more about our premium membership.premium members are receiving deep-dive tech earnings analysis straight to their inbox each week. We also offer real-time trade notifications, weekly webinars, a completely transparent portfolio of 20+ positions and more. Learn more about our premium membership.
Big Tech Capex H2 2022
Alphabet’s Q2 Capex grew by 24% YoY to $6.9 billion. Ruth Porat, CFO of Alphabet, said, “Turning to CapEx. The largest investments in the second quarter were in servers followed by data centers and office facilities.” were in servers followed by data centers and office facilities.” The company had invested $24.6 billion in Capex in the year 2021, up 11% YoY. The management expects Capex to rise in 2022. In the Q2 2022 earnings call, Ruth Porat said, “We continue to expect an increase in CapEx in 2022 versus last year. For the balance of 2022, the increase will be particularly reflected in investments in technical infrastructure globally with servers as the largest component.” Earlier this year, the company announced its plan to invest about $9.5 billion in data centers and offices in the U.S. for the year 2022. This is up from about $7 billion spent in 2021.
Similarly, Microsoft’s Capex including financial leases, grew by 19% YoY to $8.7 billion in the Q4 FY2022 quarter (i.e., Q2 CY2022). Amy Hood, CFO of Microsoft, said, “Maybe let me start by talking about Q4's capital spend. Obviously, the big driver of our growth this quarter was in data center spend, both new and newbuilds as well as adding capacity to existing data centers. We are seeing, obviously, good demand signal.” data center spend, both new and newbuilds as well as adding capacity to existing data centers. We are seeing, obviously, good demand signal.” The management expects a sequential decrease in the next quarter due to the normal variability in the quarterly spend. In the CY 2021, Microsoft’s Capex including financial leases, grew by 33% YoY to $27.5 billion.
Amazon incurred capital expenditures, including equipment financial leases, of about $60 billion in 2021. About 40% of this is made up of technology infrastructure supporting AWS and worldwide stores business. The management expects Capex to increase over the last year with the increase in technology infrastructure.
Brian Olsavsky, senior VP and CFO, said in the Q2 2022 earnings call, “For full-year 2022, we do expect to spend slightly more on capital investments than last year, but the proportion of capital spending shifts among our businesses. We expect technology infrastructure spend to grow year-over-year, primarily to support the rapid growth in innovation we are seeing with AWS. We expect infrastructure to represent a bit more than half of our total capital investments in 2022.”
Meta’s capital expenditures in Q2, including principal payments on finance leases were $7.75 billion, up 64% YoY. The company’s CFO, Dave Wehner, said in the Q2 earnings call, “Capital expenditures, including principal payments on finance leases, were $7.7 billion, driven by investments in servers, data centers and network infrastructure. The big step-up in CapEx, both year-over-year and sequentially related to server spend, including for our AI infrastructure.”driven by investments in servers, data centers and network infrastructure. The big step-up in CapEx, both year-over-year and sequentially related to server spend, including for our AI infrastructure.”
The company expects 2022 capital expenditures, including principal payments on financial leases, to be $32 billion at the mid-point of the guidance, representing a 66% YoY growth. Tracking the Capex in the first two quarters, Meta Platforms had spent $13.3 billion which suggests the spend will be higher in 2H 2022. When we deduct from the mid-point of the guidance, it comes to $18.7 billion for H2.
Meta also recently announced its plan to expand the Eagle Mountain data center project. It is Phase 3 expansion plan and brings the total investment in the project to over $1.5 billion.
Earnings season kicked off this week and our premium members are receiving deep-dive tech earnings analysis straight to their inbox each week. We also offer real-time trade notifications, weekly webinars, a completely transparent portfolio of 20+ positions and more. Learn more about our premium membership.premium members are receiving deep-dive tech earnings analysis straight to their inbox each week. We also offer real-time trade notifications, weekly webinars, a completely transparent portfolio of 20+ positions and more. Learn more about our premium membership.
Conclusion
Thanks to very big Big Tech capex budgets, Nvidia’s data center revenue grew 71% YoY to $7.6 billion in 1H 2022. Similarly, AMD’s data center revenue grew by 83% YoY to $1.5 billion in Q2 2022 and doubled in Q1 2022.
Due to consumer-related weakness, the data center is now the leading segment for these companies, which we had predicted would occur in 2018 in my free weekly newsletter. We also provide regular deep dives for our premium research Members on a more granular level as to what will happen next in the semiconductor industry.
Royston Roche, Financial Analyst for the I/O Fund contributed to this article.
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.
