First-quarter earnings from Nvidia (NASDAQ:NVDA) on May 16 are going to be ugly. Nvidia management already has guided for a tough Q1, and indeed, a difficult fiscal year 2020 (ending January). That weakness, at least to some extent, already is priced into Nvidia stock.
Despite that outlook, NVDA stock had rallied, at least until recently. With a 4%-plus decline on Thursday, NVDA now has dropped 9% in just four sessions. Renewed trade war fears have hit chip stocks as a whole. Disappointing earnings from Intel (NASDAQ:INTC) haven’t helped.
The pressure on Nvidia stock, and the chip space, sets up a crucial earnings report next week. The focus isn’t going to be on the Q1 numbers, which we know are going to be rough. This already was a second-half story, as I wrote back in March. For the company to reverse these recent declines, management must re-inspire confidence that a rebound is on the way soon.
At this point, I’m skeptical Nvidia will be able to do so.
What’s Going Wrong for NVDA Stock
Two key pain points led the big decline in Nvidia stock, which fell by more than half in the last three months of 2018. First, what the company itself called a “crypto hangover” led to a massive glut of inventory, and plunging prices for the company’s GPUs. Secondly, data-center demand unexpectedly weakened toward the end of last year and into the beginning of 2019.
The combination should lead to a significant decline in Q1 results. Nvidia’s own guidance suggests a 31% drop in sales year-over-year. Earnings per share should fall by something close to 60%, thanks to lower margins.
The good news for Nvidia stock is that a bad quarter isn’t going to surprise investors. And it does appear at this point that guidance likely was accurate, if not conservative.
A little over two weeks before the Q4 release in mid-February, Nvidia issued updated and lowered guidance for the quarter. The lack of a similar update this time around strongly suggests a significant downside surprise isn’t on the way. Nvidia earnings may not look strong on a year-over-year basis, but they seem likely to come in at least around where investors and analysts expect.
What to Look for in Nvidia Earnings
The bad news, however, is that even an earnings “beat” on its own is unlikely to move NVDA stock. The question at this point is not what fiscal-first quarter results were. It’s what second half FY2020 — and for that matter, FY2021 results — will be.
The bull case is that first-half weakness is just a blip, caused by the cryptocurrency bubble and a temporary slowdown in data-center spending by companies like Microsoft (NASDAQ:MSFT) and Amazon.com (NASDAQ:AMZN). This is the story Nvidia management is telling: full-year guidance is for revenue to be “flat to down slightly” year-over-year, which suggests a reversal to strong growth starting likely in Q3.
The bear case is that Nvidia simply is dealing with the standard cyclicality of the semiconductor business, to which bulls — myself included — argued Nvidia was immune. If that’s the case – and if FY2018 and FY2019 earnings were simply cyclical tops – then Nvidia isn’t a company growing for the long-term. And there’s a path for NVDA stock to drop as far as $100 (think something like 15x FY2021 EPS of $6.50 or so).
Nvidia isn’t going to answer this question for good on Thursday. But investors will be looking for clues. Management on the earnings call no doubt will be asked — and perhaps asked often — about these central questions: outlook for the second half, the lingering effects of cryptocurrency mining, and the health of data-center demand. I’d expect the answers to those question to be of much more importance to NVDA stock than the actual Q1 numbers themselves.
Caution for Nvidia Stock
And I’d expect the answers might not be quite what investors want to hear. Even with the recent pullback, Nvidia stock already has gained 30% so far this year, pricing in a reasonable probability of a recovery in the back half. Yet Intel expressed caution toward data-center demand in its most recent report. Meanwhile, Advanced Micro Devices (NASDAQ:AMD) posted a strong Q1 report, and appears to be an ever-strengthening rival in data centers and GPUs.
It’s likely that the late 2018 selloff in NVDA stock went too far. The same may be true of the 2019 rally, however. If the worries last year were about GPUs and data centers, recent news doesn’t look good. Nvidia is back to trading at 20x-plus earnings. The broader market looks a bit rattled this year.
There are a number of concerns which could push investors away from Nvidia stock, at least in the near term. Meanwhile, Nvidia management isn’t going to be able to definitively answer those concerns after Q1. The long-term argument over NVDA isn’t resolved, which might be a good thing for patient investors. I doubt that will be a good thing next week, however.
As of this writing, Vince Martin has no positions in any securities mentioned.