Nvidia (NASDAQ:NVDA) reported earnings on Thursday after having negatively pre-announced. They guided below the Street again for Q1. What bothered us about the call is that the guide appeared to be based more on hope than anything. The back half is a little bit of a dice roll.

Brief History

We had downgraded Nvidia from Strong Buy to Neutral in September 2018 at 275 to subscribers (paywall). On Nov. 12, days before earnings that saw a drop of 19% we called out “Earnings Report Risk.”

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What’s Next?

As you know from my work I care about the earnings model, growth rates and what the company has to say to make it all make sense.

What CEO Jensen Huang said on the earnings call on Thursday did not instill much comfort for the rest of the year.

Let’s see what he said last week,

“Well, in the short term, in the near term, we have relatively limited visibility. We don’t think it’s going to remain this way. And with a little bit of tailwind, I think we could have a fairly good year. And so we’ll just see how it turns out.”

When I listened to the earnings call and specifically this comment by the CEO, the word “incongruous” popped into my head, out of nowhere.

No, the word has nothing to do with politics as in Trump isn’t getting along with Congress.

I had to look it up just to be sure.

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What’s a little strange is I don’t think I ever used that word before in my entire life, I barely knew the meaning, and for sure couldn’t spell it without the help of Google search (results linked and shown above).

I’m not the type of guy to spit out SAT words in a business meeting so it came from nowhere.

If you’re an English Lit major in college, please go easy on me, but I’m going to try to put my new favorite word in a sentence.

The CEO saying he has “limited visibility” is incongruous with expecting a second half “tailwind.”

Maybe Google can use my new quote as their definition in the future.

I’ve been doing this business for a couple of decades. I care what companies have to say. We have their reported numbers and what they say. I think that’s a lot.

So I have to listen to what they say and then model it to make sense of it.

When a company says they have “limited visibility” it means they don’t know what’s going to happen. Things now are either going down or volatile. That’s what it means when they say something like that.

Someone who says they have “limited visibility” can’t then tell you they expect a “tailwind” in the second half. They don’t know. They don’t know now and they certainly don’t know in the future. Thus my new favorite word.

You’d like to hear Nvidia say something like we’re expecting a tailwind in the second half because we’re seeing a larger order book in the back half. But that’s not what they said.

I think the stock popped initially before the earnings call based on the company giving annual guidance hoping that meant the company had confidence.

But the stock probably traded off all day on Friday when investors processed their “limited visibility” from the conference call.

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The stock opened up strong I think because of follow through of trapped shorts after the company’s 2020 revenue guide: “Revenue is expected to be flat to down slightly.”

Let’s Do A Quick Segment Review And Decide

What matters is do we think the impacts to their business are one time and shorter term in nature, or are they something that can last for a while?

That depends. Let’s see what they had to say in their two main businesses.

Their two biggest businesses are Gaming and Datacenter so those are what I want to focus on.

Gaming made up 43% of last quarter and Datacenter made up 31% of the quarter. So combined you’re talking about three-fourths of the business.

This is what matters. And it didn’t sound to me like the issues in either business are so one time.

Gaming, 43% Of Revenues

Here’s what they said on Gaming.

“Second, deteriorating macro economic conditions, particularly in China, impacted consumer demand for our GPUs, and third, sales of certain high end GPUs using our new Turing architecture, including the GeForce RTX 2080 and 2070 were lower than we expected for the launch of a new architecture.”

These are two important issues that, for now, is out of Nvidia’s control to fix.

“Deteriorating” means that it’s getting worse now. That’s not something that we can hope just swings back. You likely have to assume the trend.

Look at the problem building in their inventory position.

2018 2018 2019 2019 2019 2019
Q3 Q4 Q1 Q2 Q3 Q4
Inventories 857 796 797 1090 1417 1575
YOY Growth 26.22% 0.25% -2.92% 27.49% 65.34% 97.86%

Source: Elazar Advisors model pulled from Nvidia earnings releases

You see the acceleration of the company’s inventory position. This is a sign of not selling goods. This also is a sign that a company is not slowing production to match slower demand which is a risk to future numbers.

Why would you want to produce more even when things slow? So that you can lever fixed costs over more units and sell goods at a higher margin. The right thing though would be to cut production, but it would mean a hit to margins.

This building inventory position is telling you there’s future margin risk, especially when matched with “limited visibility.”

Here’s what they said on the earnings call:

“In Q2 and Q3 of last year with the benefit of hindsight, we shipped a higher amount of desktop gaming products relative to where end demand turned out to be.”

You see that Nvidia now admits that they did not slow production and shipped into weak demand. But their higher and higher inventory position means they haven’t taken their medicine yet either. I think there’s still risk to come.

Datacenter, 31% Of Revenues

Let’s see what Nvidia said and then match it to the numbers.

“The Q4 sales decline was broad based across verticals and markets and geographies. As the quarter progressed, customers around the world became increasingly cautious due to rising economic uncertainty and the number of deals did not close in January.

In addition, hyperscale and cloud purchases declined both sequentially and year-on-year as several customers paused at the end of the year. We believe the pause is temporary.

Our visibility remains low in the current cautious spending environment, and we don’t forecast a meaningful recovery in the data center segment until later in the year.”

When the company said “as the quarter progressed” that means the quarter got worse as it proceeded. The growth rate starting the quarter was probably higher than how they exited the quarter.

They said hyperscale and cloud customers “paused at the end of the year” also pointing to a building weakness. That they said they thought it’s “temporary” is also “incongruous” with “our visibility remains low in this cautious spending environment.”

Let’s look at the Datacenter numbers. Remember this had been a core driver to the company’s overall numbers. Things have changed.

Calendar 2018 2018 2019 2019 2019 2019 2020
Fiscal 2019 2019 2019 2020 2020 2020 2020
Q2 Q3 Q4 Q1 E Q2 E Q3 E Q4 E
Jul Oct Jan Apr Jul Oct Jan
Datacenter 760 792 679 824 694 855 1073
Datacenter QTQ Growth 8.4% 4.2% -14.3% 21.4% -15.8% 23.2% 25.5%
Datacenter 1 yr growth 82.7% 58.1% 12.0% 17.6% -8.7% 7.9% 58.0%
Datacenter 2 yr growth 258.2% 166.8% 116.8% 89.0% 74.0% 66.0% 70.0%
Slowdown -91.4% -50.1% -27.8% -15.0% -8.0% 4.0%
Pct Change Of Slowdown -54.8% -27.4% -15.2% -8.2% -4.4%

Source: Elazar Advisors models and analysis, data pulled from Nvidia releases

So we’re taking what they say and we’re factoring that into the numbers.

We like to use the two-year growth rates to see underlying trends. In Q3 the two-year slowed by a lot, 91.4%, and in Q4 it slowed also by a lot, 50.1%. That is a huge slowdown. Granted, they were growing at amazing growth rates but this is a sharp drop-off.

So to get to our Datacenter numbers we took the pace of that two-year slowdown for Q4 and extrapolated those growth rates into the rest of the year.

The Datacenter business probably doesn’t bounce back to respectable growth until Q4.

Let’s see what we get overall

Our Revenue Numbers

When we run the growth rates on a segment basis we get decently below their guide of $11.7B in sales for 2020 (paywall: see full model).

That’s based on assuming a continued two-year slowdown. I think the two-year helps you parse-out one-time things like crypto affecting the numbers.

By using the two-year trends you understand that the one-year growth rate that most are used to following is affected by a) this year’s trends and b) the base year’s (last year’s) ups and downs.

So as the base year gets worse, the one-year should get better. But as the two-year trend gets worse, you have to reflect that too. So we think our two-year method accounts for their comments that they hope there will be a second half “tailwind.”

Our numbers don’t agree though.

Conclusion

I don’t think Nvidia is a Buy yet. The company doesn’t have visibility so nor can we. Nvidia’s a great company so people having a five-year horizon or so, it’s probably OK, but we are shorter term looking out six months to a year. In that time there’s still probably as much risk as there’s upside.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: All investments have many risks and can lose principal in the short and long term. The information provided is for information purposes only and can be wrong. By reading this you agree, understand and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Elazar Advisors, LLC, and their related parties harmless. Elazar and its employees do not take individual stock positions to avoid front running and other potential customer related issues.

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2019-02-18