nVidia and the Big Chip, the Top Line, and Gross Margins
Monday, May 25th, 2009nVidia recently turned in quarterly results that looked good, yet at the end of the day the stock kept falling. A little digging revealed nVidia had a bad miss on gross margins. “NVDA reports Q1 gross margin of 28.6% vs. 35.5% street expectation”. Thank you Briefing.com.
The next day brought confirmation: the company had been negatively assessed by many analysts over gross margins. You can’t blame the analysts. Gross margins is the single most important metric by which tech companies are evaluated.
Wrote one analyst: “without concrete evidence of a major design improvement, we would expect NVDA’s cost structure to remain less competitive than AMD’s and hinder its margins and profitability” (Tech Trader Daily).
JoAnne Feeney’s comments are a thinly veiled reference to nVidia’s practice of creating big graphics chips as opposed to AMD’s “sweet-spot” strategy of making smaller graphics chips. Bigger graphics chips are more expensive to make in part because you get fewer graphics chips out of each silicon wafer.
Feeney and others think that nVidia should mend its big-chip ways and pursue smaller chips like AMD makes.
First of all, I would like to say, gross margins are very important, and nVidia needs to raise them, and nVidia would probably be the first to say this.
Second of all, something’s wrong if you’re downgrading nVidia and upgrading AMD on the basis of their Q1 gross margins.
Retail
Retail has been on a tear lately, with many companies putting up results that have beaten expectations. Still, the beats primarily came from cost cutting and inventory management. What is needed now, experts say, is top line growth:
“What we need now is top line growth. David Berman, who runs a hedge fund that specializes in retailers, and others noted to me this morning that while cost cuts are clearly working, top line growth has been meager. It’s time for the top line to kick in.” (CNBC)
Unlike retail stores, however, the top lines of semiconductor companies have been improving since February.
Same-store sales stand to retail like gross margins stand to tech: it is the key metric by which the industry is judged.
It is interesting to note that retail stocks rallied recently based on bottom-line results and not same-store sales. Same-store sales in fact appear to have been down, and yet “most professional traders in retail stocks are not worried about the lack of topline growth” (CNBC).
It is as if there is a tension between the forces that drive stocks and the rules that the professionals use to move the market.
The Semis
I once read that in a recession technology is a trailing indicator: that tech is the tail of the dog. I can’t speak for past recessions, but in the current recession the statement that tech trails is false. The semis in particular led the latest rally.
First there were rumors of rush orders, though people did not put too much hope in them. In February however the top lines of almost all companies having anything to do with semiconductors, as reported in Digitimes, bounced. It wasn’t just one company, it was the whole group.
While revenue rose in February, compared to January, the good news didn’t start to trickle in until the first days of March. This was about the time the market in the U.S. hit its latest rock bottom, March 6 or March 9. Two months after, and it was as straight up as stocks ever are.
If that weren’t enough, the rally began to correct as top-line growth for the semis started to stall. News began to trickle in during May. Top-line growth in the semiconductor sector appears to have peaked in April.
I wish I could tell you that the bounce in the top lines of semiconductor companies reflected real end-user demand. I’d be lying.
The top-line bounce had everything to do with inventory and not much with end-user demand. Downstream companies had stopped placing orders for semiconductor products in the fourth quarter and began living off existing inventories. The bounce in the top lines of semiconductor companies from February to March reflected that downstream customers had finally depleted supplies.
Some analysts refused to upgrade the semiconductor sector because they saw the bounce in the top lines as an inventory issue. They were certainly correct in seeing it as inventory.
The point however is that stocks did not seem to care if this was an inventory issue or not. Some semiconductor stocks went up over 100% from their November lows.
nVidia among them.
Green Shoots
Comparisons with other semiconductor companies is made difficult in that nVidia does not break out its financials by month the way Digitimes does for the semiconductor companies it covers: also by the fact that nVidia reports a February-through-April quarter. For example Intel’s and AMD’s Q1 results were weighed down by the month of January, which was bad for almost everyone.
But if we can’t make apples-to-apples comparisons, at least we can look for green shoots.
nVidia’s top-line results sequentially were about as strong as any that have been published. Desktop GPUs (graphics processors) were up almost 50%. Notebook GPU 28%. Core logic was up about 94% (Earnings Call Transcipt).
Gross margins were hurt largely by softness in workstation graphics. Until the enterprise comes back, nVidia’s gross margins could remain pressured.
In the meantime, nVidia continues to spend on R&D. If the enterprise ever comes back, nVidia will be there, with a big chip to address those parts of the market demanding the most performance.
Disclosure: long nVidia and Intel
