NVDA stock may fall further before rising again, providing an entry point for long term investors.
Shares of NVIDIA Corporation (NSDQ:NVDA) registered an uptick yesterday after a week of correction, driven by all the excitement and anticipation around CES 2017. While there's no disputing the fact that Nvidia looks poised for a good run in the long term, a couple of headwinds that investors seem to be ignoring, could potentially stall the stock's stellar rally in the near term. And that's not including some of the concerns raised in Citron Research's bearish call last week.
If you look closely at all of the news that's come out over the course of December 2016, and analyze the triggers that have driven NVDA stock higher, you'd probably come away with the impression that a further correction could be in store. So, even if the announcements from CES drive the stock higher over the next couple of days, investors who plan to buy into the stock might want to watch the stock closely and wait for a correction to enter the stock.
What's been driving NVDA stock lately?
Nvidia shares had a massive run in 2016, rising by over 224% for the year, and nearly 264% at the peak of the rally, before Citron’s bearish commentary put a temporary stop to the euphoria. In spite of Nvidia's great run in the early part of the year, the stock continued to pile on handsome gains of ~75% over the last three months of the year. Interestingly, gains of nearly 37% came in December alone, backed largely by bullish commentary from analysts, rather than fresh news. What triggered these gains?
Most of Nvidia's strengths aren't new to investors. Be it the company's presence in on-the-horizon sectors like Artificial Intelligence (AI), Virtual Reality (VR) and self-driving cars, or it's growing presence in the data center space, these are catalysts that observers have been aware of. Most of the renewed optimism in the last month or so came largely on the back of upgrades and price target hikes by popular analysts, based on existing facts, which served as reinforcements to the bullish sentiment that had been around for most part of the year. At large, the stock was driven by sentiment alone towards the end of 2016. Apart from lifting the stock to newer highs with each passing day, these louder by the day bullish calls also seemingly drowned out every word of caution.
What could go wrong for Nvidia now?
On 12th December, a report by Barron's saw Pacific Crest's Michael McConnell warn investors about "dark clouds forming for Nvidia". In that report McConnell raised concerns about the piling up inventory of graphic cards and the potential impact the trend could have on Nvidia. Quoting McConnell from the report:
"Our specific findings were as follows: High-end NVIDIA GeForce GTX 1080 and 1070 card inventory levels have risen to 2 to 2.5 months in the channel versus targeted levels of 1 to 1.5 months due to weaker-than-expected sell-through in late October and November. Two weeks ago, desktop graphics card manufacturers began to experience order pushouts and cancellations of GTX 1080 and 1070 cards from channel customers ahead of the holiday season. Given the excess supply situation, GeForce GTX 1080 pricing has dropped ~10% in the channel"
What's especially important here is that the GPUs in question are Nvidia's high-end GPUs, which command higher Average Selling Prices (ASPs) than some of Nvidia's more mainstream offerings. While the drop in pricing dents Nvidia financially, the potential dip in high-end GPU sales, also allows arch rival AMD (NSDQ:AMD) to potentially reduce the gap in market shares of the two companies. While the report suggests that AMD's GPU sales were also "characterized as disappointing QTD", it indicates that the problem could be concentrated in the high-end desktop GPUs segment, which is the high-end gaming market at large, where Nvidia reigns supreme. In this context, McConnell notes:
"Given the weaker-than-expected sell-through of higher ASP GeForce GTX 1080/1070 product and higher sales mix of mainstream GeForce GTX 1060/1050, not one desktop graphics card manufacturer we surveyed is expecting sequential revenue growth in calendar Q4, with forecasted sales declines of 5% to 15% q/q. We note this contrasts with NVIDIA’s guidance for sequential revenue growth in its gaming segment (62% of sales) in FQ4 (Jan.), after record-high sales in FQ3 (up 59% q/q, 65% y/y)."
It's hard to quantify the impact of these developments at the moment. However, given the valuations Nvidia currently trades at, any disappointments could trigger a correction. Nvidia's earnings for the quarter ending Jan 2017 are due to come out in mid-February. So keep an eye out for that announcement.
Another factor that's probably getting overlooked is that Nvidia's near monopoly in the high end GPUs space could well be at risk with AMD's upcoming line up of Vega GPUs. Armed with a more fine-tuned 14-nm FinFET technology, these GPUs are expected to increase operating speeds and reduce power consumption simultaneously, to deliver better performance per watt than AMD's current GPU line-up. More importantly, AMD's Vega line up could potentially outperform Nvidia chips as The Motley Fool's Harsh Chauhan points out.
"AMD's Vega 10 GPU will be equipped with second-generation high-bandwidth memory, or HBM2. The deployment of the HBM2 should ideally help AMD's high-performance RAM to clock a higher bandwidth and consume less power at the same time as compared to NVIDIA's cards. In fact, it is estimated that the Vega 10 GPU will offer bandwidth of up to 1,024 gigabytes per second, which is much higher than the 320 gigabytes per second delivered by NVIDIA's GTX 1080 card. Thus, AMD's latest-generation GPUs are expected to exceed the bandwidth of NVIDIA's flagship GPU by a really big margin, allowing the card to deliver a better VRAM performance."
That's not the only source which suggests that AMD could dent Nvidia though, and we'll take a deeper look at this aspect of Nvidia's business in an upcoming post. For now, investors might want to re-assess the degree of optimism attached to Nvidia. As we said at the beginning of this post, CES 2017 is giving investors a lot to be excited about, like Nvidia's tie up with Audi, which plans to bring self-driving AI cars to the market by 2020. However, investors might do well not to ignore the near-term risks.
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