Artificial Intelligence & Innovation Update: Our Stance After The Nvidia Warning
29 January 2019
- Nvidia was sharply down last night on the heels of a major profit warning (the first one in years), with Q4 revenue outlook cut by 20% and gross margin outlook reduced to 56% from 62.5%. After the cryptocurrency mining weakness in the previous quarter, Nvidia suffered from “deteriorating macroeconomic conditions, particularly in China” in its Gaming division (54% of revenue) and from a “more cautious approach” from data center customers (25% of revenue).
- The direct impact on our Artificial Intelligence and Innovation portfolios was moderate yesterday (around -50bps) as we materially cut our Nvidia exposure in recent weeks in light of the China and data center risks but, admittedly, the total impact was much larger as Nvidia dragged down many semiconductor stocks that populate the two certificates. That being said, it’s worth reviewing the investment case to figure out if it’s already time to turn more aggressive on the artificial intelligence leader or to exit the position.
- While the Chinese risk and the datacenter slowdown were well flagged following numerous China-related profit warnings (Apple for instance) and underwhelming figures from datacenter providers such as Intel, the Gaming division’s swing from strong revenue growth in previous quarters to a revenue decline in Q4 came as a shock.
- We view the current data center slowdown as a speed bump as cloud providers digest massive investments made over recent years and believe that the artificial intelligence revenue opportunity is intact. But we are worried in the short term about the Gaming outlook considering that Nvidia had underestimated the contribution of cryptocurrency mining to the Gaming division last year, that the 2019 lineup of video game blockbusters is poor (and only a few of them will require the ray tracing technology that Nvidia’s graphics cards offer) and that the outcome of trade negotiations between the US and China remains uncertain.
- Hence, even if Nvidia’s profit-warning clearly resets earnings expectations, there is still downside risk in the very short term (the Q1 guidance is likely to be underwhelming). But as we get closer to the end of the year and to 2020-21, the outlook should gradually improve as comparison bases become easier and as the massive “autonomous driving” catalyst unfolds (a several billion revenue opportunity for the company in the medium term).
- In all, we’ll stick for now with our small position in Nvidia in light of its leading position in AI and strong fundamentals (pricing power, margin strength) and considering that the focus will soon shift to autonomous driving. But it’s probably a bit too early to aggressively buy the stock and we feel much more comfortable right now in the AI chip space with rivals Xilinx (which benefits from a large telecoms/5G exposure) and AMD (market share gains in the server market at the expense of Intel).
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