The chip sector comes into sharp focus ahead of a key earnings report, with signs of divergence in the sector.
Mega-cap chipmaker Nvidia (NVDA) is set to deliver earnings Wednesday, and considering how investors have treated its competitors so far this earnings season, there could be a high bar for success.
Semiconductor earnings to date left behind a bloodied battlefield. The most severely wounded was Intel (INTC), which suffered a 12% share decline after delivering what investors believed to be disappointing guidance. Advanced Micro Devices (AMD), an artificial intelligence competitor of NVDA's, was hit following its report, while Texas Instruments (TXN) and Qualcomm (QCOM) fared a little better. The exception, at least until now, was Arm Holdings (ARM), which catapulted more than 50% following monster earnings results earlier this month.
One school of thought suggests the sector was so hot approaching earnings that strong results were already built into prices. That set the shares up to fall if earnings were less than perfect. If that's the case, then the sector pullback might be temporary. After all, the PHLX Semiconductor Index (SOX) rose more than 60% between the end of 2022 and mid-January 2024 before earnings season began despite the industry's lingering inventory overhang.
The more worrisome theory is that semiconductor firms face real struggle, at least near term, even in the high-flying AI business. Much of the sector's 2023 sizzle reflected AI enthusiasm.
"AMD stock's drop suggests that anything less than a huge guidance raise will be treated harshly when it comes to popular AI stocks this earnings season," Barron's noted.
Nvidia's report may provide some insight.
Meteoric rise
Shares of Nvidia soared in 2023, climbing around 200% as AI excitement swelled and demand grew sharply for Nvidia's graphics processing unit chips, which Nvidia calls "ideal" for machine learning critical to AI. Fiscal Q3 results in November included revenue growth tripling from a year earlier to outpace analysts' average estimate by nearly $2 billion.
It'll be important to watch when Nvidia reports how quickly AI continues to produce revenue and profit. Last time out, Nvidia said on its call that "surging demand" for AI is related to three elements. First is what it calls "deep recommender systems" essential to recommending the right content, item, or product to someone using a device or interacting with a computer using just their voice. The second has to do with large language models with the ability to learn representations of all kinds of languages. This can go beyond human language to the language of biology or chemistry, to name a couple. Similarly, the human genome is also an area of focus.
The third element is generative AI, which goes beyond perception to help create something or generate product. This could mean generating videos or text to enhance performance, reduce costs, or improve productivity, Nvidia said in its Q3 earnings call.
There are similarities elsewhere in the industry.
AI revenue story still positive, but rest of chip story unclear
The positive AI story this quarter came from Meta Platforms (META), Microsoft (MSFT), and other mega-cap companies reporting that AI continued to help drive growth in platforms like cloud computing and digital advertising. This could be a solid revenue story for chip sector companies like Nvidia and AMD, as well as Super Micro Computer (SMCI), which incorporates NVDA's chips in its servers, and chip equipment makers like Applied Materials (AMAT), ASML (ASML), and Lam Research (LRCX).
Beyond AI, demand for more conventional chips used in everything from cars to video games to phones has been harder to pin down, making companies and investors more cautious about the future. Some have cited what they called "optimization" from customers, meaning that companies are buying less and working to get the most out of what they have on hand. While much of the chip excitement surrounds AI applications, the basic blocking and tackling for most of the chip sector remains in the established businesses of data centers, video games, and consumer products.
"Chips for the automotive and industrial markets have been showing most of the weakness this past quarter," said Nathan Peterson, director of derivatives analysis at the Schwab Center for Financial Research. "Not all semi companies are created equal; it depends on what markets they are serving."
On the one hand, Taiwan Semiconductor Manufacturing (TSM), the world's largest contract chip manufacturer and a company with a good feel for the pulse of the industry, lifted spirits on its January earnings call.
"Coming off the steep inventory correction and low base of 2023, for the full year of 2024, we forecast the overall semiconductor market excluding memory to increase by more than 10% year over year, while foundry industry growth is forecast to be approximately 20%," CEO C.C. Wei told analysts. Inventory, he added, has returned to a healthier level, though macroeconomic and geopolitical risks remain.
Wei also sounded excited about the AI opportunity.
"The surge in AI-related demand in 2023 supports our already strong conviction that the structural demand for energy-efficient computing will accelerate in an intelligent and connected world," Wei said.
On the other hand, investors emerged from AMD's earnings report later in January a bit less enthused about AI, while Intel and Texas Instruments both delivered cautious guidance.
AMD, in particular, didn't offer investors much near-term excitement in its guidance.
"For 2024, we expect the demand environment to remain mixed, with strong growth in our Data Center and Client segments, offset by declines in our Embedded and Gaming segments," said Lisa Su, CEO of AMD, in the earnings call.
She added that there's some "cloud optimization" occurring and that there's "caution" in enterprise technology, a reference to the large organizations that use computing for things ranging from accounting to payment processing to security monitoring, among many other applications.
Nvidia looms
All of which builds up to Nvidia, expected to open its books after Wednesday's U.S. market closing bell.
Heading into earnings, analysts expect Nvidia to report fiscal Q4 earnings per share of $4.53 and revenue of $20.24 billion, compared with $0.88 and $6.05 billion a year ago. With that kind of annual growth possibly in the mix, guidance is likely to get a close look from investors. Nvidia has a tough battle to keep growing at that pace.
"Investor expectations are lofty with the stock up over 40% year to date," Schwab's Peterson said.
At the same time, Nvidia has previously warned about headwinds from China. Even with the stock up sharply since November, the wild card could be what it said then in a letter to shareholders. Executives noted that sales to China and other destinations "will decline significantly in the fourth quarter of fiscal 2024, though we believe the decline will be more than offset by strong growth in other regions."
Export restrictions related to tension between the United States and China over technology continue to weigh on Nvidia and the rest of the sector, though hopes briefly rose last fall when President Joe Biden met with Chinese President Xi Jinping.
Another area of focus is demand for Nvidia's products from cloud service providers like Alphabet (GOOGL), Oracle (ORCL), and Microsoft. Any Q4 advances on these fronts, as well as any new partnerships on AI initiatives, could potentially move the needle for Nvidia shares. Traditional gaming and automotive businesses also come under a microscope when Nvidia reports, especially after Intel's struggles last quarter in the self-driving space.
Nvidia's recent forward price-to-earnings ratio stood at a relatively high 55, and the options market is currently approximating a ±9% move following the earnings release. That could mean volatility for Nvidia and the chip market in general in what's often a tough month for tech. Buckle your seatbelts.
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