Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Chief Investment Strategist
There is probably not an earnings release more important for equity market sentiment right now than Nvidia’s FY24 Q4 earnings (ending 31 January 2024) out Wednesday night after the US equity market close. With the AI boom being stronger than ever and spreading to more and more stocks all eyes will be fixated on this earnings release. Analysts expect revenue of $20.4bn up 238% y/y and EPS of $4.60 up 613% y/y in what is probably the most extraordinary increase in a mega cap business ever recorded. We have never seen a $1trn market value company with 12-month revenue of $45bn and a net profit margin of 55% grow at these blistering growth rates.
The chart below shows Nvidia’s quarterly revenue and analyst estimates projecting quarterly revenue to hit more than $25bn within the next year. This level of revenue is around four times the level in late 2022 when Nvidia was hit by a collapsing demand from Bitcoin mining due to falling Bitcoin prices and generally lower technology spending as Silicon Valley was adjusting to higher interest rates.
If we take a look at the geographical revenue split we can see that it is really the US segment that has taken off in the previous two quarters followed by strong growth in Chinese and Taiwanese sales. Singapore was once again separately split out in the previous quarter accounting for 15% of revenue. This is naturally odd and it is clear Singapore is used as a legitimate hub for re-exporting of Nvidia chips to countries were export controls may apply. As we have highlighted in the past a significant amount of Nvidia revenue comes from China and Singapore (37% of revenue) which given the ongoing trade frictions and potential Trump election win later this year could become a key geopolitical risk for Nvidia.
Will Nvidia beat estimates and how is the market positioned? Nvidia has beat on revenue and EPS in the past 7 of 8 earnings releases and the recent signals from Arm and other companies in the AI ecosystem are not suggesting growth is slowing down in the short term. We are leaning towards the view that analysts will once again underestimate Nvidia’s growth, but uncertainty is 2.5x larger than normal around this earnings release. The normal average 1-day move around Nvidia earnings is 4.3% but equity options are pricing 10.5% this time. To get a sense of the explosive growth in cumulative AI performance we are highlighting a slide from Nvidia’s recent investor slide deck (see below).
What about Nvidia’s valuation. Can the outlook justify it? As we pointed out in a recent equity note on Arm shares, both Arm and Nvidia are valued significantly above the market, which is not strange given the underlying growth in AI chips. But is it too much? It depends of course on the underlying assumptions for the future. NYU professor Aswath Damodaran, one of best on equity valuations, recently wrote about the magnificent seven and said this about Nvidia:
“…Nvidia and Tesla, where questions remain about what the end game will look like, in terms of market share. Historically, neither the chip nor car businesses have been winner-take-all businesses, but investors are clearly pricing in the possibility that the changing economics of AI chips and electric cars could alter these businesses.”
Later in the article, Damodaran says explicitly that Nvidia looks overvalued despite factoring significant AI growth into his valuation models before serving a contradiction as he owns shares in Nvidia.
The past year has been all about the evolving AI theme powering equity markets higher. Our AI theme basket consists of 20 stocks that have a high degree of exposure to the AI boom representing $10trn of market value which is around 16% of the MSCI World Index market value. As the table below shows, it is a group companies enjoying close to double digit growth rates and strong profit margins. Analysts also remain bullish overall on AI related stocks and the average 5-year total return is significantly above the market.
If we take a look at revenue growth for this group of AI related stocks then we can see why the market is getting excited over this theme. Median revenue growth excluding Nvidia bottomed out in Q2 2023 at 2% y/y and has so far rebounded to 8.4% y/y in Q4. If Nvidia is included in the calculation then revenue growth rose to 15.3% y/y in Q3 and will undoubtedly rise again in Q4.
The AI sentiment also seems to have reached proportions not seen since the 2021 tech bubble and the dot-com period. Two stocks, Arm and Super Micro Computer, have increased 102% and 197% respectively since 14 September 2023 with the big jump coming this year. There is really a sense of fear of missing out (FOMO) in AI related stocks. But with all important long-term technologies the beginning has its bubble-like tendencies as we get too excited in the short-term and extrapolates too much. The recent news flow from OpenAI’s latest AI programme called Sora, that can render detailed videos of greater length than ever from text input, is an example of the incredible hype and excitement over AI technology. This AI boom will likely not be any different from previous cycles.
Besides the important earnings release from Nvidia the market will also get earnings from Walmart (Tue, bef-mkt) and Home Depot (Tue, bef-mkt). Analysts estimates 4% revenue growth for Walmart and EPS of $1.65 down 4% y/y as cost pressures continue to weigh on Walmart’s results. Home Depot is expected by analysts to report another quarter with negative revenue growth (consensus is looking for -3% y/y) as higher interest rates continue to subdue demand in the US home improvement industry. Home Depot is also expected to report EPS of $2.77 down 16% y/y.
This week is also a major week for global mining giants such as BHP, Rio Tinto, and Glencore. Iron ore prices were on average 19% higher in USD terms in 2H 2023 compared to the same period a year before and thus analysts expect positive growth rates for both BHP and Rio Tinto. The Bloomberg Industrial Metals Index, which is a broader measure of industrial metals prices, is down on average in 2H 2023 compared to the same period last year and as a result analysts expect Glencore to report revenue down 6% in 2H 2023.
The list below highlights all the major earnings releases this week: