Is NVIDIA's Gaming Business About to Hit a Major Roadblock?

NVIDIA (NASDAQ: NVDA) is feeling the heat after supply chain checks by BMO Capital Markets revealed a big drop in graphics processing unit (GPU) shipments during the first quarter of 2017. Analysts Ambrish Srivastava and Tim Long estimated a 16% drop in GPU shipments from Q4 to Q1, which is alarming as the normal seasonal drop has averaged 6% over the last three years.

The BMO analysts believe that the greater-than-expected seasonal decline will trigger a slowdown in NVIDIA's gaming business. Not surprisingly, shares of the chipmaker dropped when this analyst note was publicized, as gaming is its bread and butter, supplying 62% of total revenue and driving terrific growth in recent quarters.

However, investors shouldn't start panicking yet, as the GPU weakness could be temporary.

Data from NVIDIA. Chart by author.

New cards might have pushed back purchases

NVIDIA and AMD's GPU battle has drummed up a lot of media attention as both companies are trying to go one up on each other with new cards. For instance, AMD announced in late February that it will be releasing its Vega GPU line-up in the second quarter of 2017. NVIDIA came up with a counter by announcing its next flagship -- the GTX 1080 Ti -- just one day later and priced it aggressively at $699.

NVIDIA CEO Jen-Hsun Huang claims that the new GPU is 35% faster than not only its predecessor but also its premium-priced Titan X that retails for $1,200, giving gamers a good reason to hold off GPU purchases. What's more, the GPU maker said in early March that when the 1080 Ti arrived in stores, it would reduce the price of the older GTX 1080 to $500. And NVIDIA was not done yet as it announced an even more powerful GPU -- the Titan Xp -- in the first week of April and priced it at $1,200.

NVIDIA's previous flagship graphics cards -- the GTX 1080 and the Titan X -- were released in May and August last year, so it wouldn't be surprising if NVIDIA customers delayed first-quarter purchase this year while waiting for new cards. Given that the 1080 Ti went on sale at the end of March and the Titan Xp hits stores this month, first-quarter GPU sales should have taken a hit.

Image source: NVIDIA.

This is nothing new for NVIDIA. The chart given earlier shows that its gaming revenue dropped over 15% in the first quarter of 2017 but made a strong comeback in subsequent quarters once its new cards hit the market. For some perspective, overall GPU shipments were down over 15% in the first quarter of 2016, far higher than the 10-year average decline of 3.57%.

Gaming hardware growth will be a tailwind

Jon Peddie Research estimates that PC gaming hardware revenue crossed $30 billion last year thanks to a growing preference for high-end systems, with gamers preferring the platform for consuming high-definition and ultra high-definition content. The growing craze for e-sports is another factor powering the PC gaming hardware market as the category requires high-end graphics cards to run games seamlessly.

Jon Peddie forecasts that the PC gaming hardware market will continue growing at an annual rate of 6% for the next two years, creating a tailwind for GPU shipments. Additionally, 70% of NVIDIA's installed user base is still on the older Maxwell GPU architecture, pointing toward a substantial upgrade cycle as the platform is around three years old.

All these catalysts could boost annual GPU sales from 30 million units in 2015 to 67 million units in 2020, according to estimates from Research and Markets. This is great news for NVIDIA investors as the company dominates this space with a market share of over 70%. The drop in GPU segments in the March-ended quarter is nothing new and investors need not panic as secular end-market growth should help NVIDIA sustain its growth after a seasonally weak quarter.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Nvidia. The Motley Fool has a disclosure policy.