Motley Fool Money - Chips, Glorious Chips!

Episode Date: August 1, 2024

Someone’s gotta make ‘em, and someone’s gotta buy ‘em. (00:21) Asit Sharma and Mary Long look at earnings from companies on either end of the AI spending spree. They also discuss: - whether you should fall in love with companies - AMD’s data center business - Meta’s “special treatment” Then, (18:08) Karl Thiel and Ricky Mulvey look at Dexcom, a medical device manufacturer that’s fallen out of favor with Wall Street. Companies mentioned: AMD, NVDA, META, DXCM, ABT, MDT, ISRG, NVCR Host: Mary Long Guests: Asit Sharma, Karl Thiel, Ricky Mulvey Producer: Ricky Mulvey Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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Everybody wants chips, and you're listening to Motley Full Money. I'm Mary Long, joined today by Asset Charma. Asset, great to have you back on the show. Mary, thanks for having me back. I cannot believe that it is August 1st today. Do you want to explain to me how we got here, how that happened, how the years flown by so quickly? Well, in common parlance, Mary, we blinked, and here we are. That's all I can say.

I am searching my consciousness to see what happened in the last seven. months and I'm getting nada. Anything you're looking to do before the end of the year that you want Motleyful Money listeners to hold you accountable for? It's TMI, but Floss Knightley. I have a dentist appointment later today and I know we're going to come to a conclusion here. I'm pretty good about it, but you know, that last 5%,

after seven months, that last 5% is what gets me. How about yourself? Oh, I wasn't even, I should have known that you've heard this question back on. To me, dard it, dart it. You might know that I'm on an improv team. I do know. We've got some show. I'm new to the team, so I've got some shows coming up.

So I guess I'll be there to do that. Well, yours is a lot more exciting than mine. Speaking of exciting, I'm going to talk about earnings today, especially from AMD and META. AMD, to be fair, reported after the bell on Tuesday. But wanted to hit that with you because I know that you are an AMD fan. Results from that company were super strong and sent a bunch of semiconductor stocks up along with it. So I wanted to touch on that. Before we get to those results, again, you've been an AMD fanboy for a while now.

So let's rewind maybe to last week before these results come out. Why do you love AMD? Well, I guess we should say a couple of things up front here. I also love Nvidia. I'm putting this forward in case someone is already starting to type an angry email. I am a big fan of that company. And other disclaimers, we shouldn't really fall in love with companies. Mary and I are saying this sort of jokingly.

But you can be a fan of a company as long as you retain your objectivity. If something changes in the thesis or with the people running it, the strategy, you can fall a little bit out of love. And why I like AMD is Mary, it went through this sort of amazing trajectory where it was a leader in chip fabrication. It had partnership with Intel. It competed with Intel and then didn't compete so well with Intel and nearly went out of business. Dr. Lisa Sue took over as CEO in 2014, and they have been on an upward path since then by focusing on innovation. Even if it takes longer, let's make the best products we can. And they were caught a little flat-footed at the beginning of this explosion and interest in generative AI and all this capital spending that we'll talk about today.

but they're pretty quickly catching up in terms of having a competing product. I'm not talking about market share because we know that in the GPU market, NVIDA reigns supreme. But AMD just needs a little slice of that. And they're one of the few companies around that has the technical expertise, that innovation, edge, the ambition, the capital to really compete and take a few pieces of market share from NVIDIA. That's a lot harder than it looks.

So some highlights from this most recent quarter, overall revenue up about 9% year over year to $5.8 billion. But if you break that down into different segments, you get lots of different stories. So the big winner here was the data center segment, revenue for that up 115% year over year. Not so much winners were the gaming and embedded segments, which were down 59% and 41% respectively. So before we kind of get into what's going on in each of these stories, Osset, for listeners who are unfamiliar with the details, of the chip industry, can you help us understand what these different segments mean? And what? So, Data Center versus Gaming versus Client, Embedded is another one. What do those mean? What kinds of chips fall into those? Why do we have to have different

chips for these processes at all? Mary, are you ready for a string of acronyms? Always. I'll try to break it down a little bit. Okay. So data centers, as we all know, have become this really important part of artificial intelligence, inference and training. And also, it's the traditional place where stuff gets computed. When you and I reach into the cloud via our keyboards, we're usually hitting a data center of some sort.

So think about central processing units, CPUs, the kinds of chips that are already in computers, but now exist in servers in a data center, GPUs we've all learned about if we haven't in the last few years. And then a bunch of other specialized chips like FPGA's field programmable gate or Rades, AI accelerators, which are combinations typically of GPUs, adaptive system on chips. So what I'm painting a picture here of is a bunch of specialized chips that work together on servers to make the magic happen when we talk to chat GPT. Then, AMD has what they call the client segment, and this is something that's easier to grasp.

So this is mostly the CPUs chip sets that we see in desktop computers, laptops, handheld devices. Then they have the gaming segment, and that's pretty easy to understand as well. When you're using a console gaming device, you may have some component inside that's made by AMD. So these are discrete GPUs. They are also semi-custom system on chip products, basically designed for companies like Sony and Microsoft to sit inside those devices. And then finally, we have the embedded segment, which sounds sinister to me, but we're not

talking about embedding in anything. but other devices. These can be industrial devices. They can also be specialized servers in data centers. This is a segment that AMD recently started competing in through its acquisition of a company called Silenks. So just think of specialized chips that could be in any type of device, but often in industrial type machines.

So it's that data center segment that was really the winner this most recent quarter. and that's in large part because that's kind of where AMD gets to compete with NVIDIA the most. So AMD's data center segment directly competes with NVIDIA's AI market. Still, and you mentioned this, that it's a big game to catch up to NVIDIA. Nvidia's AI arm does $22.6 billion a quarter. AMD just made waves for making $2.8 billion a quarter. So there's a lot of catch-up to happen there. But so much of this language around AI is kind of centered around,

an arms race. So you're a literary guy. Are we watching a chip version of the tortoise and the hair kind of take place here? Not really. I think to me this is more sort of slow motion running. So if you think about two competitors who are in a foot race, and one is a lot near at the tape, just about to finish. And the other is a bit behind, but catching up, obviously not going to win. But maybe passing like the third place finisher. That's more what this race is like. I don't think anyone expects, and I don't expect that AMD is going to overtake NVIDIA.

But the numbers are fairly interesting. Now, remember, Nvidia is a native GPU company. I mean, they basically took this fledgling technology and made it mainstream and then enhanced it. Every time we have some crazy innovation in tech, GPUs are front and center. This competitive GPU offering from AMD really isn't their core business. They have built their accelerators using a little bit of a different technology than Nvidia.

They function really well in the space called chiplet architecture, so they stitch different chips together. Their approach is interesting. They don't have as robust of software as Nvidia has. Invidia developed this amazing software called Kuda, which makes their chips better, their GPU is better. But, look, AMD has thrown open their software to the open source community. It's getting better and better. And we see companies like Microsoft.

We see companies that support META's large language model, which is Lama, starting to turn to AMD as a lower cost option. They've gone from $0 in this GPU accelerator market to about $4.5 billion on an annualized run rate in less than a year. So that's pretty fast. And if we're talking about shaving maybe five to 10 points of market share out of the next five years from Nvidia, this is where AMD starts to look really interesting to me. I don't want to ignore those pretty steep declines in the gaming and embedded segments that we mentioned earlier. What's behind the downturns there? Sure.

So gaming itself is a bit of a mature industry. The whole console gaming industry has undergone a lot of consolidation. As of late, sales are slowing a bit. So that naturally, especially in the post-COVID world, is slowed down some. Also, the embedded segment tends to go in tandem with the larger economy. So where we've got a more skeptical outlook on purchasing for manufacturers, other companies that use these embedded chips, that hurts a little bit when AMD is trying to scale it up. So it's a little cyclical.

Now, this segment had just a tiny bit of a sequential gain, so one quarter after the next versus quarter over quarter, year over year. So maybe that is troughing out. But there's something else going on here, Mary. AMD is actually not investing as much in these spaces as it was before generative AI exploded. They have trained their innovation cannons on the GPU market, the accelerator market. And that's part of why these two segments are sort of falling off. And there's a similar story going on, actually, over at NVIDIA. If you have this technology, you're not going to waste too much of time and resources trying to make these slower growth segments front and center. You're going to focus on where that gravy is. AmD's trading at a forward PE ratio of about

42, just a hair below NVIDIA. What would you say to somebody who's looking at this stock right now and thinking, gosh darn it, I missed out on NVIDIA, but I won't miss out on this one? You know, it seems like the answer would be an easy like, you know, hop on, hop on the bandwagon, but it never is in this industry. This whole industry is cyclical. It's hard to remember this, but Nvidia itself is cyclical. It's going to come a time when that demand supply equation hits equilibrium and Nvidia may sell off some. I personally think it's worth holding this company 10 years because there will be other waves that we don't yet foresee.

But the same is true with AMD. the best strategy for highly specialized semiconductor companies, whether you're talking about AMD and Nvidia or a company like Synopsis, which makes software to design chips, or ASML, which makes the machines to build chips. I think dollar cost averaging is a tremendous way to approach this, because those PE ratios are going to move around. They're going to be overvalued. Mary, they're going to show extreme undervalue to the longer term investor. and that these trends can happen in a matter of weeks sometimes. So just keep buying steadily if you like this company or others in the semiconductor industry.

That's the best approach, in my opinion. So revenues from these chipmakers come from AI-Hungry tech companies. Meta is one of those AI-Hungry tech companies. They reported earnings yesterday after the Bell. A few highlights from that report. Overall revenue up 22% to about $39 billion advertising revenue, a huge chunk of that, basically all of that. Family, daily active people, which is their term for daily active users, came out to about nearly 3.3 billion, which is up 7% year over year. Seems impressive that that

can keep growing. Capital expenditures spend up 33% largely to support these AI ambitions that we've mentioned for the quarter. Meta spent around $8.5 billion, but they intend to spend up to $40 billion for the full year. What sticks out to you, Asset? Anything else that I missed? I mean, you hit on so many nice points here, Mary. And the first thing that stands out to me is this family, daily, active people, nomenclature. It always reminds me of shiny, happy people. Why can't they just say DA you like everyone else? More seriously, the advertising revenue, you said that's a huge chunk of their top line.

And it is. But it also shows how different their model is than almost any other company their size that they compete with. And that's what sticks out to me is once again, they're able to grow that pie by double digits, and it's extremely profitable. Their margins are almost the same. Their operating margins are almost the same as Microsoft's, just a little bit below. But Microsoft has to do so many things to make that margin from software sales to the cloud, to their gaming segment.

Here we have meta, which just offers this family of apps, and they make so much profit. just from advertising. So it's a good business. And I think this may have something to do with an answer to a question that you posed to me before we started taping. Yeah. And that question was just like the story of the past few weeks, as tech earnings have been rolling in, has been about AI spend. And the market reaction to a lot of AI spend from Alphabet from Microsoft has been to send their stocks lower. Well, Meta kind of had the opposite response. And they're spending a ton of money on capital expenditures that are related to AI as well. So my question, for you basically was, why does Medi get the special treatment? I think investors, number one,

are used to seeing Mark Zuckerberg take some high-end matches and just walk from pile to pile of money and just set it a light. I mean, we've watched this company. Cough Cough, reality labs? Totally. We've seen this company burn so much cash on reality labs and the metaverse. But, you know, what's the net result? I'm looking at the cash flow statement for this quarter, $19 billion in operating cash flow. And with all that spend on AI and the infrastructure behind it for META, only $8.2 billion in spend on that. That left a lot of money to repurchase shares, to pay a nice dividend to investors.

This business is just highly cash generative. And investors, I think, are starting to say, look, at some point, that is going to get some yield out of all the money they've thrown. at the Metaverse and now AI. And you can already see it in some of the uptake on their expressions of large language models. So there's a way that you can look at this investment as being slightly different than a Microsoft, which is they have to grow their market share in the cloud. Aser has to compete with Amazon Web Services.

They need to get a yield on all of that that they're spending. I mean, Zuck hasn't had any kind of yield on tens of billions of dollars, and they're still making money. So I think that's the difference in the reactions this week. I want to get your take on this because I've heard Zuck say this a few times recently, that meta-AI is on track to be the most used AI assistant in the world by the end of the year. But again, I've heard that a couple times. And my first reaction is always, that can't be right. But tell me, please, am I living under a chat GPT-sized rock? I mean, I'm sort of under that rock with you, Mary, but I will give you the argument why he

probably is correct. So there are two things going on here. One is Meta has its own AI assistant that it's now putting at the top of its family of apps. If you happen to use WhatsApp, which I do because I've got family all over the world, you'll notice a little box at the top, meta AI. Basically that's an AI chat bot that runs on Meta's Lama large language model. So there are tens, nay, hundreds of millions of people who are using that. They called out India in the conference call for this quarter's earnings as people really rapidly adopting that chatbot assistant because Indians are big users of WhatsApp. The other thing which isn't as visible is Lama and Lama 3.1 now, I guess, is going to be the latest version. All the Lama models are open source.

So basically, you're probably using meta's chatbots in many different places and don't realize it because developers have taken that open source model. They've built their own chatbot, offered you up, a portal to AI, but you don't see the branding on it. So I think probably if we look more deeply into this, we could see that Zuckerberg may be correct in saying this. They're pretty competitive in this space. They may not have all the branding yet, but some of that infrastructure investment is paying off in their development of the open source model Wama and all the expressions that they're starting to derive from it. Awesome, always a pleasure talking to you. Thanks so much for hanging out with me on this lovely Thursday morning. I appreciate it. Mary, see you soon.

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to check their blood sugar without pricking their finger. But for investors right now, it is a story because the stock is down 40-ish percent after its latest earnings call before we get to what happened in this latest earnings call. What is slash was the bull thesis for Dexcom? So the bull thesis is that Dexcom has been a pioneer in these continuous glucose monitors. They're certainly not the only player, but they were early to the market. They're dedicated to the market. And it's really about, you know, making a product that, patients really love that have had some advantages, and we can talk about that more, whether that still pertains, but has had some advantages over competitive products, and mostly

just about the size of the market. So, you know, you can argue that almost everybody with type 1 diabetes should be using one of these products, but nowhere near that number are. So there's a huge penetration story there. You can argue that a large number of people with type 2 but diabetes should be using these products. And some do. There is a market there, but penetration there is even lower. And that's, you know, a massive opportunity. So, you know, this is a company that has executed really, really well for most of the time that we've been following it, you know, has really given us a lot of faith in this company and the management team and has, you know, managed to do really well in sort of opening up a nascent market.

The growth story changed this quarter, and it has to do a lot with the revenue guidance, which last quarter for Dexcom was rosy. They were expecting a growth rate of about 20% for their top line revenue. This quarter, they said that's going to be cut about in half to about 11 to 13%. CEO Kevin Sayre, getting ahead of it, naming three headwinds for the analysts. One was that the company realigned its sales team and they weren't performing as well as they expected. Number two was greater rebate eligibility for their device, which I have questions about. And then number three was that they had less sales to healthcare institutions, which is their durable medical equipment channel.

What are these problems? It seems odd to just say, hey, we shifted our sales team and now we're cutting our sales guidance in half. Yeah, yeah. So there's kind of a lot to unpack there. I think, first of all, the biggest problem is that it was such a shot, like just such a reversal, right? This is a company that raised the bottom end of its guidance in Q1 before turning around and doing this in Q2. This is a company that was raising its long-term sort of 20-25 outlook significantly in the middle of last year. And again, now this is happening. It's just such a

sudden shift that you really have to wonder what's going on. So, yeah, they put it down to these three factors. The rebates one is, I think, the easiest to deal with and kind of the least concerning one to me, which is basically that when you get new patients going to the G7 device instead of the older G6 device, they get a rebate. The company is actually quite sensitive to that on a revenue level. So more rebates means less revenue for them. They had expected it to be sort of a 2x over what they had seen with the G6. It's more like a 3x. And there's maybe even a double whammy effect there that we can talk about just because a lot of This is happening through the pharmacy channel.

But I don't think that's, they put that down. So if you call what they did to their Revenue Guidance, you call it about $300 million reduction in revenue guidance for 2024. About 75 million of that, they said, was the rebates. And they expect that to abate in Q3 or Q4. That's kind of the least concerning one, because it does involve, you know, people getting onto the product. The second one was the Salesforce realignment.

And, you know, I mean, that was the one that I think. think analysts were really skeptical about on the call. I don't know what they did there that would be so difficult, but I think it sort of relates into another factor that you mentioned, which is the sales channel. So if you are a user of these products, you probably get your product one of two ways. You either get it through a durable medical equipment supplier, which is some sort of specialty supplier of diabetes products, and they probably say, it straight to your house, or you get it through a pharmacy. What they're saying is, basically, it's usually cheaper for patients to get stuff through the

pharmacy channel because there are, you know, kind of lower deductibles associated with that, usually. So they're saying basically, they're doing pretty well in the pharmacy channel, but they're really suffering in this DME channel. And as patients move to the pharmacy channel, they're kind of seeing some, again, I guess, some margin impact from that. The part that's confusing about it is they just kind of said, oh, we've seen some breakdown in our relationships with the DME channel.

We need to really refocus. The quote was, we need to refocus on those relationships. I don't know what that means. Exactly what they mean by that. Like, how did that go so sour so quickly? And this is what I suspect is the real problem, because they mentioned the third factor they mentioned it was just sort of of like, oh, the patient missed.

Like, we just didn't start as many patients as we hope to. The thing that worries me, and to me, the biggest factor in all of this is how much competitive factors are playing into this? I mean, how much are they finding that sales are hurting through the DME channels because other people are just taking up the slack? And that's something, you know, we can get into a little bit more because that's the thing that I think is going to have the longest impact on the company. Let's get into it because I think some of these are,

Some of those are dark clouds that can be seen through. But, you know, if you're buying stock in Dexcom, it's really a bet on their device, which is the G7. And, you know, are there real competitors to this products now that are hurting this company's growth story? Yeah. Yeah, there are. I mean, so, you know, there's kind of three big players.

There's some others, but there are three big players. And the other two are very large companies. So it's Medtronic and Abbott. They're in very different positions. The real sort of main competitor to Dexcom is Abbott, which has a product line called the Freestyle Libra that is relatively similar in its specs. You could argue it's actually a little better. It's also often a little cheaper for patients.

And probably part of that is because Abbott can afford to price it a little bit less because of their size. And then Medtronic is obviously a huge player. And there's kind of two factors going on here. One is that more and more, what you want to do with these continuous glucose monitors is you want to pair them with an insulin pump. So you don't want to just get the information that the CGM provides. You want to use it in order to inform as automatically as possible with as little input from

the user as possible how to supply insulin. And up until the beginning of this year, the Abbott's product, didn't really integrate with the most popular insulin pumps. Now it does integrate with a very popular one from tandem. It's, I think, on track to pretty bring integration with the Omnipod from Insulate pretty soon. So my question is, how much of this is about people suddenly seeing, like, well, now I can finally use this Abbott product, the freestyle Libra the way I want to, and it's gaining market share that way. Medtronic has almost the opposite thing. Medtronic had a major product manufacturing problems in some of their diabetes lines back at the end of 2021, have seen sales tanked.

And I don't want to say that there's nowhere for them to go but up. But, I mean, in a way, it's like they've invested massively in this. They are really trying to improve this. So, you know, they might be making some inroads there, particularly internationally, actually, where they have done particularly well and where Dexcon was particularly weak in this past quarter. On X, there's a user on there at Marcelo Lima pointed out that Dexcom historically traded in an earnings multiple anywhere from the 60s to the 240s. This was a growthy growth stock. Now it's at about 40. That's the lowest that I've seen when I looked at the company on Y charts. The stock has pretty much given up all of its gains from the pandemic. We've talked about the risks. We've talked about the competitors. But now for this company, Dexcom, is it worth putting on investors radar? I mean, I think it's definitely.

worth putting on a watch list because, you know, yeah, we've talked about a bunch of negatives. I would say, you know, the larger story that they have a product with sort of leading mind share among users that has really good specs. And still, you know, there's no question that the market's growing. I mean, that's, you know, one of the disturbing things, I guess, was that Abbott just had a really great quarter for their freestyle line. So the market's still growing. So in that sense, you know, they can sort of get control of all this. I still think they have a great opportunity. The question is, do they deserve to be priced at that kind of multiple that you were talking about? I don't think so unless we can see that that kind of growth is returning again. And then as we close out,

any other medical device companies catching your attention, maybe a stock or even a technology that you're finding interesting right now? Boy, you know, lots of, I mean, intuitive surgical sticks out just as they're sort of the Dexcom. If Dexcom didn't really have competitors and had never made a misstep, that's kind of where Intuitive Surgical is at right now, including the extremely high price. I mean, Intuitive Surgical is price for perfection. It's just that they seem to continually deliver perfection. And then almost on the opposite end of the spectrum, I still continue to be interested in Novacure, which is a company that is absolutely beaten to heck right now, but continues to put out interesting data, has a lot of interesting opportunities coming up in the relatively

near future, and is not priced terribly high. Appreciate you putting some companies for us to check out. Carl Thiel, thank you for your time and your insight. Appreciate you being here. Yeah, thank you. As always, people on the program may have interests in the stocks they talk about. And The Motley Fool may have formal recommendations for or against, so don't buy ourselves stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you

tomorrow.