$NVIDIA (NVDA.US)$The conservative guidance for the gross margin for the remaining two quarters of this year and 2025 has dragged down the stock price. After the release of the financial report, it quickly plunged, falling below 8% at one point. However, Morgan Stanley believes this is not a problem.

Morgan Stanley believes that these are some strategies adopted by Nvidia to better develop. Although the production issues of rev 0 Blackwell have affected the gross margin guidance, and there are many unknown factors in the chip market next year, the pressure on Nvidia's gross margin is moderate, and the bear market expectations have been exaggerated.

On Monday, September 9th, Joseph Moore, a Morgan Stanley strategy analyst, and his team released a report stating that Nvidia's lower gross margin has always been seen as dragging down its stock price, but we believe this is a strategy that will enable Nvidia to gain more market share in the AI processor market next year.

Morgan Stanley believes that Nvidia's future gross margin may slightly decline, but the concerns have been exaggerated. Nvidia's gross margin has several potential influencing factors, the most important of which is Nvidia's decision to adopt a more proactive product positioning, including accelerating product release schedules and making Blackwell's pricing more cost-effective. In March of this year, after the Nvidia GTC conference, Morgan Stanley wrote:

"Will Blackwell's gross margin be lower than Hopper's? Yes, we do expect the gross margin to decline, and we have noticed that Nvidia has similar expectations."

"We believe that optimizing the gross margin to over 70% could increase Nvidia's competitiveness. Nvidia is very focused on maintaining its market leading position and not allowing other competitors to gain a foothold in the market."

Trading gross margin for market share.

Morgan Stanley believes that Nvidia is expanding market share at a low gross margin by putting pressure on competitors and accelerating product release speed to gain more market share.

First, Nvidia proactively lowers its gross margin to seek a larger market share.

Reports from Nvidia's competitors mention that Nvidia has lost its chip pricing power, but Morgan Stanley believes the opposite is true: Nvidia is working hard to improve the value of its own products and services and limiting the expansion of its competitors' businesses. By reducing the gross margin from 76% to 74.5%, Nvidia has exerted significant pressure on its competitors.

Morgan Stanley believes that Nvidia's market share of AI processors this year will exceed 85% (including only Nvidia and AMD's GPUs, as well as custom ASICs used for AI processing and excluding CPUs), and this proportion will continue to rise slightly next year as some ASIC-focused customers return to GPUs.

Second, Nvidia has accelerated its product release pace. This action incurs certain costs but benefits Nvidia's long-term market share.

Morgan Stanley points out that Nvidia has shifted to a faster product release pace. Nvidia's goal is to launch new products every year, although in reality it may be more than once a year. This means that a significant portion of Nvidia's revenue will come from new products, unlike the time of the Hopper period.

This action incurs certain costs, but the rapid pace of AI ecosystem updates is a critical advantage for chip companies. It not only enhances market competitiveness but also continues to drive technological progress.

In addition to the two long-term factors actively chosen by Nvidia, Morgan Stanley states that there are also two short-term strategic factors putting pressure on Nvidia's gross margin.

First, there is a certain delay in the update from rev 0 Blackwell to rev 1 Blackwell for Nvidia. This is due to the low production of rev 0 Blackwell, and Morgan Stanley believes that many of the rev 0 Blackwell produced have been scrapped. For detailed analysis, see the following text.

Second, the new products of GB200 include microprocessors and NV Link switches, which have relatively high gross margins but may still be lower than the company's average level.

Excessive use of inventory reserves in the first half of the year has dragged down next year's gross margin.

The factors that affect Nvidia's gross margin have been mentioned in the previous text, and these factors should have been understood by the market. Why does it still weigh on the stock price? Morgan Stanley believes that the important reason is the excessive use of inventory reserves by Nvidia in the first half of the year.

Compared with the previous quarters, Nvidia's actual gross margin in Q2 of this year is disappointing. However, there is an important hint in Nvidia's 10Q report:

"For the second quarter and first half of fiscal year 2025, reserves for inventory and excess inventory purchase obligations were $0.908 billion and $1.3 billion, respectively, primarily due to low yields of Blackwell materials. Previously reserved inventory sales and settlement of excess inventory purchase obligations released reserves of $85 million and $199 million in the second quarter and first half of fiscal year 2025, respectively, resulting in an adverse impact on gross margin of 2.7% and 2.0% for the second quarter and first half of fiscal year 2025."

Every quarter, Nvidia sets aside inventory reserves, but this expense was significantly higher than normal levels in Q2 of this year due to production issues with rev 0 Blackwell. Morgan Stanley believes that without these expenses, Nvidia's gross margin would have been over 100 basis points higher than expected.

Looking ahead, Nvidia's gross margin guidance for the third quarter is 74.5%-75.5%, the full-year gross margin guidance for this year is mid 70%, and the gross margin guidance for 2025 is below 74%. Assuming no upside, Nvidia's gross margin for 2025 will be similar to the fourth quarter of this year, below 74%.

According to Morgan Stanley, Nvidia does not have a clear gross margin headwind in 2025, but there are many unknown factors, including a large number of new products (Grace CPU, NV Link switches, SpectrumX Ethernet), and early production issues with product releases.

Overall, Morgan Stanley believes that Nvidia's gross margin will face moderate pressure next year, but the bearish expectations have been exaggerated, and Nvidia's actions are all for market share growth.

Morgan Stanley believes that the current gross margin forecast for Nvidia shows a decrease, but they are conservative, and in fact, there may be an upward trend. However, the high gross margin situation brought by the mature Hopper product line a few years ago will not occur.

The market often says, 'even a slight decrease in the gross margin of growth-oriented semiconductor stocks is not good.' But this is a complex situation, and Nvidia has unique growth opportunities. Morgan Stanley does not want to miss this opportunity because of rules that apply to more cyclical stocks.

Editor/ping