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It has been the case, over the last decade or so, that as goes Megacap technology companies so goes the market.
This is because these behemoths started to take up more and more of a percentage of overall indices as capital crowded around these companies.
Investors have held technology companies up on a pedestal due to high-quality earnings, high scalability, and a general better understanding of the business models vs. the dot-com era.
Until now…
Technology has been absolutely crushed, especially on the high beta software side as capital rotates into real assets and shifts towards value over growth as a hiding place. This is due to the introduction of a new rate-hiking cycle, fears of a recession, bubble-like valuation/speculation, and concerns over growth rates.
We know the sentiment side has been crushed, but what about the other component -the fundamentals? What about earnings? We now have our answers.
This week, we had a lightning-round of tech earnings as all 5 megacaps entered the earnings crucible with Google and Microsoft reporting on Tuesday, Facebook on Wednesday, and Apple and Amazon on Friday.
All this under the weight of a Fed meeting as well as economic indicators including (but not limited to) GDP, household income, spending, PCE inflation, durable goods orders, and new home sales.
For the purpose of this newsletter, I will only be diving into the tech earnings.
Paid subscribers will get access to the full macro analysis including Fed action, bear markets, earnings, economic indicators, and a roadmap on where to go from here.
This week, in <5 minutes, we’ll cover megacap tech earnings:
GOOGL Google 👉 Ad Spend Mixed with Cloud Growth
MSFT Microsoft 👉 Enterprise Software Boosted by Cloud
META Facebook 👉 Checking the Pulse of Social Network Spend
AAPL Apple 👉 Checking in on the Hardware Business
AMZN Amazon 👉 Supply Chain, Input Costs, Labour Market, Consumer Spend, AWS Bonus
Let’s get started!
1. Google 👉 Ad Spend Mixed with Cloud Growth
Into the Print
Google is seen as much more recession-resilient given its lower-funnel marketing exposure with very little Apple privacy change impact exposure. The company’s Cloud segment is also seen as more resilient with a SaaS-like model and much better cost efficiencies.
Quarter Summary
Google parent Alphabet Inc. reported second-quarter revenue that met analysts’ expectations, reflecting the Internet giant’s resilience amid slowing growth in advertising.
By the Numbers
Total revenue of $69.7B, in line with street estimates of $69.8B
Services revenue of $62.6B vs. estimates of $64.0B
Cloud revenue of $6.3B vs. estimates of $6.5B
Others Bets revenue of $193M vs. estimates of $324M
Adj. EBITDA of $28.1B vs estimates of $28.7B
Macro Readthroughs
This one looks like a textbook “better than feared” where everyone was worried about a drastic slowdown in ad spend on Google’s search business. Instead, Google proved to be more resilient than anticipated in a downturn. Although cloud was a little softer than expected, still solid numbers from a growing base.
Google doesn’t give formal guidance and its qualitative outlook commentary was very thin, but because of its scale and track record, Google will benefit from a flight-to-quality among marketers that no other platform except for maybe META can match.
Google has more diversification among its advertising revenue verticals than any other company in the world.
They are also fully exposed to that part of advertising spend—direct response ads—that are likely to be the last to be cut during a recession as they are directly tied to sales.
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2. Microsoft 👉 Enterprise Software Boosted by Cloud
Into the Print
All eyes were on Azure, and more specifically, the guide. There were rumblings of cracks in the cloud so everyone was looking for a potential slowdown in growth rate as an indicator. Hardware business was expected to be slower due to China headwinds and lower PC demand. FX was also a known headwind.
Quarter Summary
Very noisy quarter with a lot of moving parts while adjusting for FX. The $300mn headwind from the extended production shutdown in China and ad headwinds on LinkedIn & Search ($100mn) were the biggest issues in the quarter on a fundamental basis – Azure (cloud) coming in at 46% in c/c vs. expectations closer to 47% was seen as “close enough” given the concerns about consumption trends
And when looking at the growth in the commercial segments of the business, it is very clear that Microsoft is still executing at a high level in the enterprise category.
Not a typical Microsoft “beat and raise” but about as good as can be expected when adjusting for F/X and accounting for the MPC headwinds, which were known by the street going in.
By the Numbers
Total revenue was $51.87bn (+16% in c/c), below estimates of $52.38bn (+13.5% y/y).
Productivity and Business Process = $16.60bn, (up 17% in c/c), vs. consensus forecast $16.64bn.
Intelligent Cloud revenue up 25% in c/c to $20.91bn, below consensus of $21.09bn.
Operating income grew 14% y/y in c/c, while
Op margins came in at 40% for the quarter vs. consensus margins of 40.2%.
Non-GAAP EPS came in at $2.23, up 8% y/y in c/c, vs. consensus of $2.29.
Free cash flow came in at $17.8bn (+9% y/y), below consensus of $18.68bn.
Macro Readthroughs
A little bit too much noise around the quarter, although it was good to see a lot of the cloud growth persistent in a segment that was up in the air.
All in - I would be a buyer of this one on weakness as the company continues to execute and be a staple in the trend towards digitalization.
Modest Proposal sums this one up beautifully:
Before we continue, let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel!
3. Facebook 👉 Checking the Pulse of Social Network Spend
Into the Print
Meta is facing headwinds on multiple fronts. Overall pullback on ad spend on social platforms is the primary headwind, along with attribution problems post-IDFA. A key catalyst for Meta remains evidence of the company’s ability to successfully develop and deploy an effective post-privacy ad attribution model.
Quarter Summary
Meta ran into the difficulties of macro headwinds, Apple privacy change, FX headwinds, tough comps, and the ongoing reopening driving a reversion to Offline, creating some headwinds to the eComm vertical.
All in - weak as expected, but starting to look even MORE like a value stock.
By the Numbers
Q2 Revenue of $28.8B (vs. $28-30B guide) was just a touch below the Street, declining -1% Y/Y, or +3% ex-FX
Op Income came in ahead of the Street by 1%, with 29.0% Op Margin contracting 14pts Y/Y; and
EPS of $2.46 was 3% below the Street.
A clear negative - Q3 Revenue guide of $26-28.5B came in 7% below the Street at the high end (or 11% at the mid-pt), including 6-pts of FX headwind, implying flat Y/Y ex-FX, a deceleration on substantially easier comps.
Macro Readthroughs
I think META will work through the Macro challenges as well as any other major ad platform (except Google), and its massive reach and frequency will allow it to continue to improve its value proposition to advertisers in a post-IDFA world once the kinks are worked out.
The Metaverse proposition is a massive gamble, but Meta can afford to take the gamble for now, and I wouldn’t bet against Zuck.
4. Apple 👉 Checking in on the Hardware Business
Into the Print
Apple is also an interesting one when looking at consumer spending habits and supply chain problems. While a weakening consumer affects lower income levels, Apple is generally targeted at the wealthier individual in the premium bracket of spend.
The third quarter is generally its weakest of the year, as it is in the back half of the iPhone’s annual refresh cycle which typically doesn’t boost revenue until September or October, so pretty easy comps to beat.
The FX impact will also be interesting because Apple has significant exposure to China both in terms of where it sells units and where most of the products are assembled.
Remember that China was much harsher on its zero-Covid policy and has had rolling lockdowns recently.
In April, the story for Apple wasn’t about demand, it was about supply. “Right now, our main focus, frankly speaking, is on the supply side,” Apple CEO Tim Cook told analysts.
However, recent channel checks in China’s smartphone market before the print saw YoY growth in June for the first time in 2022 and Apple’s shipments reported 225% YoY growth.
Going into the print - investors were also wary of the guide.
Quarter Summary
Apple reported an in-line June-qtr print but well ahead of street fears given worries around consumer demand being impacted by macro worries.
By the Numbers
Revenue of $83.0B was in line with street estimates of $83.0B
EPS beat at $1.20 vs. street at $1.16
Gross margins came in at 43.3%, above consensus of 42.8%.
Product margins were down ~150bps y/y to 34.5% (cons. 34.4%).
Services margins were up 180bps to 71.5% (cons. 69.5%).
Macro Readthroughs
Apple revenue appeared more driven by supply constraints than it was macro worries, though they did note pockets of softness due to macro (digital advertising, wearables, etc).
With an expanding install base, revenue acceleration, and gross margins above 42%, the long-term secular growth story at Apple remains intact for now.
5. Amazon 👉 Supply Chain, Input Costs, Labour Market, Consumer Spend, AWS Bonus
Into the Print
From Amazon - this is an interesting one because they get the tricky macro picture from both ends. If the consumer does ultimately weaken, obviously the product marketplace will see lower volumes, but Amazon became the default over COVID instead of putting something on a grocery list, you just load up the app and hit buy now, so their product categories in terms of lower spend on the household budget will prove to be more resilient.
They're also right in the middle of the whole supply chain mess across the world, with rising input costs, and too much inventory, so they are pairing back on the aggressive warehouse expansion which they were all-in on before.
All this is backstopped by AWS, the biggest cloud provider which is still growing at a massive pace from a massive base.
Quarter Summary
AMZN posted Beat & In-Line Q2 EPS results, with Q2 Revenue and Operating Income both ahead of Street estimates. Q3 Revenue Guide bracketed expectations, and Op Income Guide was below, but Recession fears had market expectations much lower.
By the Numbers
Revenue in Q2 was 2% above the Street at $119B, up 10% Y/Y ex-FX (vs. 9% in Q1) and up 24% on a 3-yr CAGR basis vs. 25% in Q1.
Q2 Op Income of $3.32B was $1.5B (84%) above the Street, with ~410 bps of Y/Y Op Margin contraction (vs. ~500bps in Q1), as the company experienced ~$4B of incremental cost pressures Y/Y in Q2 (vs. $6B in Q1) – higher fuel, trucking and shipping rates.
The Q3 revenue guide of $125-$130B or 13% to 17% Y/Y (incl. a ~390bps FX headwind), raises the Street modestly, which was at $126.5B
AWS Revenue growth decelerated 4-pts, from 37% Y/Y in Q1 to 33% in Q2 (ex-FX). This compared to Google Cloud’s Q2 Revenue growth of 36% Y/Y and Microsoft’s Azure at 46% Y/Y Revenue growth.
Macro Readthroughs
A Better than Feared Q2: With management citing in-stock inventory and delivery speed improvements along with no macroeconomic demand weakness plus increased Prime member spend, it appears demand was rather healthy through the quarter.
Demand for cloud migrations remains as strong as ever, as partners believe that we could go from 20% of workloads on the cloud today to 40-50% in the next 3-5 years and 80% in the next 10 years.
Wrapping Up…
Evangelists will basket-in Tech stocks as “otherworldy” with massive scalability as some magical solution to all the world’s problems.
Luddites and value investors will yell at new investors over multiples and bubbles.
The truth is somewhere in between. Although they have incredibly scalable solutions (high growth) that are usually high margin. I think both the revenue and the margin will be challenged in a very real way.
These companies are incredibly tied to the real economy. Real people buying things all while getting fed ads. As consumers’ confidence erodes, so does spending power.
On the B2B segments, they are also feeling the squeeze and may not look to renew an expensive contract as sales cycles are extended.
Everyone is getting hurt and tech is not bulletproof. I would give tech a 7/10 on the scoreboard and we’ll see where we go from here.
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
P.S. Have you checked out our new CARBON newsletter? Read the first issue and subscribe here!
What else we Grittin’ On?
TWITTER. $TWTR shareholders will get a say on the Musk acquisition in September. All we want is an edit button.
EV GAP. Buffet-backed Chinese EV maker BYD is closing the gap on Tesla. The company's Shenzhen-listed shares are up ~30% over the last 6 months.
CHIP BOOST. The Senate advanced a bill that would provide funding and subsidies to the US semiconductor industry. Over $50B will go to boosting competition against China.
NORD STREAM. Gazprom announced it was reducing gas flow to Europe from the key pipeline to 20% of capacity. European natural gas prices are already at record highs.
ACTIVISM. Elliot Management reportedly has a stake in PayPal. The size of the stake and Elliot's intentions remain a mystery.
Sources:
Evercore Research Team Notes - Mark Mahaney in Internet group and Amit Daryanani in the Hardware group
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