In this Weekly Insights we focus on cloud spending, semi-conductor earnings and the macro backdrop.
The fall of the tech giants and thoughts on earnings
- Are cloud investments over? Earnings from Amazon (AMZN), Microsoft (MSFT), and Google (GOOG)
- Semiconductor earnings collapse; are we there yet?
THE FALL OF THE TECH GIANTS
The stock prices of Amazon, Microsoft, and Google were holding up relatively better through this tech downturn. But disappointing earnings have now sent their shares down ~40%ytd. The main driver was disappointing cloud growth for Amazon and Microsoft, and lower advertising spend for Google. In this report we dive deeper into the cloud dynamics.
Are cloud investments over?
Cloud spending is one area where we expect strong secular growth for years to come. But there are several aspects of the hyperscalers’ business model that is not well understood by investors.
- When companies move their operations to the cloud they are essentially shifting risk from their balance sheet to the cloud vendors (i.e. moving their cost structure from fixed to variable). This means that during downturns, they can optimize their spending (i.e. cut their spending in areas that are not critical).
- The hyperscalers (AWS/Amazon, Azure/Microsoft, GCP/Google) take the risk during downturns (e.g. excess capacity, higher energy costs), and generally work closely with clients to help them reduce costs, which in turn results in lower revenues for the cloud vendors, but more workloads over time in a relatively consolidated market.
All three cloud vendors noted that their customers are in the process of optimizing spend, resulting in slower than expected growth. It is important to point out that growth is still coming at 25%+ but it is lower than previous quarters and expectations.
- AWS fared worst from the three reporting 28% growth and noting that growth trended down to the low-twenties towards the end of the quarter, which is now embedded in the 4Q22 guidance (potentially conservative).
- Azure reported 42% growth in C3Q22 and guided to 37% growth for next quarter, below the 39% Street expectations. This was disappointing at first, but looked better compared to the AWS result.
- GCP reported 47% growth on a significantly smaller base and with an easy comp (~9%). The company cited similar optimization efforts.
It was surprising to investors that instead of the hyperscalers focusing on their own profits (or lack thereof), they were more focused on talking about ways they can help their clients reduce costs. As an example, Amazon (AWS) cited several ways in which the company is helping clients reduce costs:
- managing workloads better
- switching to lower cost products that have different performance profiles
- switching to Graviton chips that have higher performance ratios
The reason for this is not because AWS is not a profit maximizing entity, but because over time as customers extract more value they will likely move more workloads to their cloud.
Semiconductor earnings collapse
Despite all the negative PC datapoints since May, Nvidia’s warning last quarter, AMD’s pre-announce this quarter, earnings for semis continue to surprise to the downside. But stock price reactions are starting to be mixed, implying that the bottom may be in sight.
- AMD (AMD) results came inline with the pre-announcement (revenues/EPS lower by 17% / 36% vs. the prior guide). The company guided Q4 revenues at $5.5bn (down 1% qoq), 8% below analyst estimates. The stock outperformed on this result.
- Intel (INTC) reported mediocre results; 3Q better-than-feared but 4Q guide worse-than-expected as macro headwinds intensified (potentially lasting into 2023).The company outlined significant cost reduction efforts, expecting $1b in COGS savings and $2b in opex savings in CY23 yoy, and $8-10b in longer-term annual cost savings. The stock had a positive reaction ~10%.
- Qualcomm (QCOM) just reported a strong quarter, but provided disappointing guidance for the December quarter (revenues/EPS guided 20%/32% below consensus). The company cited elevated inventory in the channel ($2bn or roughly 8-10 weeks), which according to management will take several quarters to work through.
The downside, thus far, has been centered in the consumer end-market with data center spending holding up relatively better.
While many investors are worried that data center will be the next area of downside surprise, we would note that AI adoption requires an infrastructure upgrade that we believe will drive the next wave of data center spending. Recent capex commitments from large tech companies (Meta, Oracle etc.) on expending AI infrastructure confirm this trend.
Meta/Facebook (META) announced an aggressive spending plan targeting AI and related infrastructure. The social media giant plans to invest $34 – $39 billion of capex in 2023 focused on AI. Management provided several examples of how AI is helping drive real improvements (e.g. a single AI advancement in scaling recommendations resulted in 15% watch time gain for Facebook Reels etc). The company is rolling out more AI and ML improvements in some of the new ads offerings and is encouraged by early results. While many investors are criticizing Meta for the high capex spend, we believe that AI is becoming a necessity to compete.
Oracle (ORCL) recently announced that it is teaming up with Nvidia to offer its customers the Nvidia AI stack on Oracle Cloud. This is a big win for Nvidia, as Oracle is one of the largest providers of cloud computing services. The partnership will give Nvidia’s AI platform a major boost in reach and adoption. The Nvidia AI stack includes a number of powerful tools for machine learning and artificial intelligence, such as the Nvidia DPUs and the cuDNN library. Oracle will be offering these tools to its customers through its GPU-powered cloud instances. This will give Oracle’s customers access to some of the most powerful AI hardware and software available.
Note that the last paragraph about Oracle was written by Jasper, an AI assistant who searched the web and produced original content. No typos!
THE MACRO BACKDROP
Yesterday, the Federal Reserve delivered its latest monetary policy announcement, with the central bank hiking rates by 75 basis points, in-line with expectations. The Fed chair speech on the other hand, was significantly more hawkish, resulting in a steep market sell-off.
There were two interesting datapoints to highlight:
- In the accompanying statement there was language about how the Fed will be taking into account “the cumulative tightening”, “the lags in which monetary policy affects inflation” etc, which the market interpreted as positive
- Fed’s chair speech, on the other hand, included statements like: “the ultimate level of interest rates will be higher than previously expected”, “he would rather raise rates too much than too little”, which suggested many more rate hikes ahead and resulted in a steep market sell-off.
What does this mean for industrial tech stocks?
There are two major implications as a result of the higher rates: 1. valuation impact 2. recession risk and impact to earnings.
- With respect to valuation, it will all depend on where the 10Y treasury settles (currently ~4% but could drift higher until we get more data). We estimate that a 50bp move to 4.5% would result in 7%-10% downside for technology stocks. Note that tech was down 3.5% yesterday, pricing in significant portion of the move.
- With respect to earnings, companies are already issuing very weak C4Q22 guides and eluding to a tough 2023. We expect that the earnings impact to technology stocks (especially B2B) will be relatively limited as secular tailwinds will off-set cyclical pressures and comps get easier in 2023.
It is important to note that for long term investors, rates moving back to “neutral” from “restrictive” territory, creates an attractive set up, as the return to normal would act as a valuation support. The upside/downside will depend on the earnings trajectory in 2023 and beyond.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.