Quick Thoughts: 2Q Earnings – A Big Week After the INTC Bombshell

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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July 27, 2020

Quick Thoughts: 2Q Earnings – A Big Week After the INTC Bombshell

  • More than $5T of TMT market cap reports this week, with FB on Wednesday and AAPL, AMZN, and GOOGL on Thursday the headliners.
  • Last week was odd. IBM and TXN weren’t quite as bad as feared and soared, while MSFT crushed expectations with double digit growth but took a haircut. SNAP beat consensus with 17% growth in a TOUGH ad market, but took a hit on meh sub growth, while TWTR got killed on the top and bottom lines but jumped on a huge sub number.
  • The only blemish on MSFT’s killer quarter was deceleration in its Azure cloud hosting revenues, still up 50% in constant currency but a tad behind street forecasts. This growth number has bounced around a bit, so its likely to soon to make a definitive call, but investors sold anyway. We’d buy.
  • INTC blew out 2Q numbers with strength in both datacenter servers and PCs but revealed a devastating 6-month delay in its 7nm process. Rival AMD with its partner TSMC will have a 5nm CPU selling before INTC’s parts hit the market. This could be a catastrophe for the company.
  • AMD reports Tuesday – it ought to kill it based on the read across from INTC. So should STX. Thursday, XLNX reports – we have been cautious on telecom infrastructure spend, but TXN gives some hope for a modest beat.
  • On Wednesday, we expect a sober report from FB with an advertiser boycott on top of generally weak ad spend hitting the top line and investment in vetting content hitting expenses. SHOP expectations are sky high after 46%+ YoY growth in 1Q, but we think they have room to beat. PYPL may have a little less room, given pressure on international transactions. QCOM has been cheerleading a 5G smartphone recovery but we think it is too early.
  • Analysts have been hedging their bullish calls on AAPL but consensus sales down 2.9% YoY in the midst of this could still be a tough bogie. The street is more bearish on GOOGL – looking for a sharp topline drop from 13.4% growth in 1Q to a -4.1% drop in 2Q. We think that’s too pessimistic. Finally, we expect AMZN to obliterate sales expectations, but pandemic related costs and investment in new opportunities may drag earnings down. No company is gaining more LT advantage from the pandemic.
  • Other reports to watch: V and MA will give us a glimpse of overall consumer spending – we’re a tad cautious. We think SaaS names NOW and ZEN will both beat.

 

Last week was a bit odd for TMT investors. On average, the sales and earnings were a bit better than expected amidst the pandemic. IBM and Texas Instruments were obvious examples. Big Blue saw sales down 5.4% YoY and EPS off by nearly a third, but since the street was expecting worse, shares popped 3% on the print and closed the week flat against a tough tech tape. We like the long-term potential and the 30% growth the company delivered in its cloud business, but the consulting heavy business is not well positioned to thrive during this stretch of social isolation. Texas Instrument got a similar reaction to its 12% YoY sales decline, jumping at first on beating the dreary consensus before settling down 2% for the week but holding pretty flat YTD despite absolutely horrific performance from the automotive segment (-40% YoY!) and no apparent turnaround in sight.

Meanwhile Snap absolutely crushed it against expectations, delivering sales UP 17% YoY despite a tough ad market. So what! The daily average user (DAU) number was a touch lower than the analysts had assumed, so the market took Snap out behind the woodshed and took 10% off of its market cap for the week, no matter that the “disappointing” DAU growth was still more than twice as fast as it had shown a year ago. The market’s mood played to Twitter’s favor – it missed top- and bottom-line estimates badly, with sales off 19% YoY, BUT its favored engagement metric, “monetizable” DAUs, was up 34% YoY and way ahead of the forecasts from analysts (who had apparently not noticed the outsized role that the platform was playing in the dissemination of news about COVID and the civil unrest). Shares were up about 3% for the week. We think both companies have reason to be happy with their performance – Snap is raking in market share in the digital ad market while Twitter is locking in its news distribution dominance and should reap the benefits as the overall ad market returns.

Of course, the big news of last week was Intel and the debacle of its manufacturing process development. Once the clear world leader in semiconductor manufacturing, its rivals caught up with the transition to 14nm. With 10nm, Taiwan Semi, Samsung, and Global Foundries, seemed to have passed Intel, which struggled with yield issues with the processes. The just announced six-month delay in delivering 7nm (and it could turn out to be longer than that) means that the competition will be more than a year ahead in delivering parts at scale. This is a BIG deal.

With this as the context, Intel’s actual 2Q results were a bit of an afterthought, but they were, in fact, GREAT. Sales up nearly 20% YoY with datacenter chips up 34% and PC chips up 7%. EPS was up 29% YoY, beating consensus by 10%. Management raised guidance for the full year. No matter. The stock was down nearly 20% for the week, dropping it to just 10% above its March lows. It will be hard to fight the tape on this one, but the read across for other stocks is strong. Obviously, AMD is a beneficiary of Intel’s clownish performance, but the obvious strong market demand in datacenters and PCs would be good even without the prospect of future share gains (Exhibit 1). This has good read-across for other datacenter focused names like NVidia and Xilinx, and for PC related stocks like Dell, HP, Seagate, Western Digital, and others.

One final point on last weeks results. Microsoft delivered a BLOWOUT quarter. Sales were up 13.8% YoY, more than 400bp better than analysts had predicted. Operating income was up 8% and free cash flow was up 16%, both handily above consensus expectations despite pandemic related costs. Microsoft’s primary businesses are ALL advantaged by the hard turn to work-from-home and we expect its dominance to be even greater once the pandemic is behind us. Why then was the stock down 5% after that report? Azure, Microsoft’s cloud hosting platform, was only up 47% YoY vs. expectations of 50% growth. Azure growth has been a bit choppy in the past, so we think it’s a bit premature to be souring on the company just yet. We’d be happy buyers.

Exh 1: INTC’s strong data-center performance reads well for NVDA, STX, XLNX

Exh 2: Snapshot of Azure Cloud Sales YoY Growth Rates, 4Q16 to 2Q20

Now on to this week. Tuesday will see AMD and Seagate report. Intel and Microsoft were ample hints that the PC and datacenter markets are pretty robust. For both stocks, consensus is projecting a sharp deceleration from the extraordinary YoY growth delivered in 1Q20. We are a LOT more optimistic than that. Xilinx, which reports on Thursday will get the benefit of big investment in hyperscale cloud datacenters but its exposure to the automotive market is substantial offset as will the sluggish 5G infrastructure market. Still, the Street is thinking the 8.7% YoY sales decline reported in 1Q goes to a 14.6% drop in 2Q. Texas Instrument has us thinking that results could be a bit better than that. The other big chip stock reporting next week is Qualcomm. We just don’t see a lot of reason to be excited about premium smartphone sales during a massive world-wide recession, particularly given our reservations about near term 5G adoption. (Smartphones: They Picked the Wrong Year to Call for a Supercycle)

Payments will also be in the spotlight. Consensus isn’t expecting a lot out of V and MA – sales estimates are down close to 20% YoY. We think that is probably smart given what seems to be going on in global consumer spending. Meanwhile, analysts expect growth to pick up for PayPal. The Robinhood crowd is likely overestimating how important Venmo is to PayPal’s whole picture – international transactions could be a major albatross here. On the other hand, we remain bullish on SaaS software – Zendesk and Service Now report this week and we expect them to beat.

Last, but certainly not least, Apple, Amazon, Alphabet and Facebook all report this week. Facebook is first up, and it is sailing into a fierce headwind. Overall advertising spending is down, and Facebook is facing an advertiser boycott over its inability to avoid placing paid spots near undesirable content. Unilever, Adidas, Sony, Clorox, Ford, Disney, Verizon, Microsoft, and others have pledged not to spend on any of

Exh 3: Expect sales growth to pick up and costs to increase at AMZN

Facebook’s franchises until they are satisfied with the company’s processes for dealing with the problem. At the same time, Facebook has been hiring willy-nilly to beef up its vetting program, so as sales drop, expenses will be rising. Analysts are still expecting sales and earnings up from last year. We see a lot of risks to that.

Thursday brings the other three megacaps. Consensus expects Apple sales to be down 2.9% YoY despite consumer lockdowns, store closures and disappointing carrier results in most of its major markets. We don’t see a lot of upside to this. On the other hand, Amazon is only projected to accelerate its topline growth a few hundred basis points despite the extraordinary demand generated by hundreds of millions of people constricted in their homes across the world during most of the 2nd quarter. There may be negative short-term implications for margins, but we’d be really surprised if Amazon doesn’t beat the sales number by a wide margin (Exhibit 3). Finally, Alphabet. Analysts think sales growth will plummet from 13.3% YoY in 1Q to a decline of 4.1% in 2Q. With clear signs of share gains in the enterprise business and robust engagement on the YouTube platform, this seems to be a pretty pessimistic perspective. Frankly, we’re much more confident that Search ad spending will recover quickly than we are for a smartphone industry rebound (Exhibit 4).

Exh 4: Snapshot of AAPL sales growth trend – stock performance has clearly not been in sync with business performance

 

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