David Garrity, CEO of GVA Research joined for the full hour on Fast Money (1/26/17) to give his live reaction to the Alphabet and Microsoft earnings call.
Below is full analysis leading up to the earnings calls, as well as thoughts on next week’s calls:
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The U.S. technology sector reporting season kicked off last week with NFLX (Wed 1/18) and IBM (Thurs 1/19). Results from both were well-received and the companies’ shares reached new 52-week highs in response. However, the technology sector as a whole has been lagging the broader market indices since the November 2016 U.S. Presidential Election as investors sought out more cyclical sectors such as financials and industrials expected to benefit from the Trump Administration’s economic stimulus and regulatory & tax reduction programs. The technology sector would benefit from tax reduction to the extent it allows the repatriation of overseas profits, but there are possible concerns relative to Trump’s trade protectionist statements that may lead to rising tariff barriers, an area where we expect technology hardware providers are more exposed than software & services vendors. Consequently, apart from the companies recently reporting results, technology stocks have taken a breather such that on average it has been over 2 months since they have recorded new 52-week highs as uncertainty trumped the sector’s superior growth profile. As such, this week offers a test of whether the sector can regain its market leadership position.
– Thurs 1/26: GOOGL & MSFT – GOOGL is expected to show solid growth in part due to online advertising activity around the year-end holiday shopping season as well as the recent U.S. election campaign. While expense growth at GOOGL outstrips that of sales, the P/E/G ratio at 1.13x shows investors that the shares’ valuation is reasonable in relation to the underlying growth prospects. For MSFT, little growth is expected and the valuation at 2.43x P/E/G ratio appears high. Management will need to highlight growing parts of its operations such cloud computing and the recent acquisition of LinkedIn to retain investor interest going into 2017. For more detail, please see 2) and 3) below.
– Tues 1/31: AAPL – Despite the iPhone7 September 2017 launch, financial performance is expected to be flat as consumers are holding off upgrading smartphones until the expected September 2018 iPhone8 introduction. Meanwhile, with hardware sales showing only modest growth, we expect investors will focus on what growth potential AAPL can realize from its software & services sales through the App Store, a channel with potentially high margins off a revenue base in excess of $20bn. AAPL shares’ valuation at a 1.25x P/E/G ratio does not appear stretched, but investors should note share price appreciation is likely to be driven by the timing of and announcements related to the upcoming iPhone8 introduction.
– Wed 2/1: FB – The company is expected to deliver sector-leading sales and EPS growth, reflecting its rising importance to online advertising. However, management needs to offer clear commitment to addressing in a substantial, committed manner the company’s role in distributing “fake news”, an area of significant concern around the recent U.S. and upcoming E.U. elections. FB share valuation relative to its underlying growth prospects is the most reasonable amongst the peer group at a 0.92 P/E/G ratio.
– Thurs 2/2: AMZN – Team Bezos is expected to turn in another solid quarter for both sales and EPS growth driven by both year-end holiday shopping and the expansion of its cloud computing operations. Given CEO Jeff Bezos’ interest in the Washington Post, investors should be at least aware that the Trump Administration may take greater regulatory scrutiny in examining AMZN operations. That said, AMZN shares’ valuation at 1.12x P/E/G ratio appears reasonable.
Alphabet (GOOGL) Has New Ad-Growth Drivers, But Can They Kick In Fast Enough In 1H17?:
GOOGL is expected to put in a solid 4Q16 performance with consensus expectations showing sales +18% y/y ($25.2bn) and EPS +11% y/y ($9.63). While the transition from desktop to mobile search continues to depress ad pricing, GOOGL has developed new revenue drivers such as Expanded Text Ads (ETAs), the 4th mobile ad unit, device bidding, PLAs, & Maps which serve to improve targeting and conversion rates. Also, with YouTube, GOOGL is well-positioned to participate in online video advertising. The key question is whether these improvements can gain traction fast enough to offset the margin compression occasioned by the transition to mobile, wherein 4Q16 is expected to represent a cross-over point to mobile driving the majority of search activity. Other factors serving to depress profits margins are: 1) growth in hardware business such as the Pixel smartphone, 2) the datacenter build-out supporting the expansion of the GCP operations competing with AMZN’s AWS (#1 with estimated 80-85% share) and MSFT’s Azure (#2, 10-15# share), and 3) ongoing activity in Other Bets. Look for GCP to garner greater attention with the upcoming Google Cloud Next 2017 conference (SFO, 3/8-10) as the business pushes on machine learning and AI, data center expansion, and sales force execution. All told, GOOGL’s challenge is to manage the ramp-up of its growth drivers against the pricing headwind of the mobile transition and the costs of the investments made to expand GCP and Other Bets’ initiatives. Still, GOOGL remains compelling to investors as it represents one of the few companies seeing +20% growth off a massive $90bn ad revenue base. Not bad to be a duopoly player in digital advertising and smartdevice operating software.
Microsoft (MSFT) Will Cloud Computing Growth Buy Enough Time For LinkedIn To Accelerate Growth?:
With PC sales continuing secular decline, MSFT 4Q16 results appear lackluster with consensus expectations showing sales -2% y/y ($25.3bn) and EPS +0% y/y ($0.79). However, with MSFT, it’s the changes occurring under the surface that investors are eagerly watching unfold that are expected to lead to an acceleration in top- & bottom-line growth rates, some of which has been already reflected in the share valuation. On the revenue side, MSFT cloud computing initiatives are expanding at an eye-catching pace. In 4Q16, the Commercial Cloud annualized revenue run rate is expected to increase to >$14bn, more than 70% of Microsoft’s FY18 $20bn target. Forecast Commercial Cloud revenue of $3.6bn (+53% yy) assumes sustained rapid growth in Azure (+90% y/y) and Outlook365 Commercial (+46% y/y). Also, 4Q16 will see a modest contribution from the LNKD acquisition that closed 12/8/16. While dilutive near-term, LNKD contribution expected to accelerate revenue growth and drive profit margin expansion from 2H16 onwards. To the extent costs and margin pressure related to phone operations are falling away, it is possible to see how business mix will lead to profit margins expanding, a development generally directly related to improving equity valuation especially when joined with revenue acceleration. MSFT management must continue to demonstrate superior execution capability, but the conditions appear to have been set for MSFT to enjoy a higher growth and margin profile for the medium term.
Small-Cap Idea: Former YHOO CEO Ross Levinsohn Returns To Public Market With Mundo Media (HRMN):
Investors looking for opportunity in current market environment where valuations may appear fully priced may look with interest on the return of former YHOO CEO Ross Levinsohn to the public market. Levinsohn is currently executive chairman at Mundo Media, which is being acquired by Harmony (HRMN, $10.15) in a two-step SPAC transaction. Founded in 2008, Mundo Media is focused entirely on data-driven mobile marketing. A global company based in Toronto, Mundo Media supports clients in 180 countries. Serving 1k+ advertisers and 35k+ publishers, Mundo Media has 2016 revenues of $113mm (+7% y/y) and net income of $12mm (+31% y/y) and comparables such as TradeDesk (TTD $30.45). Look for Ross to capitalize on industry trends and opportunities.