Head of Equity Strategy
Summary: This week is the apex of the corporate earnings season and of the hundreds of companies we track, Microsoft, Facebook, Tesla, Fanuc and SK Hynix each offer crucial insights into the health (or otherwise) of business worldwide.
It proved to be a very strong Q3 fiscal quarter for Microsoft (ending 31 March) with both revenue and earnings surprising to the upside. The main driver is Microsoft’s cloud business (Azure) which is winning market share. Revenue growth was 14% y/y and EPS was up 26% y/y. In terms of valuation Microsoft generates around $33.6bn in free cash flow against an enterprise value of $912.6bn translating into a rather attractive free cash flow yield while offering a clear growth path for investors.
Revenue is up 26% y/y in Q1 as advertisers continue to flock to Facebook’s various social networks, solidifying the company’s position as the strongest player in online advertising. One of the key drivers behind ad revenue growth is the monetisation of Stories which will go on for years, management said during the conference call. The big story for Facebook was the CFO’s comments that expenses growth will slow over the years, improving return on capital. Facebook also booked a $3bn charge related to a soon be announced settlement with the Federal Trade Commission over violation of a privacy settlement in 2011.
EPS in Q1 was a loss of $2.90 vs estimated loss of $1.30 and revenue is $4.54bn vs estimated $4.84bn; Tesla says the larger than expected loss was due to timing of revenue recognition which was impacted by delivery issues to the European market. Two takeaways are Q1 customer deposits were down q/q which is a worrying sign for demand and that CEO Elon Musk finally admitted that a capital increase might be on the cards. With Q1 results in mind the default probability has gone up for Tesla which is already at some of the highest levels in five years according to Bloomberg’s default probability model. As we said on Tuesday the Autonomy Investor Day on Monday seems more likely to have been a smokescreen to divert attention away from the company's current troubles. Tesla needs a high share price to get good financing conditions from its creditors. Given some thoughts to the new FSD chip announcement it’s our view that this potentially unnecessarily drains resources from Tesla at a time where it can least afford it. Hardware is not the only problem standing in the way of self-driving cars.
One of the world’s largest manufacturers of industrial robots disappointed on its FY outlook, coming in at half the current estimates by sell-side analysts. Orders in Q4 were down almost 30% y/y and China revenue was down 10% y/y, confirming the sharp decline in economic activity in China in Q4. Again, this underscores that China was likely in some degree of recession in late 2018. Management calls the current environment “difficult and unpredictable” and blames trade impact, tariffs and currency volatility.
In our recent Equity Monthly publication we highlighted South Korea once again as the key country to watch in terms of turning points in the business cycle. One of the big cyclical companies is SK Hynix which is the second-largest chipmaker in the world, after Samsung. The company misses on operating profit in Q1 against estimates but surprised on revenue. Management seems confident that demand is rising in Q2 and momentum is likely to strengthen. This outlook basically confirms the business cycle turning point already highlighted by the OECD. South Korea seems to be in recovery mode and the world will soon follow.
Where we're at
After the market close Intel and Amazon will be the two most watched earnings releases. We expect Amazon to continue showing strong numbers driven by AWS.
This week is the busiest week during the earnings season with around 35% the companies we track during the earnings season reporting earnings. It also happens to be the week of technology earnings and thus very important for sentiment as the technology companies are a share of the major equity indices.
The earnings season continues to be neutral for equity markets as we mentioned in our recent equity update despite the positive surprise ratios on revenue and earnings are high. Sell-side analysts were too negative going into the earnings season relative to market expectations as we highlighted in our Earnings Watch ahead of the US earnings season start. In terms of revenue growth the Q1 2019 earnings season is the weakest since Q2 2017 as the chart below shows.