Enterprise tech beating consumer tech; earnings from Microsoft, Amazon, Google, GE, Fortive and?more

We've created a new?Weekly Insights?series where we share our latest thoughts on current themes and hot topics across the Industrial Technology landscape.?This week we focus on?consumer vs. industrial (enterprise) technology, semiconductor opportunities,?and?earnings?from Microsoft, Amazon, Google, Intel, GE, Fortive and more.?

CONTENTS

Macro Datapoints??

• Earnings trend: bifurcation between?industrial?technology?(e.g, Cloud spending, related technologies, cybersecurity) and?consumer technology (online shopping, streaming, telehealth)
• Earnings summary: post pandemic losers (Amazon Consumer, Spotify, Teladoc), enterprise technology winners (Azure, GCP, AWS), inflation biting margins (GE, Amazon)?

Stocks and Focus Areas?

• Focus on Cloud spending?
• Opportunities in semiconductors?

MACRO DATAPOINTS?

This week's earnings reports demonstrated a clear bifurcation between strong trends for?industrial (enterprise) technology?and post-pandemic reversal for?consumer technology.?We believe that investors have been overweight consumer tech, and less focused on?industrial?technology, a space that is likely to drive the next wave of innovation.

Over the past 10 years we have experienced a consumer technology super-cycle which was further accelerated by the pandemic. Consumers started incorporating technology in every day life from home deliveries, home streaming, payments, telehealth etc. Covid-19 accelerated this trend and pushed valuation of many businesses to unsustainable levels (as investors applied peak multiples on "one time" future earnings).??

Industrial technology, on the on the other hand, did not experience a similar surge in demand as companies and enterprises move at a slower pace than consumers. First, many companies had their facilities shut down for several weeks, which was followed by supply chain nightmares, making it difficult for companies to focus on their operations. As demand is beginning to normalize, and inflation is still persistent, many companies are embarking on digital transformation journeys and implementing software and automation technologies in order to optimize their businesses. We believe productivity improvement is the only way to sustainably tackle inflation in the medium/long term, and consequently we expect acceleration in demand for automation and software tools.?

Weak consumer tech earnings vs. strong enterprise fundamentals

Last week we flagged our expectations for weak consumer tech driven by post-pandemic reversal; Summary of the most notable consumer tech reports:?

• Amazon?missed on revenue and profit and guided to 2Q net sales growth of?3% to 7%?YoY. AWS surprised to the upside?growing 37% in 1Q22. Disappointing profits came as a result of inflation and, more importantly, the fact that the company is overstaffed and overexpanded.?Amazon has been aggressively expanding over the past 2 years,?adding double the fulfillment network in 24 months, compared to what was built over the last 25 years?in order to meet surging in demand. The company is now focused on productivity improvement rather than expansion.?Stock was down 14%.?
• Apple?and?Google?reports also disappointed, but were relatively better. Apple guided to 2Q profit below consensus driven by supply chain constraints, and Google's YouTube adds disappointed, growing only 14% YoY vs. 25% in 4Q21 and 49% in 1Q21.Google Cloud was the bright spot, with revenue growing 44% YoY.?Stocks were down MSD%.?
• Spotify?guided to weak gross margins as a result of incremental investments (stock was down 10+%);?Teladoc?cut its guidance and is now expecting to grow revenues 18-23% from 25-30% (stock was down 40+%)??

Conversely,?industrial and enterprise technology?companies reported strong earnings.?

• Microsoft?reported strong results with Azure and Commercial Cloud the bright spots. Commercial Cloud revenue and bookings grew +35% YoY in F3Q22. Azure growth re-accelerated sequentially to 49% YoY in F3Q22, from 46% YoY in FY2Q22. The company guided to double digit revenue and profit growth for F4Q and FY23. (stock was up MSD%, but is still near lows for the year).
• PTC?reported strong earnings and raised full year guidance. The company is a leader in design software (CAD/PLM/IoT)?

Quote from Satya Nadella, Microsoft CEO (F3Q22 conf. call):?

I don't hear of businesses looking to their IT budgets or digital transformation projects as the place for cuts. If anything, some of these projects are the way they are going to accelerate their transformation.?I have not seen this level of demand for automation technology to improve productivity, because in an inflationary environment, the only deflationary force is software."

Margins are getting squeezed, but not for every company

We expect that many companies won't be able to pass through higher costs in a challenging demand environment.??

• General Electric?reported weak results, implying FY towards the low end of guidance. In addition to lower price/cost, supply chain dragged Healthcare's 1Q revenue by 7-8pts (potentially ~250bp margin drag).?

But high quality companies showed resilience and ability to pass through margins.??

• Fortive?was able to achieve ~300bps of price realization over the quarter, more than offsetting inflation, which helped expand gross margins by +60bps. The company was able to beat expectations despite China dragging results.?

Overall, we expect that challenging macro will weigh on these companies for the next few months, but it may prove to be a good opportunity to select the winners.?

STOCKS AND FOCUS AREAS

Cloud spending: the bright spot

Cloud spending was one area that clearly stood out from earnings. All three public Cloud vendors reported 35%+ revenue growth.?

• Amazon (AWS) grew +37%?
• Google (GCP)?grew +44%
• Microsoft (Azure) grew +53% ex-EMS?

It is impressive to see Azure gaining marker share as the business is about 2x the size of Google Cloud.?Microsoft mentioned that the company doubled the number of $100mn+ deals in the quarter.?

Expect benefits to spill over beyond Cloud vendors

Cloud spending does not only benefit public Cloud vendors. The changes in architecture creates opportunities for an entire ecosystem of providers. Companies are not only moving data to the Cloud, but are finding new ways of performing analytics, including the use of AI. These new infrastructures require different hardware and cybersecurity solutions creating entirely new markets and opportunities.?

• For easy access and?Cloud analytics, companies are turning to Snowflake and Databricks.
• For?cybersecurity solutions?companies need to upgrade their entire infrastructure from endpoint security (securing mobile devices, laptops) to securing workloads in the Cloud.?More details in our?Cybersecurity Primer.?
• For?hardware solutions?hyperscalers (Cloud vendors) are in the process of upgrading their own infrastructure to enable their customers to efficiently run AI workloads.??

Expect strong infrastructure demand?for semiconductors

Consumer demand for PCs has weakened. This is not new. We highlighted weakness in used chips it in our?Weekly Insights?two weeks ago. Many companies, including Intel confirmed these datapoints. However, we expect that the driver for semis over the next cycle is going to be infrastructure spending (inl. Cloud), and not consumer. While all growth stocks have been treated equally in the sell-off, not all of them have the same exposure to infrastructure.?

For Marvell and Nvidia, infrastructure represents more than 50% of revenues, consequently we expect that these companies will be better positioned to weather the storm.?Moreover, Nvidia's exposure is to the high-end of the consumer spectrum i.e. users that specifically need Nvidia's chip for a specific workload (e.g., gaming, graphics, AI etc), rather than a generic PC.?

Overall, we believe that industrial and enterprise technology is in the early innings of adoption, creating many dislocations and investment opportunities. For more info on our products as well as research reports visit our website?spear-invest.com