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Article / 20 October 2017 at 10:58 GMT

Earnings Watch: Prepare for the big US technology test – #SaxoStrats

Head of Equity Strategy / Saxo Bank
Denmark
  • Intel, Microsoft, Alphabet and Amazon all report on Thursday
  • US earnings have been OK so far but Europe disappoints
  • US technology sector is up a staggering 39% this year
  • With elevated expectations comes downward risk if expectations unmet

Amazon etc..

Alphabet, Amazon and Microsoft all report earnings next week.
Images: dennizn / Denis Linine / achinthamb / Shutterstock

By Peter Garnry

Next week is the first major earnings week with 485 out of the 2,000 companies that we track during earnings season all announcing results. The week will mostly be dominated by US companies. Among 79 companies that have already reported Q3 earnings in the S&P 500 around 80% are reporting growth on their top and bottom lines. The revenue and EPS surprises are 1% and 5% respectively. Revenue growth is 6.5% y/y and EPS growth is 9.4% y/y. So the numbers are okay for now in the US whereas Europe has disappointed a bit on the early earnings releases.

In this week's Earnings Watch we focus on the US technology sector and the three major releases by Amazon (hybrid technology/retailing company), Microsoft and Alphabet (Google's parent company). The US technology sector is up a staggering 39% this year as sentiment has strengthened throughout the year as investors acknowledged that this sector is the only one that consistently delivers strong revenue and earnings growth. But with elevated expectations comes downward risk if these expectations are not met.

S&P 500 Information Technology Index
S&P 500 Technology Sector
 
How does a physical grocery fit into an e-commerce empire?

With Amazon's latest Whole Foods acquisition there will be a lot of focus on the company's entrance into the physical grocery market. The company is expected to continue growing at 25% y/y driven by strong demand in its e-commerce business and cloud business (AWS). Amazon's relentless focus on top line growth is sacrificing operating margins and translating into a very low ROIC of around 3.6% – considerably lower than the cost of capital of around 10% Shareholders are willing to keep up the share price despite this short-term destruction of capital/value because they are betting on Amazon to become the world's biggest retailer. Here are the key things to watch in Q3:

  • Amazon reports Q3 earnings on Thursday after the market close.
  • Analysts expect EPS $1.88 down 11% y/y and revenue $41.4bn up 27% y/y
  • Investors will ask for more colour on the Whole Foods integration and strategy. We know that Amazon has slashed prices significantly to increase foot traffic but how does physical grocery fit into the Amazon strategy.
  • AWS grew revenue by 42% y/y to $4.1bn in Q2 2017 and we expect +35% y/y growth in Q3 2017. AWS is the main profit engine of the Amazon business subsidising rapid expansion in the e-commerce business and now presumably in the Whole Foods expansion as lower grocery prices will cut operating profit close to a few percentage points.
  • Third-party sellers on Amazon's platform will also be a key focus point for investors as this segment is the second-largest with $7bn in revenue in Q2 compared to $23.8bn in the retail business. The third-party selling business is also key for Amazon to fend off competition from Alibaba that is planning rapid international expansion.
  • Our quant model has a neutral rating on Amazon.

Amazon daily share price in 2017
Amazon share price
Source: Saxo Bank 

Going cloud

Microsoft is fully focused on going into the cloud, shifting their legacy business onto the cloud which long-term should help improve margins. The company is also competing in the new hybrid legacy-cloud business going head to head with the VMware-Amazon partnership. In cloud-based CRM the LinkedIn acquisition is seen as instrumental to compete against Salesforce.com. WIth the share price up 35% this year and at record highs there are big expectations. Here are the key things to know ahead of next week's Q3 earnings releases:

  • Microsoft reports on Thursday after the market close.
  • Analysts expect EPS $0.72 down 5% y/y (not reported but adjusted non-GAAP) and revenue $23.6B up 6% y/y.
  • Focus on the cloud business Azure up 98% y/y in the last quarter and gaining market share in the cloud business still dominated by Amazon, although Microsoft offers cloud application and Amazon offers cloud infrastructure mainly. Azure's operating margins are expanding healthily.
  • Revenue in the phone and surface category is expected to be weak.
  • Biggest potential upside on revenue is enterprise adoption of the new Windows 10.
  • Our quant model has a positive rating on the stock driven by positive fundamentals and technical factors.

Microsoft daily share price in 2017
Microsoft share price
Source: Saxo Bank 

Regulated life

Alphabet, Google's parent, is finding itself in the crosshairs of regulators who are scrutinising the company's behaviour as it's judged to be monopolistic in some cases. The EU Commission has fined Google €2.4bn and three more charges are under way. Despite regulatory headwinds the Google profit engine is still going strong taking advertising market share. YouTube, mobile search and cloud infrastructure should also add meaningfully to growth in Q3. The key things to watch in the Q3 earnings release are:

  • Alphabet reports Q3 earnings on Thursday after the market close.
  • Analysts expect EPS $9.92 up 10% y/y and revenue $22.1bn up 21% y/y.
  • Investors will focus on EU antitrust fines. Google is challenging the €2.4bn fine in the EU General Court but more fines are on the way. Google is considering splitting out its shopping service to avoid more fines.
  • Mobile search continues to rise and Google has the largest market share in mobile operating system with its Android OS. Key growth driver for investors. Mobile search ads is still only 67% of total ad revenue compared to 83% for Facebook.
  • YouTube is the most important future growth driver as video content is the biggest growth market in online advertising the next 5-10 years.
  • Our quant model has a negative rating on the stock driven by weak technical factors relative to global peers,

Alphabet daily share price in 2017
Alphabet share price
Source: Saxo Bank 

Below is a snapshot of the 30 most important earnings releases next week.

Top 30 earnings releases
Source: Bloomberg and Saxo Bank 

– Edited by Clare MacCarthy

 

Peter Garnry is head of equity strategy at Saxo Bank

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