Over the next few weeks, a slew of US names will release quarterly earnings reports. Despite a host of headwinds, from cost inflation to low consumer confidence, earnings are expected to grow moderately.
It’s shaping up to be an important quarter, and not just for US investors. This earnings season will be a good barometer of how current conditions are affecting business performance.
Some companies are going with more momentum than others, and there are some big names with something to prove. Here’s a closer look at the three stocks.
This article is not personal advice. If you’re not sure if an investment is right for you, seek advice. All investments can go down and up in value, and you may get less than you invest.
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Amazon
It’s not often that Amazon delivers a quarter that can only be described as disappointing. But that’s exactly what the first quarter was. Investors will be hoping that the upcoming second quarter will be significantly more promising.
Net sales of $116.4 billion were slightly ahead of expectations, but eyes were firmly on operating profit. It’s almost a stretch to say that operating profit of $3.7 billion is a disappointment. But that reflected a 58.6% decline and came in well below market expectations of $5.3 billion.
The guidance also didn’t fill markets with much confidence, with second-quarter operating profit expected to be between a loss of $1 billion and a profit of $3 billion. If lower expectations are correct, it would mark the company’s first quarterly operating loss since 2014.
More worryingly, however, every ounce of profit came from its high-end cloud computing business, Amazon Web Service (AWS).
The pressure is already on the retail arm to start contributing to profit, rather than eating into it. Clearly a casualty of its own success, consumer sales grew so quickly over the past two years that its fulfillment network had to double in size to keep pace.
But when costs rise to increase production, sales must keep pace or profitability falls. And the world looks very different now than it did even six months ago. Consumer confidence is down and rising living costs mean spending is under pressure. It now appears that the full court press was a bit excessive and there is work ahead to bring costs back under control.
However, it’s certainly not all doom and gloom. Aside from Amazon’s retail arm being a consumer staple we can’t live without, AWS is a golden goose.
Revenue for AWS grew 37% year over year with the business becoming even more profitable during the period – operating profit rose 57% to $6.5 billion.
As you might expect with a giant like Amazon, the balance sheet is in a strong position with net cash of $18.8 billion. This is a war chest that can be deployed to create additional businesses such as the recent acquisition of MGM studios, which should help add Prime Video and Amazon Studios.
From here, AWS looks to be the main engine for growth. Though there’s only so long it can support a valuation that’s over 60 times forward earnings. The big challenge over the coming quarters is whether it can bring back its retail arm. Expect disruption as that journey unfolds, especially given how uncertain the global consumer is right now.
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Meta
Meta has been on a roller coaster lately.
Late last year, the markets received the shocking announcement that Facebook was rebranding as Meta. A move that signaled growing ambitions to push beyond a social media platform, into the virtual world of the metaverse.
This sounds strange and exciting. But in reality, we are waiting to hear real news about how it will work. Meanwhile, increased investment in research and development, along with a higher number of staff, average costs have increased – about 31% in the last quarter.
Higher costs aren’t necessarily a problem, especially when you’re trying to reinvent the wheel. Plus, there aren’t many businesses that can boast $44 billion in net cash. But with revenue growth expected to be at its slowest pace in a decade, margins are starting to feel the pinch. Operating profit fell 25% last quarter to $8.5 billion.
For now, traditional advertising revenue is Meta’s bread and butter. And as far as that goes, headwinds abound.
Changes to Apple’s iOS, which mean users can opt out of letting Facebook track them around the web, mean advertisers are likely to spend less. In general, e-commerce seems to be softening. After a boom over the pandemic, advertising demand has been affected by increased competition and the effects on businesses resulting from the war in Ukraine.
In response, Meta is looking to capitalize on a user who is spending more time watching short videos. These include scroll likes on Instagram, which already account for 20% of users’ time. At the moment, this change is proving to be a revenue drag as the reels don’t serve as many ads. But Meta is no stranger to changing behaviors and has a proven track record of turning them into tailwinds.
2022 marks an important turning point for the Meta, and the markets haven’t been too impressed so far. The group’s valuation is significantly lower year-to-date, which could make it look attractive. But that’s based on earnings expected to fall about 15% this year, and we wouldn’t be too surprised if there was a bigger-than-expected decline.
The Metaverse can be a treasure trove for anyone who can build and monetize it first, and we wouldn’t put it past the Meta to do so. But the risk of getting it wrong is high, which means there can be some ups and downs.
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I tweet
Speaking of roller coasters, Twitter has been on a roll since Elon Musk offered more than $40 billion to buy the company in April. Citing concerns over Twitter’s estimates that less than 5% of their accounts are fake ‘worlds’, Musk officially notified Twitter that it would not follow through on the deal.
It turns out that pulling out of a multi-billion dollar deal isn’t so simple, especially when the group’s valuation is now trading significantly below the offer price. And so, Twitter now finds itself in a legal battle to essentially force the deal at the previously agreed upon price.
Whether Twitter will succeed or not remains to be seen, so we prefer to turn our attention to the core business. On which there is now more pressure than ever, given the backlash to Musk’s potential takeover downs and downs.
However, Twitter is a giant advertising machine with a huge amount of user data, which it also monetizes. The more users, the more advertisers will pay. Last year was a record year for revenue, with a 37% increase north of $5 billion. This was supported by a 13% increase in potential daily active users (mDAU), a measure of verified logins, to 217 million.
Twitter’s goals are bold, targeting $7.5 billion in revenue and 315 million mDAUs by the end of 2023. But there are some very real challenges to overcome.
As mentioned with Meta, Twitter also felt the pinch of the iOS change – although it seems to be a bit more optimistic about the impact. There is also the wider concern that the weakening economic outlook could cause businesses to hold back on marketing spending. We see the latter point as a very real challenge to this revenue target.
Then we come to costs, which rose last year around the world as investment in growth increases. That’s not necessarily a bad thing, given that growth is the number one goal, but it contributed to last year’s operating loss of nearly $500 million.
The good news is that the balance sheet looks healthy enough to support investment growth. Net cash stands at over $2 billion and free cash flow is expected to return to healthy positive territory next year, after an outflow of about $380 million last year.
We have a couple of mushrooms. The first is the large share-based group compensation. A fee of $630 million was associated with executive compensation last year. This is a 33% increase year-on-year, despite the business making a loss.
Second, and it’s hard to criticize a business that returns money to shareholders, is the renewed $4 billion buyback scheme. Given all the cash demands, we can’t help but think this would be better kept within the business for the time being.
The group trades at a forward price-to-earnings ratio of around 27. This is way below its long-term average, but still requires strong upside from here to justify itself. We expect volatility in the near term as this valuation continues to be challenged.
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