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We Are Still in Early Stages of Tech Recovery

By Ivana DelevskaStock MarketsJun 21, 2023 07:25AM ET
www.investing.com/analysis/we-are-still-in-early-stages-of-tech-recovery-200639244
We Are Still in Early Stages of Tech Recovery
By Ivana Delevska   |  Jun 21, 2023 07:25AM ET
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  • We believe earnings for technology companies have bottomed and expect more upside from here
  • What gives us confidence in a 2H23 tech recovery
  • 1Q23 earnings takeaways: hardware bottomed, software to follow

What gives us confidence in a 2H recovery

A downturn follows a typical pattern where valuations get hit first, followed by a broad-based economic weakness that impacts the earnings of most sectors and companies. Earnings estimates usually take several quarters to re-set and we believe that 1H23 marked the bottom for earnings for the technology sector.

Phases
Phases

As interest rates stabilized this year (range bound between 3.5-4% for 10Y), valuations bottomed. Despite the sharp move off the lows for many technology companies and the media noise of a "new bubble," the average software multiple is only up to ~6x EV/NTM Revenues vs. 5x at the bottom last year, and ~8x historical (10-year) average.

This is in line with our expectations as interest rates are higher than the historical average (4% vs. 2%), and NTM growth estimates are lower (15% NTM vs. 25% 10Y median). While we don't expect a meaningful upside from interest rates in the near term, as we assume that rates will stay elevated for a longer period of time, we believe that earnings estimates are at an inflection.

EV/NTM Growth Estimates
EV/NTM Growth Estimates

Hardware earnings bottomed in 1Q23; software to follow

Semiconductors are considered to be the "canaries in the coal mine" due to the early-cycle nature of the business. As soon as there were signs of economic weakness in May of 2022, distributors started reducing inventories, which exacerbated the impact from weak demand. Nvidia (NASDAQ:NVDA) reported two quarters of dismal results and wrote off>$1bn of inventory (Apr/Aug 22). Consumer-levered semi companies such as Advanced Micro Devices (NASDAQ:AMD), felt the impact early on, and data center-focused ones, such as Marvell (NASDAQ:MRVL), slightly later.

As we get into 2H23, comps get significantly easier, and companies are starting to be able to beat lowered expectations. In addition to the cyclical upturn, we expect a significant boost to demand from investments in artificial intelligence (AI). This is not a one-quarter hype but a multi-year investment cycle. Per Nvidia, there is 1 trillion of data center hardware that is not accelerated and will need to be upgraded to accommodate AI workloads.

1Q23 Earnings Highlights:

Most semiconductor stocks that reported pointed to confidence in a 2H23 recovery (AMD, Marvell, Broadcom (NASDAQ:AVGO)), and the strongest (fundamental) result in this quarter was from Nvidia, which is uniquely positioned in AI with 80%+ market share in data center GPUs. Highlights from the reported earnings below:

  • Nvidia guided to 2Q24 (Aug 23) revenues that were 50% above consensus. Analysts raised their forward estimates by 40% in the current and out-years. The company pointed to a substantial increase in capacity in 2H23.
  • Marvell reported an in-line result but guided to AI-driven revenues to double in 2024 and 2025; $200M in AI sales for FY23; $400M+ for FY24; $800M+ from FY25 (on a run-rate of ~$5bn).

Interestingly, despite posting (by far) the strongest result, Nvidia was not the best performer in our coverage universe for the month of May (not even in top 5). This was because "the idea of semiconductor bottoming" set a floor for the rest of technology, and consequently, investors rushed into the areas of tech that could drive the next leg up.

But, if we step back, Nvidia was the only company that raised estimates commensurate with the stock price movement (+50%) which we believe provides a solid fundamental support and therefore remains a top idea in industrial technology (see our report Nvidia: The One Stop AI Shop).

Software (enterprise + cloud + cybersecurity)

Software earnings generally lag semis by 6 months. There are different areas of software that bottom at different times depending on the end-market and business model (consumption vs. subscription-based).

Revenue estimates for our software universe continued to decline, with the median NTM growth estimate now at only 15% vs. a 10-year average of ~25%. Hyper-growth companies are now growing at only ~30% vs. 70%+ previously. Companies are still citing elongates sales cycles, smaller and staggered deals, execution challenges, etc. Reported earnings were far from stellar, with many companies reporting negative net-new ARR.

But, the interesting development was that relatively small surprises got aggressively bought, and big misses were able to re-trace losses. This is usually a sign of a bottom as investors are willing to look out past this quarter if they can get confidence that we are at a bottom.

Strong results:

  • Zscaler (NASDAQ:ZS) - reported 40% billings growth in a tough macro after a difficult last quarter
  • GitLab - guided to revenue growth of +27-28% above consensus of +25%, following a 15%+ guide down last quarter
  • MongoDB (NASDAQ:MDB) - beat/raised post a very conservative guide (+19% from +17%)

C1Q3 Results
C1Q3 Results

Weak results from Cloudflare (NYSE:NET), Snowflake, SentinelOne (NYSE:S) citing a tougher macro than originally expected, were brushed off. Cloudflare and Snowflake were able to re-trace losses. SentinelOne remains TBD, but bounced significantly off the lows.

C1Q3 Bad Results
C1Q3 Bad Results

In addition, companies have been postponing spending in anticipation of a recession for several quarters, creating potential pent-up demand.

But what about the recession?

Most of the companies we cover went through significant earnings cuts in anticipation of a recession. We, therefore, don't expect that small changes in economic growth (+/-1%) will drive a meaningful difference in earnings results for technology companies.

However, the severity and duration of the recession (if it ever comes) could affect the slope of the recovery. We therefore look to invest in well capitalized businesses with strong fundamentals.

Disclosure: Views expressed here are for informational purposes only and are not investment recommendations. Spear may, but does not necessarily have investments in the companies mentioned.

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We Are Still in Early Stages of Tech Recovery
 

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We Are Still in Early Stages of Tech Recovery

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Comments (10)
Peter Cooper
Peter Cooper Jun 22, 2023 12:38AM ET
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‘We believe’ is an opening phrase that always makes me run a mile. Belief is irrational and can justify anything. What investors want are clear, high probability wins. Not beliefs.
Jack Bouwsn
Jack Bouwsn Jun 22, 2023 12:38AM ET
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'Believing' is the result of 'hope'. And 'hope' occurs when something is not going the way as expected. Don't ask me about the source who said that but I got that taught in my business psychology degree.
Saun Melkon
Saun Melkon Jun 21, 2023 11:32PM ET
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AI is just a new word for computers and search engines/software that generate false information faster than humans can. The recent tech rally was based on unfounded revenue claims by Nvidia less than a month ago. This manipulation was initiated by Wall Street banks on May 26 in the overnight trading session where they pumped Nvidia stock up 25 percent on LOWER reported earnings. AI (i.e. computers) is nothing new and it doesn't fundamentally change anything. Buy, buy, buy..
Timochin Khan
Timochin Khan Jun 21, 2023 11:19PM ET
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As long as US printing machine and free market liberalism and military strong and working, Yes, I keep buying no matter what happens, also a lit a bit of gold, just in case.
Ge K
Ge K Jun 21, 2023 10:39PM ET
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Everyone needs to test drive a Tesla. Its fun and its freee.
Michael Byrne
Michael Byrne Jun 21, 2023 10:14PM ET
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Tech will crash first and then we can talk about recovery. Interest rates have not reached their top end.
John Lakran
John Lakran Jun 21, 2023 6:47PM ET
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Unless earnings double or more the 200+pe average of the remarkable 7 of 23’ is just too high
gary leibowitz
gary leibowitz Jun 21, 2023 3:51PM ET
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HOUSING just showed a big recovery.  Last straw.  Inflation will continue higher and longer. 40 year disinflation addiction will cause more external disasters like the trillion dollar banking bet.  Once the FED raises to 6% we will drop like a stone.  Fed lost all credibility by halting rate hike in JUNE!  they will be playing catch up and no one believes the data or their commitment.  Crash of 2023.
Casador Del Oso
Casador Del Oso Jun 21, 2023 3:12PM ET
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Tech recovery at these valuations?
Karen Horne
Karen Horne Jun 21, 2023 1:30PM ET
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you should include 5 yr chart of PC production ( total units ) not inflation unadjusted revenue.
Karen Horne
Karen Horne Jun 21, 2023 1:27PM ET
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lol obviously you missed 99. You keep hoping AI which is primarily open source makes all that money you think it will.
 
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