Tech Sector: Silver Linings For Cloud, Chips, And Subscriptions In Earnings?

As the broader market attempts to gun the gas after its September slump, Tech once again leads the charge. Now earnings loom for the high-flying sector, giving investors a fresh chance to catch up on the latest developments at  “mega-caps” like Apple Inc AAPL and Microsoft Corporation MSFT, as well as the so-called “stay at home” companies powering the economy.

While Tech leads the S&P 500 Index (SPX) in sector performance year to date, Tech’s fundamentals vary on an industry level, none falling under a neat categorical umbrella. We have to look at the particulars, and how the “worst of times” may have brought out the “best” in companies equipped to help consumers deal with the pandemic and the way it’s changed peoples’ lives.

So, let’s take a look at the top Tech companies as we head into Q3 earnings and the last quarter of 2020. We’re talking about AAPL, MSFT, Zoom Video Communications Inc ZM, and chipmaker Advanced Micro Devices, Inc. AMD—companies whose streaming, remote, and (in the case of AMD) powering capabilities continue to allow households and businesses to function as near to normal as possible. 

Ideas that we might be stuck at home longer could help explain recent rallies in stocks like ZM, DocuSign Inc DOCU, and Peloton Interactive Inc PTON, though some of these aren’t “pure” Tech companies. When the virus started, many of us talked about how we’d be in the office by September. Then it was maybe October, and now people are talking about the end of the calendar year.

If shutdowns get pushed to next spring or summer, it means more of a commitment dollar-wise. The third or fourth wave of adopters will come in, meaning companies and individuals who’d put off doing things the new way will probably decide they can’t wait any longer. 

If shutdowns last, it’s bad for most people, but good for some Tech companies. They might see benefit from holdouts who thought they wouldn’t have to spend on Tech solutions that allow people to work from home. These holdouts can sometimes be the harder sale, but can be most sticky over time. They tend to hate change, but when they finally do make transitions they stay, and it can become an amazing opportunity for companies that offer solutions.

One thing seems certain: The market is rewarding Tech companies that form the heart of the “stay at home” economy.” Looking at these companies from a wide-view lens, year to date, ZM is up an eye-popping 615%, while AMD shares are up 71%. AAPL is up 65% and MSFT is up 37%. That compares with about an 8% rise for the SPX.

These performances come amid a backdrop where analysts estimate a Q3 earnings decline of -20.5% across the broader market (S&P 500), according to researcher FactSet. This gels with research firm CFRA’s recent earnings outlook, which sees 90% of the S&P 500’s sub-industries posting declines.

While Tech isn’t immune to these struggles, FactSet sees Q3 Information Technology earnings falling just 2.6%, the third best performer among sectors. If analysts are right, Tech would trail only Health Care and Utilities. 

FIGURE 1: SINGING THE SEPTEMBER BLUES. After a rough September in which the Technology sector (IXT—candlestick) fell sharply and Nasdaq went into correction territory amid fears of an overbought market, Tech is back to outpacing the S&P 500 Index (SPX—purple line) so far in October. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Among the six Tech sector industries, software occupies the lead position in year-to-date performance, according to Morningstar data.

Let’s start with MSFT, the industry’s market cap leader. MSFT came out its FY Q4 relatively unscathed. Not quite an earnings blowout, but an indisputable earnings beat, based on Refinitiv consensus. 

Cloud is often top of mind when MSFT reports, so investors will keep an eye on how it’s doing in the sizzling competition between MSFT, Amazon.com AMZN, Alphabet Inc GOOG GOOGL, IBM IBM, and other companies in the space. Growth of Microsoft’s Azure cloud in FYQ4 slowed to 47% from 59% in the previous quarter.

Also, consider keeping an eye on spending. MSFT’s capital expenditures swelled in FYQ4 as the company expands its cloud infrastructure. This can potentially eat into profit.

Looking toward MSFT’s FYQ1 earnings, expected Oct. 21, CFO Amy Hood forecasts MSFT’s Intelligent Cloud revenues to come in between $12.55 billion and $12.8 billion, with Productivity and Business processes revenue between $11.65 billion and $11.9 billion. Hood sees the More Personal Computing segment delivering around $10.95 billion and $11.35 billion.

MSFT may be among the industry leaders by market cap, but in terms of market performance, it got dwarfed by relative newcomer ZM, whose video conferencing technologies struck the proverbial gold mine when it happened to offer one of the most adaptive resources for the “lockdown lifestyle.”

In its most recent quarterly results, ZM dished out yet another earnings blowout, doubling Refinitiv EPS expectations and delivering year-over-year revenue growth of 355%.

Unlike other Tech behemoths, whose portfolios of products can often be diverse, ZM has a single but scalable product focus—its video conferencing platform. More than 80% of its revenue is driven by consumer subscriptions. And based on its market performance it appears many investors may not see momentum slowing any time soon.  

There’s a saying that fortune favors the bold. Whether fortune continues to find ZM or not, it made an arguably bold move in its last earnings press release, revising its Q3 and full 2021 fiscal year guidance significantly higher (from the previous quarter), betting on continuing demand for remote work solutions. 

As its rival MSFT recently announced it will be allowing its workers to ditch the office for the comforts of a remote workspace (presumably using the MSFT Teams app), ZM’s forecast of future workspaces remaining remote might be right on the mark.

Upcoming Earnings Data

Data as of 10/15/20. Data sources: Reuters, TD Ameritrade

Apple Unveils New Products, but Declines on Providing Guidance

AAPL’s fiscal Q3 meant COVID-19 supply chain disruptions, store closures, and its seasonally weakest earnings period. Turns out that AAPL ended up posting a blowout earnings report with growth up 11% year over year—setting a record for the June quarter. Ending the quarter with record achievement, AAPL offered a 4-for-1 stock split in August, aiming to make shares accessible to a broader range of investors, according to the company’s press release.

Despite iPhone sales rising a mere 2% in FYQ4, the company saw double-digit growth in iPad, Mac, and wearables, setting record sales for its June quarter (again, seasonally the slowest for AAPL). Many of these products appeared to be useful to consumers during the quarantine period, pushing demand higher. 

Looking forward to AAPL’s October 29 earnings report for FY Q4, the tech giant declined to give guidance. However, the company said it expects to see strong year-over-year performance across all product categories, which maybe means a continuation of the same growth trend.

Also, remember that the company recently introduced its first 5G model iPhones and a bunch of health, fitness, and various other product upgrades. But you might have to wait a few quarters to see how the adoption of these new features impacts AAPL’s bottom line.

As always with AAPL, investors will likely be watching the company’s services growth, as that segment grows in importance vs. iPhones.

Chipmakers Looking Chipper

On an industry level, chips may be trailing software and hardware in year-to-date market perfornance, but if you look at the Philadelphia Semiconductor Index (SOX), the industry’s gains of 29% are on the heels of COMP, and far outperforming SPX.

The story over the last few quarters is technologies helping people thrive despite the pandemic’s restrictions. Semiconductor chips provide the basic foundation for all of these apps and gadgets to work. So seeing chipmakers turn red hot should be no surprise.

Topping the news earlier this month was the Wall Street Journal report on AMD’s potential acquisition of rival chipmaker Xilinx, Inc XLNX, a deal estimated at $30 billion. Along with data centers processors, desktop and notebook computers, AMD also makes chips for game systems (think Xbox and PlayStation), all in high demand in the current and potentially future “remote” work and play environment. 

Adding XLNX to the mix may give AMD a larger stake in the telecommunications space making its position against rival Intel Corporation INTC even more competitive. AMD is set to report earnings on October 27, though that date hasn’t yet been confirmed.

The truth is, nobody knows what the future holds with regard to the post-pandemic work, school, and entertainment environment. It may even be too early to say “post-pandemic” Regardless, semis—and the Tech sector in general—may be well-positioned to offer much-needed services whether we find ourselves in locked down or reopening. Either way, software, hardware, and those little chips that power it all aren’t going away.

TD Ameritrade® commentary for educational purposes only. Member SIPC.