In this episode, we are joined by Brad Freeman, author of the Stock Market Nerd newsletter, to discuss key takeaways from tech earnings.
The episode is based on yesterday's newsletter which is available on Substack.
A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.
Show Notes
00:00:00 Introduction
00:00:43 Resilient Consumer Starting to get Jittery
00:03:00 Some Weakness in Spending?
00:04:09 Meta Worries
00:09:19 Cracks in the Cloud?
00:13:45 Weaknesses in Housing
Transcript
Introduction
[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of the Transcript, along with Erick Mokaya, who's our lead author. And we have a special guest today, Brad Freeman, who writes the Stock Market Nerd Substack. And what we're going over this week is a heavy week of earnings calls. Last week we had the height of earnings season and a lot of tech companies that we're reporting as well. And Brad, I know you cover a lot of the tech companies, so thanks for joining us today.
[00:00:28] Brad: Absolutely. Big fan of you guys. I don't know how you churn out transcripts so quickly and follow the quotes so perfectly, but that is a gift. Mine are paraphrased. I definitely miss words and you guys don't, so big fan of you guys.
[00:00:41] Scott: Thank you. We appreciate it.
Resilient Consumer Starting to get Jittery
"Due to concerns about the high price of everyday goods and gas, a potential recession, rising interest rates, and declining personal savings rate, we are seeing a more cautious consumer today, but one that is willing to purchase an offering that provides good value." - Newell Brands (NWL 0.00%↑) CEO Ravi Saligram
"Over the last few months, I've visited markets around the world, hearing from employees, franchisees, and restaurant teams about how the challenges we face globally impact our restaurants locally. Three themes came through loud and clear. There is increasing uncertainty and unease about the economic environment," - McDonald's (MCD 0.00%↑) CEO Chris Kempczinski
Starting at the top just on the macro section for our newsletter this week, we wanted to highlight some of the things that we're finding. It's really a continuation of what we've been seeing for several months now, which is that even though the reports of consumers having a little bit more hesitation about the state of the economy, consumers are still spending pretty strongly. Consumer spending is resilient, and that, of course, continues to help promote inflationary trends. And this makes it harder for the Fed to be able to slow down on interest rate increases. But I think the market was buoyant last week. Capital markets were buoyant last week at the idea that they might slow interest rate increases, which I think will get a better sense of this week. Brad, what are you seeing out there? What, how are you filtering through the things that you're looking at?
[00:01:30] Brad: Yeah, in macro land, and I'm sure you guys know this, there's so much noise and there's this little portion of really relevant signal that I try to focus on as closely as possible. I love stock picking. I love talking about micro, I love talking about companies and their fundamentals and their prospects. But when macro's such a headwind, when you have to focus on it, and this is mainly US focus, but the trends are very clear across the globe. So we have this combination of manufacturing and economic data looking pretty bad. We have layoffs that are coming. Unfortunately daily at this point in time, but at the same time, we haven't really seen the employment market become the more pressing Fed mandate versus inflation PCE, which is their favorite metric came out last week and yeah, it was a little cooler than expected, but it's still over 5% year over year. The Fed, they can't pivot when we still have an unemployment rate that looks pretty healthy. So, to me, it's very clear, like the economy's weakening, it's going to continue to weaken and it can only continue to weaken for so long before inflation starts to look better. And employment starts to look worse. And the Fed has to focus on that growingly fragile mandate. Now and this is where I'm gonna like very closely agree with you. We're pretty far away from that happening right now. It does seem somewhat likely to me that Q1 Q2 next year, 2023 will mark the end of this hawkish tightening cycle. I don't know if that's gonna mean we're gonna cut rates and start imploding the balance sheet again, but I do think that probably means we're gonna stop hiking as aggressively as we are right now or even at all. We're not gonna bottom and things are not gonna be fun once things are incredible and amazing, the markets are gonna sniff out that improvement in economic progress and front run it like it does in every single cycle.
Some Weakness in Spending?
"I would say consumer spending continues to be weak. Even in the month of October, we have seen lower consumer spending. I called that out as those trends where the inflation is impacting the consumer, I think, remains through the holiday season, as well as how inventory levels are adjusted by retailers is something that we will have to watch." - 3M (MMM 0.00%↑) Chief Financial and Transformation Officer Monish Patolawala
[00:03:00] Mokaya: Yeah. Maybe a key thing that maybe I wanted to highlight a bit in the macro section is something about I think it's only 3M who picked it, something about them seeing a bit of weakness in the consumer especially the month of October in the consumer spending. Overall as we say, like from the macro section is about overall spending being very strong, consumer balance sheet being strong, but this one point of weakness that stood out. I don't know if you'd have any comment on that.
[00:03:25] Scott: Yeah. I mean, I think my best explanation for this is the goods versus services spend, which 3M is going to be primarily seeing the lens into physical goods. I still go back to what the credit card companies are saying, which is they see overall resilience and they see that most of the consumers spend portfolio. So I think you have to defer there. And so the quote that stands out to me is that Visa in its own plan is not planning for a recession throughout the next year. I think this may be a good opportunity to just jump straight into tech land because that was where the bulk of earnings were. I think Facebook was the most interesting quarter of any of them with the way that the stock reacted. Brad in the newsletter this week, obviously everybody knows about the investment in the metaverse, and I think that's what was driving this sell-off in the stock.
Meta Worries
But in our newsletter, in The Transcript newsletter this week, we actually picked out two quotes that I think are a little contrarian because we have two quotes that showed that most of the spending is in AI and data centers. And then also actually that Facebook may be taking share from TikTok they said on their call, which I think those two things are totally different than what markets are expecting and the reaction to stock. I'm wondering if we're crazy or you're seeing the same thing or what your thoughts are.
[00:04:34] Brad: Yeah you're just, you're crazy. No, I'm kidding. But yeah, if you scroll through Twitter, you'd think Meta is a dying company with shrinking user growth and shrinking revenue and it's just not the case at all as you said. They are saying we're taking share from TikTok, telling us finally giving us sort of a timeline on reels monetization and when it's gonna stop being cannibalistic and start to be a revenue headwind. That's only 12 months away which to me right now, that's the main headwind for Meta because we're seeing the family of apps operating margin contraction. I think it went from 38 to 32% sequentially. That's really a matter of them leaning into reels and leaning away from these more profitable monetization vehicles which is coinciding with all of this macro pain and just adding to the headache for them right now. And then you have fx, which is shaving five, 6% off the top line as well. So it's just this perfect storm of headwinds. But then as you're saying, you look at the core business and it's doing way better than any kind of takeaway after their earnings report may hint at. Engagement in all the apps is up. It's really a matter of them just, or Zuckerberg just being so unwilling and so just apathetic to the investment community's preferences and wants right now. The main focus in the investor community has pivoted aggressively from revenue growth to free cash flow generation right at the exact same time that Meta of pivoted away from free cash flow generation and leaned into revenue growth to build the next hardware interface, to make themselves more insulated from Apple and to take that next computing platform for themselves. And so to me it's a matter of Mark Zuckerberg saying, I don't care what you think about my spending, I'm gonna continue to spend way more than anybody else wants me to. And meta can afford for this to be an absolute zero in a bagel and still to be sitting on tens of billions of dollars in cash on hand still to have half of the world on their apps and still able to pivot high probability growth levers that they can pull.
[00:06:19] Mokaya: So maybe two additional talking points about what you talked about, Scott, in terms of CapEx, some of the CapEx is actually going towards AI. And the AI part of it is also showing up in reels. So especially reels monetization because reels is almost a copycat of TikTok trying to, I think in the same way they tried to cut the heels of Snapchat with Insta stories a while back. So think it is the same way that Meta has responded to the threat from TikTok. And I saw some statistics that show that Tiktok, especially in terms of growth has also plateaued and now reels is actually growing. I think last quarter he said was a $1 billion runway business. So now it's a $3 billion runway business across Insta and Facebook. So in that sense, and the CapEx some of it is going towards containing the threats. And I think one of the quotes I read a bit in the past about Zuckerberg is that the thing that is going to kill Facebook, we have to be the ones to create it. So in terms of they are the ones to create something like reels. So they are okay with taking a bit of a hit. I think like this quarter they took half a billion hit in terms of revenues because reels is not yet monetizing at the same pace as the other products. From one of the quotes that also took off on our Twitter page, it's about him being supremely focused, not on the stock rise. He's actually willing to take a hit on that. But he is extremely focused in terms of investing, as he calls it, the long run so it's okay to take those short-term hits for a while. What do you think, Scott yourself?
[00:07:52] Scott: Yeah, I think the opportunity that I see here is that the perception is diverged from the reality on that investment spend. To Brad's point, probably markets are more focused on free cash flow generation than rewarding companies for investment. But I think people are particularly down on metaverse investment and there is the perception that Facebook, Meta is spending so much on metaverse cause they change their name to Meta. And so it's almost become a caricature of the story to just visually look at those images of Mark Zuckerberg in the Metaverse, say the Metaverse is never going to materialize and say, oh, they're burning all of their free cash flow. Forget the fact that they generate a ton of free cash flow and operating cash flow, which I think is what really still probably matters here. But even if you set that aside, the investment is primarily in AI and data centers. Which data centers especially are a lower risk place to spend your dollars. And it's a place where an active moat can be created for companies like Meta and Amazon and Google. Like it needs to be competing in data centers. And AI as well is one where it needs to be competing. So I think honestly, if Facebook hadn't changed their name to Meta, and had changed their name to AI Inc or something like that instead, this stock easily could be trading for 50, 100, 200% more than it's trading right now. But they changed their name to Meta and this is the opportunity potentially for a catalyst.
Cracks in the Cloud?
One other area that we highlighted that I think is worth talking about in the tech sectors, in other places where I think reality may be diverging from where perception is still, and that's in cloud computing markets. We picked up negative comments from Alphabet, Amazon and Digital Realty Trust about sales cycles in cloud computing markets. And this is one where there's been double-digit percentage growth in cloud computing for several years now. And these are markets that are perceived to be extremely strong. If there is some sort of weakness starting, that could be an area where there's been misperception in markets, but Brad, I don't know how closely you follow cloud computing, but I'd be curious for your thoughts here.
[00:10:02] Brad: Yeah. Not super closely, but just reading the headlines of Amazon freezing AWS hiring, which it's one thing to freeze fulfillment hiring, but it's another thing to freeze your star revenue channel and your highest margin revenue channel. To freeze hiring there is a bit concerning. But to me, so I think, I don't have the exact numbers off the top of my head, but I think AWS slowed from like low 30% growth, to mid-twenties or something like that and Azure is at around 35% and didn't slow all that much. So to me, that growth from Microsoft's Azure is extremely impressive. Yeah, we're starting to see enterprise software spend look a bit weak, which was the best house in a bad neighborhood, if you wanna call it for a long time and the kinks are starting to show up. We saw Google guide down, we saw Amazon Guide down, we saw Microsoft Guide down. We saw Apple not give guidance, but maybe a bit underwhelming on the services side of things in their quarter like you were saying at the beginning of the call, services and goods diverging a little bit. So yeah, cloud is going to continue to be a great place to play. The runway is extremely long. The use cases are extremely objectively value building. But right now it's not really the focus. Right now the focus is on survival and then I think it'll shift back to improvement over time.
[00:11:09] Mokaya: I think maybe add to that is from AWS, at least in terms of growth, I think people have been expecting for the past couple of quarters growth which is above around 35% to 50%. From a chart I was actually developing over the weekend, you see their growth in the past couple of years is between averaging around 40 to 50%. But then now I think they're in that phase of growth where some of the companies are actually taking a bit of time in terms of thinking a bit more about how much they actually need terms of space or at least in terms of taking up a bit more of their spend to the cloud. So I think when you see that bit of nervousness a lot of people are just maybe taking a bit of time to see how does the economy play out. So I think what we talked about, how is the macro heading? Maybe when things become clear in that end, then the growth may be back in some of these cloud players. But even for AWS, they were talking about the time when they exited this quarter, they saw growth that is around the twenties, for the whole quarter is around 28. And then towards the end of the quarter they see it around 20% growth year over year. So I think in that regard then there's a bit of moderation in that, so something to pay attention to for our listeners. Brad, I wanted to maybe in closing thoughts, maybe you could give us a few thoughts in terms of anything that you'd want listeners to know and also where the listeners can find you.
[00:12:30] Brad: Sure. Yeah. So I guess just maybe going back to mega-cap tech and what we've seen over the last several weeks, we had Google and Facebook growing above 40% year over year during 2021 when the pandemic sugar high was at its all time high. And really just, about 1500, 2000 basis points ahead of their run rate growth and where they should be. So I think all this pain and for me, I wear the Meta hat because that's the position in my portfolio. All this pain needs a little bit of context because when you look at Facebook DAUs, they're at 2 billion users for Facebook alone growing at a 7% cagr. There's seven point-something billion people in the world. They're not gonna grow users by 30% in perpetuity. And by still growing at a 7% clip at this incredible base, I think it just defeats the argument that the core business is just dying and not healthy. And that's not what I see at all. I see exactly what you guys are seeing. They're not willing to slow down spend right now, and they're either gonna be fabulously rewarded for it in the future, or it's not gonna work, and they'll have to pivot and figure something else out.
[00:13:32] Mokaya: Where can the listeners find you?
[00:13:35] Brad: Oh, stockmarket nerd.com. Thank you. I appreciate you letting me say that.
[00:13:39] Mokaya: I think Scott any closing thoughts in terms of maybe takeaways from earnings, Anything that you may have missed in our talks?
Weaknesses in Housing
"The rise in interest rates over the past 7 months is certainly weighing on real estate driving prices down and reducing sales volumes. The slowdown has been broad-based across property types and geographies. Office vacancy rates continue to climb as companies continue to recover from the pandemic. And a significant number, but a minority of workers continue to work from home. In the third quarter, vacancy rates rose to 12.4%, that's approaching historic highs” - CoStar (CSGP 0.00%↑) CEO Andrew Florance
[00:13:45] Scott: Yeah. I think one other thing that we probably should highlight in the quotes that we picked up from CoStar Group in the real estate section. These were very bearish real estate comments, talking about office vacancy rates continuing to decline and how the effective rising interest rates are really impacting transactions, sales volumes, and pricing in real estate markets. And so I think one of the most various things that I saw from CoStar was talking about how distressed property markets evolved in 2008. And saying that even though the distress and dislocation was happening in 2008, this is the quote from CoStar, there were only 2,900 distressed commercial property sales in that year, and then it took four years to peak. In 2012, there were 16,000, so almost, or more than four times as many distressed sales. And he said similar to 2008, there's only been 2000 distressed sales so far in 2022, and he said he would not be surprised if the number of distressed property sales quadrupled over the next few years. So again, we see this dynamic in real estate markets, both in terms of housing and potentially on the commercial side of pricing, lagging where the interest rate environment is. And so if we're going to start pricing equity either in securities markets or real estate markets to where these interest rates are, there's still quite a bit of pricing deterioration that could come.
“Generally, once buyer and seller's expectations align again, sales volumes increase and distressed sales grow significantly. Currently, distressed sales rates are at multiyear lows, but believe they will significantly climb in the intermediate term. In 2008, the year of significant economic dislocation, there were only about 2,900 distressed commercial property sales, and distressed sales took years to peak with about 16,000 distressed sales in 2012. Year-to-date, similar to 2008, there's only been about 2,178 distressed sales. I would not be surprised if the number of distressed property sales quadrupled over the next few years” - CoStar (CSGP 0.00%↑) CEO Andrew Florance
[00:15:10] Mokaya: Thank you for joining us this week, especially Brad for this special episode on tech. We hope to have you again in the future. Thank you Scott for being with us. For our listeners, you can always follow us at The Transcript on Twitter to keep up to date on earnings calls and see you again next week to continue this earnings season again. So, bye for this week and see you again next week.
Takeaways from Tech Earnings