With a rotation into value names underway, it would be easy to discard all of tech and move towards the sectors that are working. However, as we discussed last week, one specific tech sector is currently outperforming most value names – semiconductors.
This week, we provide a brief video taken from our weekly webinar where we offer a more macro context around why we like semiconductors going forward. Some markets appear to be closer to new highs than lows, and we believe that semiconductor stocks are signaling that they are ready to resume their leadership role going into 2023.
On November 8th, 2008, the NASDAQ-100 put in a low in the largest bear market since the 1929 crash. On March 9th, 2008 the S&P 500 put in its low, as the tech heavy NASDAQ-100 made a higher low. This was the first indicator that the next bull cycle would be tech driven. More times than not, the new leadership will bottom first, and lead us out of the bear cycle.
The following bull cycle led to some of the greatest gains in tech’s history. At the time of the 2009 low, companies like Amazon, Google, Facebook, and Netflix were either not public companies, or obscure tech names with uncertain business models. These names came to provide some of the greatest gains over the last decade, as they rose to become some of the most valuable companies in the world.
Big Tech, as encompassed by the Nasdaq-100, was the most popular winner in the last bull market. From its 2008 low to the November 2022 high, it returned an astounding 1545%, compared to the S&P 500’s 622% returns within the same cycle.
However, few are aware that there was a sector within tech that not only performed better than the FAANG driven NASDAQ-100, but also led the market – semiconductors. Like the NASDAQ-100, the popular VanEck Semiconductor ETF (SMH) bottomed on November of 2008. However, during the same cycle it returned 2105%.
The FAANGs revolutionized the lives of the consumer, making them popular choices in most portfolios. Underneath these consumer products, was the need for semiconductors to drive forward smartphones and cloud data centers.
Leadership develops in two ways: 1) relative performance, or who is performing better than the others; 2) who bottoms first. Semis have been notable winners, and we believe are showing signs of continuing that leadership into 2023, along with the noticeable rotation into value stocks. Tech investors must be more discerning in this market, but the outsized gains are showing up for those that are watching the seismic shift within the markets.
Since the 2022 bear market began, semiconductors have been leading the broad market once again, except on the way down. When the leaders of a bull market continue to lead on the way down, it becomes a big warning that the predominant bull market is shifting. On November 22, 2021, SMH put in its high. On January 4th, 2022 the S&P 500 put in its high, as the semiconductors made a lower high. This was the same pattern we saw in 2008/2009, except in reverse.
Since then, we have seen 4 major bounces in this bear market. The above chart shows the VanEck Semiconductor Index (SMH) in the black bars, and the S&P 500 in blue. Each time, you’ll note how the SMH continued lower as the S&P 500 tried to rally. This was a warning of more downside to come.
On September 30th, new leadership emerged within the value sector, as many tech names continued lower. Darlings like TSLA, MSFT, AMZN, GOOGL continued to make new lows well into October. Meanwhile, many names in the boring Dow Jones Industrial Average (DJI) bottomed first, and have outperformed the S&P 500 since this recent bounce began.
As it appears that value is now leading, many have discarded tech, which is unfortunate. Though you must be discerning in this market, there are several tech names, like Netflix and Enphase, to name a few, that bottomed before the S&P 500, and are more than double the returns of the Dow Jones Industrial Average off the low.
What this rotation is signaling is twofold: 1) what the market wants to see is earnings, cash flow and stable profits. The old tech themes prior to 2021, which is growth at any cost, is over; 2) Even though it did not bottom before the broad market, one of the key leaders in this bounce is the semiconductor sector, which is a clue to what area of tech will likely lead in the next bull cycle.
Off the October 13th low, SMH climbed 40%, compared to the S&P 500 that climbed +17.45%. Even with the obvious rotation into value oriented names, SMH is still a leading sector off the October 13th low, where the Dow is up 21%.
As long as the October lows hold any additional weakness, it’s worth acknowledging that this trend could morph into semis being a (quiet) leader for when a bull market resumes. At the very least, SMH may not see new lows. If DJI and SMH, being notable leaders in this bounce, and do break their lows, I’d take this as a clear sign bear market will continue. This helps to illustrate the importance of SMH’s leadership.
In conclusion, with the information we have now, semis are most likely to lead the next bull cycle. Whether this bull cycle starts in 2023 or 2024 is unclear at this time. The catalyst within the burgeoning AI/Machine Learning tech trend, as well as the growth of EVs/automotive, and cloud, will cement their dominance. This also lines up with what the market is looking for in terms of profitability, as most semis are cash efficient companies with many offering dividends. Even though semiconductor stocks are not as exciting as owning a FAANG, we will look to add to our semiconductor positions on any weakness as we enter a new year.
Sentiment continues to show some of the most bearish readings we’ve seen since the 2022 bear market began. The AAII, which is a survey that asks investors if they are bullish, neutral or bearish 6 months out, just gave us the lowest reading of bulls since the October low.
Recently, only 24% of those surveyed are expecting bullish results over the next 6 months. Compared with the March low in 2009, this is not too far off that reading, which came in at around 19%.
When we look at the options market, we are seeing a similar rare pattern that has only occurred two times in the last 16 years. This is when we see an outsized ratio of puts being bought while the market is in an uptrend.
Regarding the put/call ratio, any reading over one signals that more puts are being bought over calls. A reading over 1.1 is reasonably rare, which I would consider a fear spike. What you’ll notice is that fear spikes occur mostly in downtrends, and culminate around the lows. The tan regions show multiple fear spikes occurring while the market is in an uptrend (2013, 2017, 2022). Each instance prior saw higher stock prices before a correction began.
Rarely do we see the market rewarding a crowded trade. Even when that trade makes the most sense. In order for a setup to go lower, we need to see sentiment reset. There is a high level of bearish bets right now, and these will likely need to unwind if we are going lower.
Interestingly, this lines up with what we have been saying for the last 3 weeks here, which is summarized in the most recent YouTube video below.
We have been raising large sums of cash throughout late November/early December in preparation for a volatile month. The volatility has only increased the number of bearish bets in the market as many stocks approach oversold conditions again. We believe that the market is setting up for another rally, which should last through early January.
Sign up for I/O Fund's free newsletter with gains of up to 221% – Click hereSign up for I/O Fund's free newsletter with gains of up to 221% – Click hereClick here
Whether we drop to new lows, or continue higher is yet to be seen. There are some markets in the US and abroad that have clean setups to new highs, which we’ve discussed here and here. This would certainly be the contrarian perspective going into 2023, which is worth acknowledging. However, the global central banks went on an aggressive rate hiking campaign while shifting global trade dynamics are exacerbating inflationary pressures worldwide. This is happening while we are experiencing drastic decelerations in key tech sectors, which we discussed here. So, we are not married to a thesis, and are ready to shift in either direction once we get clear signals. We believe the biggest risk that investors face going into 2023 is thinking they know what will happen and not considering there is more than one possibility.
In conclusion, we believe there will be a Christmas Rally of sorts as the probability favors a move higher as we enter 2023 into the first couple of weeks of January. Both the market internals and sentiment have reached a level of bearishness that rarely leads to a prolonged drop. Look for this to reset before we go lower.
Regarding the long-term narrative, instead of leaning into a thesis, we prefer to let price action determine whether we hedge, or leverage our portfolio to the long side. This neutral stance has been rewarding for us as an all-tech portfolio. As of now, we are leading our all-tech peers and our audited results will be out in Q1 of 2023.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
Taiwan Semiconductor Manufacturing has attracted a lot of attention lately after Berkshire Hathaway invested $4.1 billion in the company. This is surprising since Warren Buffet avoids technology stocks. Yet, given TSM’s expanding margins and strong bottom line, it makes sense a value investor would be attracted to the stock.
Our thesis is that the company has developed market leadership in the foundry industry particularly with advanced nodes, which are nodes defined as 7nm and below. The advanced nodes have strong demand by top design companies, such as Apple and Nvidia, particularly in high-performance computing and smartphones. The company has started the production of 3nm process technology and currently this is the most advanced chip production technology. Samsung is a competitor that has begun production using 3nm technology. However, in the past TSMC has been able to win the business from Samsung due to better yields and economies of scale.
The company’s fundamentals are also strong and that makes it an ideal bet in the current market environment. Along with the top-line growth the company’s bottom line has sharply improved. For example, the company’s net profit margin has improved from 37.7% in Q3 2021 to 45.8% in Q3 2022. This is on a large net profit base of $20 billion and is headed toward $30 billion. Many companies have struggled with rising costs while TSM has successfully navigated these challenges with cost controls and negotiating better prices with its customers.
Notably, part of the company’s success has been in developing a niche as a pure-play foundry. Its focus has been manufacturing for its customers, and its success has been built on the principle of not designing or manufacturing semiconductor products under its own name. It counts leading companies like Apple, AMD, Nvidia, Qualcomm, and Intel as its customers. Samsung lost much of its business from Apple as Samsung is a direct competitor to Apple on smartphones. The growing use of smartphones, PCs, Internet of Things, Artificial Intelligence, automotive, and 5G are tailwinds for the company in the long term as TSM has mastered advanced node output.
Market Opportunity
According to Fortune Business Insights, the semiconductor market size was $528 billion in 2021. The market is expected to grow at a compound annual growth rate of 12%, from $573 billion in 2022 to $1.4 trillion in 2029. According to Verified Market Research, the semiconductor foundry market was valued at $102 billion in 2022 and is expected to reach $183 billion by 2030, growing at a compound annual growth rate of 6.5% from the year 2023 to 2030.
TSMC is expected to grow faster than its industry. C.C. Wei, said in the Q3 earnings call, “We expect strong demand for our leading node technologies, driven by both smartphone and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.”to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.”
Similarly, McKinsey predicts that the semiconductor industry will be a trillion-dollar industry by the end of this decade. The article highlights the impact of the chip industry in our daily lives and how this industry is critical to the functioning of the modern economy. It predicts that the market could grow at an average of 6-8% from 2021 to 2030, growing from $590 billion to $1.07 trillion in 2030. About 70% of the growth is expected to be driven by automotive electronics, computation and data storage, and wireless communication.
Market leadership
According to TrendForce research, TSMC is the leading global foundry in terms of revenue. It has a market share of 56.1% in Q3 2022, up from 53.4% in Q2 2022. Samsung ranks a distant second with 15.5%, followed by UMC with 6.9%, and GlobalFoundries with 5.8%. The report suggests that TSMC was able to withstand the slowdown in the global economy and the impact from the China Covid-19 outbreak. The report states the company benefitted from strong demand from the new iPhone models.
Product and business model
Fabless semiconductor companies benefit from outsourcing their fabrication of chips to companies like TSMC. They hereby save the high costs of building and maintaining facilities for chip manufacturing. The fabless companies instead spend their resources on R&D for designing chips. There is a third category of semiconductor companies which are called integrated device manufacturers (IDMs), who design and manufacture chips like Samsung and Intel.
TSMC was founded by Morris Chang in 1987. He is known as the father of Taiwan’s chip industry and is credited to the concept of the foundry business. The company successfully developed a business model that ensures it will not compete with its customers as it does not manufacture under its own name. The company was able to win Apple’s business from Samsung since the latter is a direct competitor of Apple. . The company’s chips are mainly used in five platforms: smartphones, high-performance computing, Internet of Things, Automotive, and Digital Consumer Electronics.
Smaller nanometer technology nodes refer to a smaller size for each transistor, allowing more transistors to be squeezed in a given die area, and thereby providing better power efficiency and performance.
TSMC’s 5nm (N5) technology process follows the 7-nanometer process node. The company began volume production in Q2 2020 and experienced a strong ramp in the 2H 2020. TSMC’s 5-nanometer technology is the company’s second available EUV process technology, which enabled the company to win orders for smartphones and high-performance applications. 5-nanometer process technology provides about 20% faster speed than N7 technology or about 40% power reduction. The company also launched an enhanced version of the 5nm called 4nm technology. Apple’s A16 chip is made using 4nm technology.
TSMC’s 3nm technology (N3) will be the next die size following 5nm technology (N5). The company claims that the 3 nm will offer up to 70% logic density, gain up to 15% speed improvement at the same power and up to 30% power reduction at the same speed as compared with the 5nm technology. 3nm technology will be used for the production of chips for mobile and high-performance computing applications. The company also plans to make N3 chip production in the Arizona plant. Currently, the 3nm chips are made in Taiwan.
The company’s CEO, C.C. Wei, said in the Q3 earnings call, “Our N3 is on track for volume production later this quarter with good year. We expect a smooth ramp in 2023, driven by both HPC and smartphone applications. Our customers' demand for N3 exceeds our ability to supply partially due to the ongoing tool delivery issues, and we expect N3 to be fully utilized in 2023.
We expect N3 revenue in 2023 to be higher than N5 revenue in its first year in 2020 and for N3E to contribute mid-single-digit percentage of our wafer revenue in 2023, as our overall revenue base is much larger today than in 2020. N3E will further extend our N3 family with the enhanced performance, power and yield, and offer complete platform support for both smartphone and HPC applications. N3E development is progressing ahead of plan, and volume production is now scheduled for second half 2023.”We expect N3 revenue in 2023 to be higher than N5 revenue in its first year in 2020 and for N3E to contribute mid-single-digit percentage of our wafer revenue in 2023, as our overall revenue base is much larger today than in 2020. N3E will further extend our N3 family with the enhanced performance, power and yield, and offer complete platform support for both smartphone and HPC applications. N3E development is progressing ahead of plan, and volume production is now scheduled for second half 2023.”
Financials
The company’s revenue growth has been strong. Along with the top-line growth the margins have also improved. The October and November monthly figures suggests that the revenue might accelerate in the Q4 2022.The company’s Q3 2022 revenue grew by 36% YoY and 11% QoQ to $20.23 billion. Wendell Huang, CFO of the company, said, “Our third quarter business was supported by strong demand for our industry-leading 5nm technologies.” The company’s revenue grew 37% in Q2 2022 and 36% in Q1 2022.
The company releases monthly revenue figures in the local currency. The U.S dollar figures for the quarter and full year results will be released in mid-January.
For October 2022, revenue was approximately NT$210.27 billion, an increase of 1% MoM and 56.3% YoY. For November 2022, revenue was approximately NT$222.71 billion, an increase of 5.9% sequentially from October 2022 and a YoY increase of 50.2%. Revenue from January to November 2022 was NT$2,071 billion, a YoY growth of 44.6% compared to the same period in 2021. This marks an acceleration in revenue from the previous quarter when we look at the October & November monthly figures and helps to substantiate TSM’s comments that they will withstand a semiconductor slowdown better than competitors.
The advanced technologies, which are defined as 7-nanometer and below, accounted for 54% of Q3 wafer revenue with 5nm process technology contributing 28% and 7nm process technology contributing 26%. In Q2, 5nm contributed to 21% of wafer revenue, and 7nm contributed to 30%. This means 5nm is gaining market share sequentially.
Smartphone revenue accounted for 41% of Q3 revenue, high-performance computing accounted for 39%, Internet of Things accounted for 10%, automotive accounted for 5%, Digital Consumer Electronics accounted for 2%, and others accounted for 3%. The management has reiterated in the earnings call that HPC and Smartphone will be the growth drivers for the company in the long-term.
Another reason for the strong revenue is that the HPC and automotive business is still steady. The company’s CEO, C.C. Wei said in the earnings call. “Okay, let me answer this one. Of course, we say that so far, our customers give us their demand forecast — so the data center and automotive related are still steady. But now the market becomes solved and will take a more conservative way in our planning for 2023. And that's why we say that we don't rule out the possibility. They might have some correction also, but we did not see it right now, to be frank with you.”so the data center and automotive related are still steady. But now the market becomes solved and will take a more conservative way in our planning for 2023. And that's why we say that we don't rule out the possibility. They might have some correction also, but we did not see it right now, to be frank with you.”
The company’s gross profit was $12.2 billion, with a gross margin of 60.4%, up from 51.3% in the same period last year and 59.1% in Q2 2022. This was higher than the management guidance of 57.5% to 59.5% as the company benefited from favorable foreign exchange and cost improvements. The margin improvement is very good in spite of the inflationary pressures.
The company’s operating income was $10.2 billion compared to $6.1 billion in the same period last year. The operating margin improved to 50.6% from 41.2% in Q3 2021 and 49.1% in Q2 2022. It was higher than the management guidance of 47% to 49%.
The net profit was $9.3 billion compared to $5.6 billion in the same period last year. The net profit margin was 45.8% compared to 37.7% in Q3 2021 and 44.4% in Q2 2022. The EPADR (Earnings per American Depository Receipt) was $1.79 compared to $1.08 for Q3 2021 and $1.55 for Q2 2022.
The return on equity was 42.9%, up from 39.4% in Q2 2022 and 30.7% in the same period last year. The strong margins also highlight that the company has been able to negotiate better prices with its customers and also grow its revenues.
The free cash flow in Q3 was $4.8 billion, with a free cash flow margin of 24%, compared to a free cash flow of $4.7 billion (31% of revenue) in Q3 2021 and $4.1 billion (23% of revenue) in Q2 2022. The company generated a total of $18 billion in free cash flow in the last four quarters.
TSM has a stable balance sheet. The company had cash and marketable securities of $47.2 billion and debt of $27.3 billion at the end of Q3 2022.
Guidance
Management Q4 guidance given during Q3 results is $20.3B at the mid-point, representing a YoY growth of 29% and QoQ growth of 0.4%. The gross margin guidance is 59.5% to 61.5% and operating margin is 49% to 51%.
Below is the analyst consensus revenue estimates as per Seeking Alpha. Notably, the company discussed in detail that the first half of 2023 is likely to be weaker than the second half
C.C. Wei, CEO of the company, said in the Q3 earnings call that 2023 will be a growth year for the company, “Looking ahead to 2023 with the successful ramp up of N5, N4P, N4X and the upcoming ramp of N3, we're continue to expand our customer product portfolio and increase our addressable market. While the ongoing semiconductor inventory correction will affect the first half 2023 utilization rate we expect our business to be supported by stronger demand for our differentiated and leading advanced and specialty technologies, and for 2023 to be a growth year for TSMC.”While the ongoing semiconductor inventory correction will affect the first half 2023 utilization rate we expect our business to be supported by stronger demand for our differentiated and leading advanced and specialty technologies, and for 2023 to be a growth year for TSMC.”
The inventory correction that has impacted the entire semiconductor industry will result in a tough 1H 2023. However, the company’s technological leadership, strong relationship with the customers, and also a strong portfolio of HPC business will help the company fare better than the overall industry. The CEO said in the earnings call, “And for the inventory correction in 2023, all we want to say is like that. We expect probably 2023, the semiconductor industry were likely to decline. But TSMC also is not immune, we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”But TSMC also is not immune, we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”
Note: The revenue numbers will not match since we used company IR's revenue figures. The above figures differ, probably due to the currency conversion. However, we use the above estimates to understand the growth rate estimates.
The company reduced Capex for the full year 2022. The CFO said in the earnings call, “Three months ago, we said our 2022 CapEx will be closer to the lower end of our $40 billion to $44 billion range. Now, we are further tightening up this year's capital spending and expect our 2022 CapEx to be around $36 billion. About half of the change is due to capacity optimization based on the current medium term outlook. And the other half is still to continue to delivery challenges.”
The management continues to be optimistic about the long-term outlook. C.C. Wei, said in the Q3 earnings call, “We expect strong demand for our leading node technologies, driven by both smartphone and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.”
Valuation
The company is currently trading at a P/E ratio of 13.2 and fwd P/E ratio of 12. It has a P/S ratio of 5.6 and a fwd P/S ratio of 5.4. It is trading lower than the 5-year P/E ratio of 23.3 and a 5-year P/S ratio of 8.5.
Source: YCharts
The company has a better free cash flow margin when compared to its peers.
Source: YCharts
Risks
The geopolitical tensions related to China might negatively impact the stock. The company has been reducing this risk by setting up fabs outside of Taiwan. However, this could also lead to lower profits. For example, manufacturing in the US will be expensive compared to Taiwan. Some of the cost burden could be reduced by the benefits of the CHIPS Act of 2022.
The global economy's overall slowdown and delays caused by Covid-19 might negatively impact the company's 2023 revenues and the other semiconductor companies. The analysts expect revenue to grow single digits in 2023. However, the company has managed the slowdown better in the past and its results in the past few quarters have proved it. The analysts expect full year revenue to grow 30% in 2022, 7% in 2023, and 19% in 2024. Similarly, full-year EPS is expected to grow 57% in 2022, decline 9% in 2023, and grow by 27% in 2024.
Conclusion
The company has good long-term revenue growth potential due to its leadership in advanced technology nodes. Advanced nodes and a strong HPC presence will drive outsized market share of 15% to 20% — or nearly 3X more than the overall semi-market is expected to grow. The company has been able to negotiate prices with its customers, make cost improvements, and improve the profit margins, along with generating industry-leading free cash flow. We expect H1 to be weaker than normal, but the market will reward any incremental strength from TSM compared to peers.
This article was originally published on Forbes on Dec 15, 2022, 10:27pm ESTForbes on Dec 15, 2022, 10:27pm EST
Nearly all cloud companies are reporting a notable, sequential slowdown between Q3 to Q4. Amazon and Microsoft’s cloud infrastructure services slowed from mid-30 percent growth in prior years to 24 percent growth and 30% growth. Only a quarter ago – in Q2 – the growth was at 29 percent and 35%. This quarter marks a 5 percent decline sequentially, which is considered a rapid decline for these two companies.
For many more highly valued cloud software companies, the sequential decline is much steeper and is closer to a 15% sequential decline. On a YoY basis, the Q3 to Q4 growth is 70% lower than it was tracking last year. For example. Snowflake grew 15% QoQ last year and is expected to grow 3% QoQ this year, marking a 12 point decline in its growth rate. This is true for most best-of-breed cloud stocks.
We covered this point on popular cloud software stocks in granular detail in a premium note for our research Members when we said:
“In some ways, the Q4 guides – assuming most come in at or near those guides – marks a historic slowdown for cloud as it’s always been a resilient category.”
The question is, at this rate of rapid decline, when will we hit a bottom on slowing growth?
Gartner, a reputable and accurate third-party analyst firm, is indirectly calling for a bottom in cloud in 2022, per its recent two surveys. However, judging by the most recent earnings results provided by the Big 3 and cloud’s top performing stocks, I believe this could be premature and it’s more likely we bottom sometime in 2023.
Sign up for I/O Fund's free newsletter with gains of up to 221% – Click hereClick hereClick here
Gartner 2023 Surveys
In a recent report, Gartner predicted that in 2023, IT spending will recover from a notable low in 2022 in all areas except Data Center Systems. Devices will still remain negative to flat, yet show a remarkable recovery from (8.4%) to (0.6%), per the CFO 2023 survey. Software will accelerate from 8% to 11.3% while IT services will double in growth from 4.2% to 7.9%.
Across all categories of IT spending, Gartner is calling for combined growth of 5.1% in IT budgets compared to 0.8% growth in 2022. This will be down from 10.2% in 2021.
Gartner is also forecasting that 2022 is the bottom for a few public cloud end-user verticals with a year-over-year increase in software-as-a-service (SaaS), cloud management and security, and infrastructure-as-a-service (IaaS).
Of these, Cloud IaaS is expected to see the most growth from 27% in 2022 to 30% in 2023. This is on a large revenue base of $115 billion, expected to grow to $150 billion in 2023. Software-as-a-service is the largest category in cloud with revenue of $167 billion, expected to grow to $195 billion at a rate of 17%.
Notably, some areas are expected to decline, such as BPaaS and DaaS.
Shown below, the overall cloud market is expected to grow 21%, up from 19% in 2022. This will outpace overall IT spending with growth of 5.1% by over 5X.
The 5.1% growth lags the current inflation rate of 6.5%.
Cloud IaaS Growth Saw 3% Headwind in 2022, More to Come?
Gartner released the 2023 survey results in October, and later that month, Q3 earnings results from Big Tech reported a decline in Cloud IaaS. Perhaps the survey is predicting a rebound from H2 2022 to H1 2023, but this would be hard to determine until budgets are set in the earlier part of next year.
In most cases, we are seeing a 10% deceleration from the early part of the year to the second half of the year. For now, actual results from the Big 3 Cloud IaaS providers disagree with Gartner’s survey predictions that a rebound is coming. This is despite Cloud IaaS predicted to be the more resilient line item in public cloud end-user spending.
The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.Learn more about about our premium membership here.
Mixed Reports Following Q3 Results
Gartner’s prediction that cloud budgets will expand contrasts with other surveys that suggest the opposite. For example, according to a survey by Wanclouds, 81% of companies were directed by the C-suite to reduce cloud spending or to occur no additional costs.
The venture capital firm Accel published a report that showed private funding for cloud companies dropped as much as 42% across Europe, Israel and the United States in Q3. This often translates to lower valuations and/or lacking a clear path to a strong exit on the public markets or through an acquisition.
This doesn’t mean the migration to the cloud is slowing down, by any means. According to Accel, spending on automation and digital transformation is expected to rise from $1.8 trillion to $2.8 trillion by 2025. The drawback to these kinds of forecasts is that it may slow considerably in 2023 before a rebound occurs.
Conclusion:
Cloud spending may turn out to be softer than industry surveys indicate, especially until inflation cools off. This is because surveys capture a perception while earnings results are the culmination of a 7.1% inflation rate, plus a softer Chinese market and a softer European market.
The Big 3 are the best proxy because their reports represent the layer in the tech stack that tends to be the most resilient in terms of churn. The switching costs are quite high for cloud IaaS services. The Big 3 also afford a more concentrated view by owning 66% of market share across three companies whereas SaaS is spread across thousands of companies.
For our premium members, we dig deeper into mid-cap cloud companies to determine which ones are decelerating more quickly than their peers and also which leading cloud stocks we plan to buy when we sense there is a rebound. You can learn more here.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
For our Essentials members, we are expanding on a free analysis. For ease of access, we are copying the free article before we expand further on the Essentials analysis located under the section “Two Scenarios for Cloud Software”
Slowing Growth in Cloud Stocks: When Will We Hit a Bottom
Nearly all cloud companies are reporting a notable, sequential slowdown between Q3 to Q4. Amazon and Microsoft’s cloud infrastructure services slowed from mid-30 percent growth in prior years to 24 percent growth and 30% growth. Only a quarter ago – in Q2 – the growth was at 29 percent and 35%. This quarter marks a 5 percent decline sequentially, which is considered a rapid decline for these two companies.
For many more highly valued cloud software companies, the sequential decline is much steeper and is closer to a 15% sequential decline. On a YoY basis, the Q3 to Q4 growth is 70% lower than it was tracking last year. For example. Snowflake grew 15% QoQ last year and is expected to grow 3% QoQ this year, marking a 12% decline YoY in its growth rate. This is true for most best-of-breed cloud stocks.
We covered this point on popular cloud software stocks in granular detail in a premium note for our research Members when we said:
“In some ways, the Q4 guides – assuming most come in at or near those guides – marks a historic slowdown for cloud as it’s always been a resilient category.”
The question is, at this rate of rapid decline, when will we hit a bottom on slowing growth?
Gartner, a reputable and accurate third-party analyst firm, is indirectly calling for a bottom in cloud in 2022, per its recent two surveys. However, judging by the most recent earnings results provided by the Big 3 and cloud’s top performing stocks, I believe this could be premature and it’s more likely we bottom sometime in 2023.
Gartner 2023 Surveys
In a recent report, Gartner predicted that in 2023, IT spending will recover from a notable low in 2022 in all areas except Data Center Systems. Devices will still remain negative to flat, yet show a remarkable recovery from (8.4%) to (0.6%), per the CFO 2023 survey. Software will accelerate from 8% to 11.3% while IT services will double in growth from 4.2% to 7.9%.
Across all categories of IT spending, Gartner is calling for combined growth of 5.1% in IT budgets compared to 0.8% growth in 2022. This will be down from 10.2% in 2021.
Gartner is also forecasting that 2022 is the bottom for a few public cloud end-user verticals with a year-over-year increase in software-as-a-service (SaaS), cloud management and security, and infrastructure-as-a-service (IaaS).
Of these, Cloud IaaS is expected to see the most growth from 27% in 2022 to 30% in 2023. This is on a large revenue base of $115 billion, expected to grow to $150 billion in 2023. Software-as-a-service is the largest category in cloud with revenue of $167 billion, expected to grow to $195 billion at a rate of 17%.
Notably, some areas are expected to decline, such as BPaaS and DaaS.
Shown below, the overall cloud market is expected to grow 21%, up from 19% in 2022. This will outpace overall IT spending with growth of 5.1% by over 5X.
The 5.1% growth lags the current inflation rate of 6.5%.
Cloud IaaS Growth Saw 3% Headwind in 2022, More to Come?
Gartner released the 2023 survey results in October, and later that month, Q3 earnings results from Big Tech reported a decline in Cloud IaaS. Perhaps the survey is predicting a rebound from H2 2022 to H1 2023, but this would be hard to determine until budgets are set in the earlier part of next year.
In most cases, we are seeing a 10% deceleration from the early part of the year to the second half of the year. For now, actual results from the Big 3 Cloud IaaS providers disagree with Gartner’s survey predictions that a rebound is coming. This is despite Cloud IaaS predicted to be the more resilient line item in public cloud end-user spending.
Mixed Reports Following Q3 Results
Gartner’s prediction that cloud budgets will expand contrasts with other surveys that suggest the opposite. For example, according to a survey by Wanclouds, 81% of companies were directed by the C-suite to reduce cloud spending or to occur no additional costs.
The venture capital firm Accel published a report that showed private funding for cloud companies dropped as much as 42% across Europe, Israel and the United States in Q3. This often translates to lower valuations and/or lacking a clear path to a strong exit on the public markets or through an acquisition.
This doesn’t mean the migration to the cloud is slowing down, by any means. According to Accel, spending on automation and digital transformation is expected to rise from $1.8 trillion to $2.8 trillion by 2025. The drawback to these kinds of forecasts is that it may slow considerably in 2023 before a rebound occurs.
Takeaway:
Cloud spending may turn out to be softer than industry surveys indicate, especially until inflation cools off. This is because surveys capture a perception while earnings results are the culmination of a 7.1% inflation rate, plus a softer Chinese market and a softer European market.
The Big 3 are the best proxy because their reports represent the layer in the tech stack that tends to be the most resilient in terms of churn. The switching costs are quite high for cloud IaaS services. The Big 3 also afford a more concentrated view by owning 66% of market share across three companies whereas SaaS is spread across thousands of companies (if not tens of thousands).
Two Scenarios for Cloud Software
Cloud software is at a cross roads as the first 3 quarters of the year were quite strong while the Q4 guides are out of character to the downside. Q4 will either mark a fleeting moment of weakness for cloud or it’s the beginning of a bottoming process that needs to play out.
In a true recessionary environment, data rarely shows a bottom and a reversal in fundamentals all wrapped up in one quarter. Therefore, we are favoring the second scenario outlined below. If we are wrong, then we will simply step back into our cloud positions and a larger cloud allocation once more supporting evidence is provided. Microsoft tends to be the bellwether, so the next round of data will come end of January. The data that I’m referring to, specifically, is 2023 budgets which have not been determined yet.
Scenario #1: Cloud Will Prove Resilient
There are a lot of cloud software bulls and for good reason, this category has treated investors well with predictable revenue growth.
Scenario #1 is that cloud software is resilient because it drives down costs and increases productivity. We know this scenario well as we wrote about it many times in the past few years to defend cloud. Often these cooling off periods were welcomed to position for a 6-month bounce back after the category sold off (40%) or more.
Here is what I said in the past here on the free side and reiterated here on MarketWatch (behind paywall) in 2019 (i.e., when we weren’t facing a brick wall on growth).
“My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession. Lastly, cloud software is at the beginning of a rapid growth cycle compared to its counterparts in tech — such as mobile, e-commerce and advertising — which are reaching saturation, are finding themselves in the cross hairs of anti-trust and are susceptible to consumer spending changes.”
“Current inflationary pressures and macroeconomic conditions are having a push and pull effect on cloud spending,” said Sid Nag, Vice President Analyst at Gartner. “Cloud computing will continue to be a bastion of safety and innovation, supporting growth during uncertain times due to its agile, elastic and scalable nature.”
The issue with this assumption, which supports Scenario #1 is that Cloud growth is actually slowing downCloud growth is actually slowing down — that is the reality of things — and this wasn’t true in 2019 and wasn’t true when this survey was performed –the change has occurred as recent as a few months ago. My argument about a value rotation in 2019 playing out based on high valuations was supported at the time by industry-leading growth.
Scenario #2: Q4 is Foreshadowing a CY2023 Slowdown
A picture is worth a thousand words and what is seen below is a sequential slowdown that (collectively) cloud companies have not experienced in the past.
In some ways, the Q4 guides – assuming most come in at or near those guides – marks a historic slowdown for cloud as it’s always been a resilient category.
If the slowdown continues, cloud could remain stagnant for some parts of 2023. We will know more next month starting when Microsoft reports. If Microsoft and others forecast softer budgets in 2023, then I would expect the analyst estimates pictured below to come down.
We’ve contrasted the next 6 months expected growth and the next 9 months expected growth with the current growth reported recently to show that the estimates may not be aligned with recent budget cuts.
Pictured Above: H1 and First 9 Months growth estimates for CY2023 not aligned with the slowdown guided for in Q4. Either estimates will need to come down or cloud will need to see a quick rebound. Average was taken from earnings data and earnings estimates for 10 best-of-breed cloud companies.
If the Q4 pattern continues, many best-of-breed cloud companies (on average) will see 10% growth across two quarters, or roughly 20% growth across four quarters rather than the 30%-35% growth estimates currently in place.
Takeaway: We will find out over the next few months if Q4 is foreshadowing a steeper deceleration than what is currently baked in.
Conclusion:
The I/O Fund is being cautious with cloud until we get more information. The Q3/Q4 deceleration is not broadly discussed yet and we prefer to remain (somewhat) on the sidelines with the anticipations the narrative will eventually catch up to the data we saw come out of the most recent earnings reports. We’ve trimmed some of our cloud positions while remaining in one position at a 10% allocation. If we are wrong, and Q1 and/or Q2 shows a reliable rebound, then we will buy back the positions that we owned recently and cut.
Note, reliable means not only one or two lumpy beats but rather a predictable trajectory.
The I/O Fund portfolio and real-time trade alerts are shared with our Pro Deep Dives and Advanced Market Signals services. Learn more here.
For our premium members, we are expanding on a free analysis and also an Essentials analysis. For ease of access, we are copying the free article and Essentials article here before we expand further.
Slowing Growth in Cloud Stocks: When Will We Hit a Bottom
Nearly all cloud companies are reporting a notable, sequential slowdown between Q3 to Q4. Amazon and Microsoft’s cloud infrastructure services slowed from mid-30 percent growth in prior years to 24 percent growth and 30% growth. Only a quarter ago – in Q2 – the growth was at 29 percent and 35%. This quarter marks a 5 percent decline sequentially, which is considered a rapid decline for these two companies.
For many more highly valued cloud software companies, the sequential decline is much steeper and is closer to a 15% sequential decline. On a YoY basis, the Q3 to Q4 growth is 70% lower than it was tracking last year. For example. Snowflake grew 15% QoQ last year and is expected to grow 3% QoQ this year, marking a 12% decline YoY in its growth rate. This is true for most best-of-breed cloud stocks.
We covered this point on popular cloud software stocks in granular detail in a premium note for our research Members when we said:
“In some ways, the Q4 guides – assuming most come in at or near those guides – marks a historic slowdown for cloud as it’s always been a resilient category.”
The question is, at this rate of rapid decline, when will we hit a bottom on slowing growth?
Gartner, a reputable and accurate third-party analyst firm, is indirectly calling for a bottom in cloud in 2022, per its recent two surveys. However, judging by the most recent earnings results provided by the Big 3 and cloud’s top performing stocks, I believe this could be premature and it’s more likely we bottom sometime in 2023.
Gartner 2023 Surveys
In a recent report, Gartner predicted that in 2023, IT spending will recover from a notable low in 2022 in all areas except Data Center Systems. Devices will still remain negative to flat, yet show a remarkable recovery from (8.4%) to (0.6%), per the CFO 2023 survey. Software will accelerate from 8% to 11.3% while IT services will double in growth from 4.2% to 7.9%.
Across all categories of IT spending, Gartner is calling for combined growth of 5.1% in IT budgets compared to 0.8% growth in 2022. This will be down from 10.2% in 2021.
Gartner is also forecasting that 2022 is the bottom for a few public cloud end-user verticals with a year-over-year increase in software-as-a-service (SaaS), cloud management and security, and infrastructure-as-a-service (IaaS).
Of these, Cloud IaaS is expected to see the most growth from 27% in 2022 to 30% in 2023. This is on a large revenue base of $115 billion, expected to grow to $150 billion in 2023. Software-as-a-service is the largest category in cloud with revenue of $167 billion, expected to grow to $195 billion at a rate of 17%.
Notably, some areas are expected to decline, such as BPaaS and DaaS.
Shown below, the overall cloud market is expected to grow 21%, up from 19% in 2022. This will outpace overall IT spending with growth of 5.1% by over 5X.
The 5.1% growth lags the current inflation rate of 6.5%.
Cloud IaaS Growth Saw 3% Headwind in 2022, More to Come?
Gartner released the 2023 survey results in October, and later that month, Q3 earnings results from Big Tech reported a decline in Cloud IaaS. Perhaps the survey is predicting a rebound from H2 2022 to H1 2023, but this would be hard to determine until budgets are set in the earlier part of next year.
In most cases, we are seeing a 10% deceleration from the early part of the year to the second half of the year. For now, actual results from the Big 3 Cloud IaaS providers disagree with Gartner’s survey predictions that a rebound is coming. This is despite Cloud IaaS predicted to be the more resilient line item in public cloud end-user spending.
Mixed Reports Following Q3 Results
Gartner’s prediction that cloud budgets will expand contrasts with other surveys that suggest the opposite. For example, according to a survey by Wanclouds, 81% of companies were directed by the C-suite to reduce cloud spending or to occur no additional costs.
The venture capital firm Accel published a report that showed private funding for cloud companies dropped as much as 42% across Europe, Israel and the United States in Q3. This often translates to lower valuations and/or lacking a clear path to a strong exit on the public markets or through an acquisition.
This doesn’t mean the migration to the cloud is slowing down, by any means. According to Accel, spending on automation and digital transformation is expected to rise from $1.8 trillion to $2.8 trillion by 2025. The drawback to these kinds of forecasts is that it may slow considerably in 2023 before a rebound occurs.
Takeaway:
Cloud spending may turn out to be softer than industry surveys indicate, especially until inflation cools off. This is because surveys capture a perception while earnings results are the culmination of a 7.1% inflation rate, plus a softer Chinese market and a softer European market.
The Big 3 are the best proxy because their reports represent the layer in the tech stack that tends to be the most resilient in terms of churn. The switching costs are quite high for cloud IaaS services. The Big 3 also afford a more concentrated view by owning 66% of market share across three companies whereas SaaS is spread across thousands of companies (if not tens of thousands).
Two Scenarios for Cloud Software
Cloud software is at a cross roads as the first 3 quarters of the year were quite strong while the Q4 guides are out of character to the downside. Q4 will either mark a fleeting moment of weakness for cloud or it’s the beginning of a bottoming process that needs to play out.
In a true recessionary environment, data rarely shows a bottom and a reversal in fundamentals all wrapped up in one quarter. Therefore, we are favoring the second scenario outlined below. If we are wrong, then we will simply step back into our cloud positions and a larger cloud allocation once more supporting evidence is provided. Microsoft tends to be the bellwether, so the next round of data will come end of January. The data that I’m referring to, specifically, is 2023 budgets which have not been determined yet.
Scenario #1: Cloud Will Prove Resilient
There are a lot of cloud software bulls and for good reason, this category has treated investors well with predictable revenue growth.
Scenario #1 is that cloud software is resilient because it drives down costs and increases productivity. We know this scenario well as we wrote about it many times in the past few years to defend cloud. Often these cooling off periods were welcomed to position for a 6-month bounce back after the category sold off (40%) or more.
Here is what I said in the past here on the free side and reiterated here on MarketWatch (behind paywall) in 2019 (i.e., when we weren’t facing a brick wall on growth).
“My prediction is this may be one of the last cycles when tech is considered less safe than value stocks. As the market will find out (the hard way), cloud software is actually very safe. It is insulated from trade wars and overseas manufacturing issues. It reduces costs for enterprises, which is ideal for a recession. Lastly, cloud software is at the beginning of a rapid growth cycle compared to its counterparts in tech — such as mobile, e-commerce and advertising — which are reaching saturation, are finding themselves in the cross hairs of anti-trust and are susceptible to consumer spending changes.”
“Current inflationary pressures and macroeconomic conditions are having a push and pull effect on cloud spending,” said Sid Nag, Vice President Analyst at Gartner. “Cloud computing will continue to be a bastion of safety and innovation, supporting growth during uncertain times due to its agile, elastic and scalable nature.”
The issue with this assumption, which supports Scenario #1 is that Cloud growth is actually slowing downCloud growth is actually slowing down — that is the reality of things — and this wasn’t true in 2019 and wasn’t true when this survey was performed –the change has occurred as recent as a few months ago. My argument about a value rotation in 2019 playing out based on high valuations was supported at the time by industry-leading growth.
Scenario #2: Q4 is Foreshadowing a CY2023 Slowdown
A picture is worth a thousand words and what is seen below is a sequential slowdown that (collectively) cloud companies have not experienced in the past.
In some ways, the Q4 guides – assuming most come in at or near those guides – marks a historic slowdown for cloud as it’s always been a resilient category.
If the slowdown continues, cloud could remain stagnant for some parts of 2023. We will know more next month starting when Microsoft reports. If Microsoft and others forecast softer budgets in 2023, then I would expect the analyst estimates pictured below to come down.
We’ve contrasted the next 6 months expected growth and the next 9 months expected growth with the current growth reported recently to show that the estimates may not be aligned with recent budget cuts.
Pictured Above: H1 and First 9 Months growth estimates for CY2023 not aligned with the slowdown guided for in Q4. Either estimates will need to come down or cloud will need to see a quick rebound. Average was taken from earnings data and earnings estimates for 10 best-of-breed cloud companies.
If the Q4 pattern continues, many best-of-breed cloud companies (on average) will see 10% growth across two quarters, or roughly 20% growth across four quarters rather than the 30%-35% growth estimates currently in place.
Takeaway:
We will find out over the next few months if Q4 is foreshadowing a steeper deceleration than what is currently baked in.
The I/O Fund is being cautious with cloud until we get more information. The Q3/Q4 deceleration is not broadly discussed yet and we prefer to remain (somewhat) on the sidelines with the anticipations the narrative will eventually catch up to the data we saw come out of the most recent earnings reports. We’ve trimmed some of our cloud positions while remaining in one position at a 10% allocation. If we are wrong, and Q1 and/or Q2 shows a reliable rebound, then we will buy back the positions that we owned recently and cut.
Note, reliable means not only one or two lumpy beats but rather a predictable trajectory.
Best-of-Breed Cloud Hints More Slowing Growth to Come for 2023
To help illustrate the deceleration, we took a sample of best-of-breed stocks that are often seen in the Top 10 ranking on revenue growth, free cash flow, adjusted operating margin and/or valuations.
The best comparison is the sequential growth from Q3 to Q4 in 2022 compared to sequential growth in Q3 to Q4 (estimates) as this will take into account any seasonality from the Q4 period. Some companies maintain their Q4 is busier than usual due to the budget flush we previously discussed, while others maintain their Q4 is less busy because engineers and data scientists are out of the office, resulting in a softer consumption pattern.
There is also evidence from the CrowdStrike after hours reaction that sequential growth is most important to determine future growth as it’s in the Q2 time frame that discussions around softer budgets began. We covered Crowdstrike’s sequential slowdown in net new ARR here.
If we look at lagging information, we can see the deceleration this past year has not been too drastic. It’s primarily the Q4 guides that show a more drastic slowdown. In fact, you could say the resiliency of Q1 through Q3 this year may be creating a false sense of security.
Analysts are also maintaining high growth estimates despite weak Q4 guidance. We highlighted that up above, but here’s how the data compares on an individual level for the top 10 stocks. Looking at this data, it would appear as though cloud is quite resilient.
Yet, the Q4 guidance is out of character as we see a 2/3 decline in average sequential growth rate from 17% to 5%. This is the more severe drop off because Q4 2021 was much better than Q2 2022 in terms of the economy. However, my contention is that Q4 could be reflecting what is to come in 2023 rather a reflection of budgets from 2022 as the slowdown is more pronounced in Q4 than it has been in previous quarters from 2022.
It’s important to note that Q4 is typically strong as there is a “holiday flush” where companies use the remaining fiscal budget in this quarter. Microsoft’s weaker cloud forecast indicates this is not only a SMB problem as Microsoft’s core customers are the Fortune 500.
Conclusion:
This analysis is not meant to say that cloud software and big data/analytics companies won’t make great stocks – in fact, we have a list of stocks that we hope will provide enormous, future gains. Due to driving down costs and the ability to quickly scale, cloud is capable of being an industry-leading category again. I don’t doubt for one minute that the cloud companies that persevere will reward investors in the long-term.
With that said, I don’t believe all cloud companies will preserve. Cloud consolidation requires a separate analysis, but for brevity’s sake, my point is that cloud is overdue to be the next sector that sees consolidation as mobile has finished its consolidation cycle. This means heavy M&A activity or some stocks fading into a low growth plateau (similar to Box or Dropbox). I’ll write this up when we see more signs of this, but it’s likely on the way as part of the typical hype cycle curve and where cloud software is on the hype cycle.
I am also realistic that cloud tends to have weak bottom lines as we detailed in this analysis “Compartmentalizing Cloud Stocks.” So, the point is that if we see slowing growth, which I would define as sub-30% and certainly sub-20% fits the criteria, then given these bottom lines and subpar growth rates, the market is likely to find other places to wait out the soft economy.
Our plan is to either validate or invalidate this thesis. If it’s invalidated, we will move back into cloud stocks we like the best for 2023 (you’re seeing some of this right now with a large allocation in Datadog). If it’s validated, we will be in a wait-and-see mode to build positions again once we think cloud growth is bottoming and ready for a rebound.
TSMC reported an unexpectedly strong November, per a press release today which stated:
TSMC today announced its net revenue for November 2022: On a consolidated basis, revenue for November 2022 was approximately NT$222.71 billion, an increase of 5.9 percent from October 2022 and an increase of 50.2 percent from November 2021. Revenue for January through November 2022 totaled NT$2,071.33 billion, an increase of 44.6 percent compared to the same period in 2021.
This has been on the top of our list in portfolio meetings for some time and this press release may mark an impetus to enter the stock. We will have a deep dive in the next 1-2 weeks. Royston covered the earnings report on the forum in October here.
TSMC preannounced its Q3 2022 results on Oct 13. The company’s leadership position in advanced nodes has helped the company to continue to deliver strong results in a current tough macro environment.
Revenue growth was strong as it grew by 36% YoY and 11% QoQ to $20.23 billion.
The company’s gross margin improved to 60.4% compared to 59.1% in Q2 2022 and 51.3% in the same period last year.
This was higher than the management guidance of 57.5% to 59.5% as the company benefitted from favorable foreign exchange and cost improvements.
The operating margin was also strong as it came at 50.6% compared to 49.1% in Q2 2022 and 41.2% in the same period last year. It was higher than the management guidance of 47% to 49%.
The company’s net profit grew by 80% YoY to NT$280.87 billion (US$9.26 billion) with a net profit margin of 45.8% compared to 44.4% in Q2 2022 and 37.7% in Q3 2021.
EPS was NT$10.83 compared to NT$6.03 in Q3 2021. EPADR (Earnings per American Depository Receipt) is $1.79, beating estimates by $0.11.
The company had a free cash flow of NT$146.73 billion (US$4.84 billion) with an excellent free cash flow margin is 24%.
The average exchange rate used is $1= 30.32 Taiwan Dollars
The key trends from the earnings call:
The company has reduced the Capex for 2022 to $36 billion from last quarter’s guide to being at the lower end of the previous guidance of $40 billion to $44 billion range. The CFO said in the earnings call, “About half of the change is due to capacity optimization based on the current medium term outlook. And the other half is still to continue to delivery challenges.”
The company’s CEO, C.C.Wei, said, “On the demand side, we continue to observe softness in consumer end market segment. Other end market segments such as data center and automotive related remain steady for now for TSMC. But we start to see the possibility of adjustment unrolled.”On the demand side, we continue to observe softness in consumer end market segment. Other end market segments such as data center and automotive related remain steady for now for TSMC. But we start to see the possibility of adjustment unrolled.”
He further gave more information when an analyst asked the outlook down the road.
“Of course, we say that so far, our customers give us their demand forecast — so the data center and automotive related are still steady. But now the market becomes solved and will take a more conservative way in our planning for 2023. And that's why we say that we don't rule out the possibility. They might have some correction also, but we did not see it right now, to be frank with you.They might have some correction also, but we did not see it right now, to be frank with you.
And for the inventory correction in 2023, all we want to say is like that. We expect probably 2023, the semiconductor industry were likely to decline. But TSMC also is not immune, we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”we believe our technology position, strong portfolio in HPC and longer-term strategic relationship with customers will enable our business to be more resilient than the overall semiconductor industry. And that's why we say in 2023 still a growth year for TSMC and the overall industry probably will decline.”
Guidance:
The company expects Q4 2022 revenue to be $20.3 billion at the mid-point of the guidance, representing a YoY growth of 29%. Gross profit margin is expected to be in the range of 59.5% to 61.5% and operating profit margin is expected to be in the range of 49% to 51%.
Below are the consensus revenue estimates for the next few quarters.
Source: Seeking Alpha
The company has reiterated the long-term guidance. “We expect strong demand for our leading node technologies, driven by both smartphone and HPC applications to fuel our long-term revenue growth of 15% to 20% CAGR over the next several years in U.S. dollar terms.
Welcome to the newly launched Essentials Plan, we are glad you are here. We launched Essentials on the Thanksgiving holiday weekend and we will be ramping content on a weekly basis.
Below, I discuss our buy plan on Netflix which is briefly described in the 7-minute video below. We began building our position for our premium members around $217, and since have provided 4 buy recommendation, all of which are positive, as of this writing. We think Netflix is going to be a leading stock in 2023, which Beth outlined in the December stock pick found here.
I use a blended approach of technical analysis to determine our portfolio entries and also to pre-determine our risk management. Risk management is a key part of owning tech stocks and I share this with you in the video.
Netflix is a 10% allocation, at time of writing, which is quite high for us. We have taken some gains as we approach a pullback in the markets, and plan to buy more in the near future. In this video, I discuss the levels we plan to execute our trades in the video below.
Bitcoin is the best performing asset of our lifetime. Given the history of Bitcoin’s awe-inspiring returns shown below, the single most important question for every investor in the market today is if this gravity-defying asset can do it again.
The Bears want you to focus on the -77% bear market, as they have for all of the four major drawdown Bitcoin has experienced. You will not hear one Bitcoin Bear admit the truth, which is that Bitcoin has smashed every single performance record in equities within 15 brief years.
Source: YCharts
Yet, there is key evidence that shows how Bitcoin is stronger today than it was during the previous three drawdowns. The reason you don’t want to ignore this is because – despite steep +80% selloffs — Bitcoin has reclaimed new highs within 3.5 years, every time. Therefore, it’s not only the size of gains Bitcoin has provided which places it as the #1 asset of all-time yet it’s the speed in which this is accomplished that is also remarkable.
I want my readers to be armed with facts – not emotion – and what I’m presenting below is the culmination of a history of accurate calls that I’ve made in the past on Bitcoin plus new quant-level information presented by Vincent Duchaine of Wealth Umbrella, who has created an automated buy/sell signal in Bitcoin using on-chain metrics.
Below is an illustration of the history of how quickly Bitcoin has reclaimed its all-time high in the previous drawdowns.
The average time period for Bitcoin to reclaim its all-time high is between two to three years, with 3.5 years being the maximum amount of time. The chart shows the max drawdown for each bear cycle in red, followed by the recovery in green.
Keep in mind, that in order to break even after an 80% drop, it requires a stock or asset to go up 400% just to break even. Qulacomm, for example, suffered a similar drawdown in the dot.com bust. It took about 20 years for QCOM to regain its 2000 high. Cisco, another darling of the late 90s, has never recovered its 2000 peak.
This asset came to market during the Great Financial Crisis, and unlike most tech companies on the market today, not only has survived an economic recession, but was, in fact, found traction in 2009 during a time when tech was faltering to withstand macro pressures.
On January 3rd, 2009, the bitcoin network was created when Satoshi Nakamoto mined the starting block of the Bitcoin chain. Within the coinbase of this first block was the text "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks". This note references a headline published by The TimesThe Times and has been interpreted as both a timestamp and a commentary on the instability caused by fractional reserve banking systems. Bitcoin quietly set out to disrupt the centralized banking system, prior to which was inconceivable, at a time that was arguably more uncertain than what we face today.
One reason for this is because Bitcoin has successfully accomplished becoming a global store of value – a feat only a handful of currencies/commodities have accomplished. Many have argued against this claim based on bitcoin’s volatility. Those that make this claim fail to see that the two most popular stores of value – the US Dollar and Gold – have terrible track records.
Sign up for I/O Fund's free newsletter with gains of up to 221% – Click hereSign up for I/O Fund's free newsletter with gains of up to 221% – Click hereClick here
In 2022, gold topped with a ~45% drawdown. It took gold nearly 10 years to reclaim this high, which it was unable to hold. As of today, gold is about 8% below its 2011 high. The US Dollar, arguably, is the worst store of value. Since 1913 it has lost 97% of its purchasing power. Bitcoin, on the other hand, is up over 28 million percent since it first started trading in 2010, and has recovered from its bear cycles in a relatively short amount of time. It’s no wonder that citizens of emerging markets – who face extreme inflation — love this store of value.
This specific utility in Bitcoin is further backed when we correlate crypto adoption to a specific county’s level of corruption and/or monetary instability. For example, some of the counties with the highest crypto adoption are Ukraine, Russia, Argentina, Turkey, Brazil, just to name a few.
To these people, Bitcoin offers a secure and efficient exit from the inflationary turmoil and centralized manipulation of their personal earnings. In essence, the lofty goal Satoshi Nakamoto established in the October 2008 white paper, which was to offer an exit from the fiat system, has manifested today in real-time.
Bitcoin’s Upcoming Rally – What You Need to Know
Bitcoin has no earnings reports, management overhauls, or supply chain disruptions that can affect its price. Anytime humans come together in a codified arena and begin trading an asset with their instinct for security as the primary driver, patterns develop across price history. Therefore, in order to determine what Bitcoin does next, we must measure sentiment.
One of the simplest patterns to measure is that an uptrend moves in 5 waves up, then corrects in a 3 waves pattern down. Once we get 5 waves up and 3 down, we then repeat this pattern in a fractal manner. As of now, since the 2018 low, we only have 4 waves in place, which implies that we have one more 5th wave push before the larger bull cycle is over.
A few points I want to make about the above chart. We have from the 2021 top a very complete and filled out corrective pattern. Recently, Bitcoin pushed lower on the FTX scandal, which has now provided us with the first bullish divergence on a weekly chart since the 2021 bear market began. This is when price goes lower with less momentum. This tends to mark the near end of large drawdowns.
Another one of my favorite patterns can be found in the detrend oscillator below. This is simply measuring the difference between two moving averages, and when set to a seven-year period, it tends to provide very interesting signals. Most importantly, the oscillator is currently finding support at the 2018 low and the oscillator is now building a new uptrend. When a new uptrend is building, this oscillator will tend to build this new uptrend on prior crash lows, which is playing out now.
Note: Knox Ridley is holding a weekly market webinar on Thursday, December 15th at 2:30 p.m. Eastern for I/O Fund Members to go over a detailed buy plan for Bitcoin, plus how he hedges Bitcoin when needed. Sign up today.Sign up today.
The chart below shows a general early warning sign of when the trend is changing. The red line going down the chart is a 45 degree angle, and has stopped each attempt of a recovery since 2021. Once we reclaim this angle, it will mark an early and meaningful change in trend. As of now, that level is around $18,100.
On-Chain Analysis
This conclusion is further backed up by on-chain analysis, which is a field of study that ignores price action, and instead looks at the fundamentals, utility, and transaction activity of cryptocurrency and blockchain data.
Dr. Vincent Duchaine of Wealth Umbrella is an A.I. and Machine Learning engineer. His team spent several months analyzing on-chain metrics within the Bitcoin ecosystem to create an automated risk-on/risk-off signal for retail investors. Vincent stated that most of the on-chain metrics his team analyzed point towards Bitcoin forming a major bottom.
Sign up for I/O Fund's free newsletter with gains of up to 221% – Click hereSign up for I/O Fund's free newsletter with gains of up to 221% – Click hereClick here
The level of most metrics is such that we could have already seen it at $15.5k, while other metrics suggest that we could see the price drop down to $13.2K in a final spike down.
Here are some examples of on-chain metrics from Wealth Umbrella that are providing rare signals that have only been seen around major lows:
Shown below, the supply of bitcoin hasn’t moved in more than a year and was barely affected by the FTX scandal. Even after the recent drop, the supply of Bitcoin hovers at a near record high of around 67%, and again, this level hasn’t moved in more than a year
Previous major events, such as the Mt Gox debacle in February 2014, or the price collapse in November 2018, saw a retracement in the range of 2-3% on this metric. Meanwhile, the FTX scare only reduced this value by 0.81%. Ultimately, what this is telling us is that fewer market participants are now willing to sell their Bitcoin, which historically has put a floor under Bitcoin.
The recent low also was accompanied by a new considerable spike of outflows from exchanges. Despite a lower low on the price, this indicator didn’t make a new high, which shows that less and less people are now willing to sell their Bitcoin.
This type of behavior has been observed at bottoms (particularly in 2015). It’s also worth noting that the June spike was also in the same range than the 2015 bottoming zone and higher than what we saw in 2018.
Another interesting metric is the Bitcoin percentage of supply being held in profit for the addresses that were active in the last 7 years7 years. This is helpful to mitigate the effects of long term HODLers or lost supply. Here, we can see that we are now getting pretty close to the all-time low of ~30% of the supply being held in profit, which is the type of capitulation that marks meaningful lows.
Overall, most on-chain metrics from any layers of the Bitcoin ecosystem is providing rare readings that tend to flash around major bottoms. Until these metrics recover it is hard to say with accuracy if the bottom is already in or if we have more way to go in this correction.
One data set that suggests we could go lower is the relationship between Bitcoin’s Market Cap and its Thermocap. Thermocap is a more realistic means to calculate the size of Bitcoin, instead of using Market Cap. It was first introduced by Nic Carter in 2018, and is the cumulative sum of revenue in USD that miners have generated to secure the Bitcoin network. This can be calculated by doing a summation of the value of each of the roughly 19 million existing Bitcoins at the price they were issued. By using this metric, lost coins and static coins, like the 800,000 coins mined by the mysterious Satoshi Nakamoto, are counted in the total supply at the price they were originally mined.
Wealth Umbrella found that the price of Bitcoin relative to its Thermocap is a great method for identifying high value zones that tend to mark lows. We have entered that zone recently, which is rare, but also supporting another low deeper into this value zone is possible. However, this indicator, based on prior extreme drops, suggests that the current drawdown could see us go towards the $13,000 region before putting in that meaningful low.
Conclusion:
In conclusion, the adoption of Bitcoin beyond retail interest is growing. We are seeing more and more institutional investors, economies and businesses adopting Bitcoin. Though we are in the 4th bear cycle in Bitcoins history, the prior 3 cycles suggest where we are is a rare buying opportunity. There is ample evidence to support the $15,500 level is either a major low or very close to a major low. Both the technical and on-chain analysis support this. As Bitcoin continues to integrate into the global economy, we expect both the volatility and epic returns to calm down. For now, we are content buying Bitcoin at these lows with a long-term mindset.
On Thursday, December 15th at 2:30 pm Eastern, we will be providing our weekly market webinar where we will discuss a buy plan for Bitcoin, including how to hedge Bitcoin when needed. Our goal is to provide context, as well as identify actionable exits and entries for investors. We have used this information to successfully build positions at their lows this year plus we have successfully hedged our portfolio multiple times in 2022.
