Big Tech capex is a leading indicator for AI semiconductor companies and has been a secular tailwind for our holdings, such as Nvidia and AMD. The combined capex of Big Tech companies has increased from $41.4 billion in 2017 to $150.6 billion in 2022, growing at a CAGR of 29.5%. In the recent earnings calls, management teams from big tech companies are indicating they will continue to invest in AI.
On a side note, increased capex related to AI does not mean AI stocks will move in a linear fashion, rather we track data like this to help us determine what to buy during selloffs, and at the bottom of selloffs.
Semiconductor Market Update
According to the Semiconductor Industry Association (SIA), global semiconductor sales were up 1.9% MoM and down (-4.5%) YoY in September to $44.9 billion. Q3 global semiconductor sales were up 6.3% QoQ and down (-4.5%) YoY to $134.7 billion.
John Neuffer, SIA President and CEO said, “Global semiconductor sales increased on a month-to-month basis for the seventh consecutive time in September, reinforcing the positive momentum the chip market has experienced during the middle part of this year,”increased on a month-to-month basis for the seventh consecutive time in September, reinforcing the positive momentum the chip market has experienced during the middle part of this year,” he further said, “The long-term outlook for semiconductor demand remains strong, with chips enabling countless products the world depends on and giving rise to new, transformative technologies of the future.”
Meanwhile, South Korean exports rose in October as semiconductor exports reported the smallest drop since August 2022 of (-3.1%) YoY in October. Chip sales helped the rise in the country’s exports for the first time in about a year.
Management Commentary on Big Tech Capex
Meta
Meta spent $32.04 billion in capex in 2022, up 66.5% YoY. 2023 has been a ‘Year of Efficiency’ and reducing capex was a priority for the company. Reduced spending in 2023 was possible due to cost savings, particularly in non-AI servers and the capex shift to 2024.
Susan Li, CFO of Meta, said in the recent earnings call. “Capital expenditures were below the prior year levels primarily due to lower server and data center construction spend as we prepared to shift to our new data center design, as well as payment timing.”to lower server and data center construction spend as we prepared to shift to our new data center design, as well as payment timing.”
The management during Q3 results lowered the upper range of the 2023 capex. It is expected to be $27 billion to $29 billion from the earlier reduced estimate of $27 billion to $30 billion, representing a YoY decline of (12.6%) at the mid-point. However, they expect higher capex for next year in the range of $30 billion to $35 billion, representing a YoY growth of 16.1% at the mid-point. The CFO said in the earnings call, “With growth driven by investments in servers, including both non-AI and AI hardware, and in data centers as we ramp up construction on sites with the new data center architecture we announced late last year.”With growth driven by investments in servers, including both non-AI and AI hardware, and in data centers as we ramp up construction on sites with the new data center architecture we announced late last year.”
Microsoft
Microsoft spent $28.40 billion in capex in 2022, up 3.3% YoY. YTD September 2023, the company has already spent $29.7 billion and therefore will see a significant jump in capex for the year 2023, helped by investments in cloud and AI.
Amy Hood, CFO of Microsoft, said in the recent earnings call. “Capital expenditures, including finance leases were $11.2 billion to support cloud demand, including investments to scale our AI infrastructure. Cash paid for PP&E was $9.9 billion.” including investments to scale our AI infrastructure. Cash paid for PP&E was $9.9 billion.” She further added, “We expect capital expenditures to increase sequentially on a dollar basis, driven by investments in our cloud and AI infrastructure. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure buildout.”driven by investments in our cloud and AI infrastructure. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure buildout.”
Nvidia had announced last year that they have a multi-year collaboration with Microsoft to build a giant AI supercomputer using thousands of Nvidia GPUs, Nvidia Quantum-2 InfiniBand, and full stack of Nvidia AI software to cater to the growing demand for AI.
Alphabet
The company spent $31.49 billion in capex in 2022, up 27.8% YoY. In the recent quarter, the company’s capex grew by 10.7% YoY to $8.06 billion. YTD September 2023, the capex was $21.3 billion down (-11.1%) YoY. However, the company will see an increase in Q4 and continue to grow in 2024.
Ruth Porat, CFO of Alphabet, said in the recent earnings call. “Finally, our reported CapEx in Q3 was $8 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers, followed by data centers, reflecting a meaningful increase in our investments in AI compute.reflecting a meaningful increase in our investments in AI compute.
The growth in reported cash CapEx in Q3 is somewhat muted due to the timing of supplier payments, which can cause variability from quarter-to-quarter. We continue to invest meaningfully in the technical infrastructure needed to support the opportunities we see in AI across Alphabet and expect elevated levels of investment, increasing in the fourth quarter of 2023 and continuing to grow in 2024.” We continue to invest meaningfully in the technical infrastructure needed to support the opportunities we see in AI across Alphabet and expect elevated levels of investment, increasing in the fourth quarter of 2023 and continuing to grow in 2024.”
She further clarified to an analyst that “2024 aggregate CapEx will be above the full year 2023.”“2024 aggregate CapEx will be above the full year 2023.”
The main takeaway is that the investment in technical infrastructure is growing and will continue to grow in 2024. There is an increasing shift in investment in technical infrastructure (i.e., AI and cloud) compared to other capex like office facilities, which is of prime importance for our portfolio. Ruth had clarified the change in shift in the Q4 2022 earnings call, “We're increasing our investments in technical infrastructure. And that's not just for AI. That's to support investments across Alphabet, in particular in Cloud as well. And at the same time, we're meaningfully decreasing our CapEx for office facilities.”we're meaningfully decreasing our CapEx for office facilities.”
Amazon
The company spent $58.62 billion in capex in 2022, down (-2%) YoY. The key takeaway is the company’s technological infrastructure spend is increasing. To understand the breakup of Amazon’s capex, we looked at some of the other previous earnings calls and understand technology infrastructure spend to be over 50% of the total capex. Brian Olsavsky, CFO of the company said in the Q2 2022 earnings call, “In 2021, we incurred approximately $60 billion in capital investments. , “In 2021, we incurred approximately $60 billion in capital investments. About 40% of that is comprised of technology infrastructure, primarily supporting AWS as well as our worldwide stores business. Another 30% of the $60 billion was fulfillment capacity and a little less than 25% was for transportation, remaining 5% was comprised of things like corporate space and physical stores, “In 2021, we incurred approximately $60 billion in capital investments. About 40% of that is comprised of technology infrastructure, primarily supporting AWS as well as our worldwide stores business. Another 30% of the $60 billion was fulfillment capacity and a little less than 25% was for transportation, remaining 5% was comprised of things like corporate space and physical stores.” He further said, “We expect infrastructure to represent a bit more than half of our total capital investments in 2022.”“We expect infrastructure to represent a bit more than half of our total capital investments in 2022.”
The guidance for 2023 capex is $50 billion, down (14.7%) YoY. However, technology infrastructure continues to grow. Brian said in the recent earnings call. “Now, let's turn to our capital investments. We define our capital investments as a combination of CapEx plus equipment finance leases. These investments were $50 billion for the trailing 12-month period ended September 30, down from $60 billion in the comparable prior year period. For the full year 2023, we expect capital investments to be approximately $50 billion compared to $59 billion in 2022. We expect fulfillment and transportation CapEx to be down year-over-year, partially offset by increased infrastructure CapEx to support growth of our AWS business, including additional investments related to generative AI and large language model efforts.”We expect fulfillment and transportation CapEx to be down year-over-year, partially offset by increased infrastructure CapEx to support growth of our AWS business, including additional investments related to generative AI and large language model efforts.”
We will be listening closely for 2024 capex discussions next quarter.
Conclusion
We continue to monitor Big Tech capex commentary and are encouraged by Meta’s recent guide for FY2024. Meta is the only company that has provided this level of visibility. In addition to a potential increase in capex from Big Tech, we are hearing across the board that a higher allocation of capex is going toward AI infrastructure.
With that said, it’s normal for cloud IaaS to go through periods of optimization. Given Meta’s guide, we are hopeful a period of optimization will not happen in 2024. Meanwhile, we will continue to closely monitor Big Tech capex comments closely as an important proxy for AI accelerators.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this analysis.
Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.
Broad Market Analysis
The Larger Trend (S&P 500)
Holding the 4163 SPX level would be the deciding line between how we approach risk for the rest of the year. My primary view was that the S&P 500 (SPX) would see one more swing higher into early 2024 as long as we held this region. We have broken this level since and found a low, so far, at the 4103 SPX level. This move has altered how I view this market, and also how we plan to manage our portfolio.
Because of this, I am maintaining the two general counts; however, I am shifting my primary count to the Red count, and having the Green count as an alternative.
Red – The bear market that started in January of 2022 is still playing out. In Elliott Wave speak, 2022 was the A wave, 2023 was the B wave, and we are starting the final leg of this secular bear market, called the C wave. In other words, 2023 was a cyclical bull market within a secular bear market.
C waves are relatively easy to track because they are always 5 wave patterns. Unlike a 3 wave pattern, they tend to follow set parameters, have little room for alternative interpretations and allow for precise targets. This is the good news. The bad news is that the C wave is the most dramatic and emotional part of a correction.
If this is playing out, then we are completing the 1st wave that makes up the larger C wave. What follows the 1st wave is the 2nd wave bounce, which I believe we are in. The 3rd wave drop is where the bulk of the destruction will happen. The fact that the drop off the July top is a 5 wave pattern, this potential is present and risk remains elevated.
I do not see a recession developing in Q3, and still do not today, based on the data. So, any top would mean an “event” would likely pull forward a recession, and therefore a market top. Since then, we have had another international event occur, which the market has used to push below our 4163 critical support, forcing us to alter our primary count.
Green – This is now my alternative scenario. It is still possible, especially after so many FAANGs reported favorable earnings. However, the only difference between the Red and Green count is how high this final bounce will go – the Green targets are anywhere between 300 – 600 SPX points above the Red targets.
While I do think the odds of SPX reaching a new high has diminished due to the depth of this correction, I do believe the NASDAQ-100 and a handful of FAANGs will still see higher highs, while most stocks and indexes see lower highs.
2023 Uptrend and Top
If we zoom in on the structure of the 2023 cyclical bull market, there are a few visuals worth noting. For one, the depth of this drop has clearly broken through the trend channel that has held this move in place.
Fourth waves can, and sometimes do, break through the trend channel, but they need to reverse back into the channel quickly, which we have just seen. If this is a 4th wave, and it did temporarily break the trend channel, expect the 5th wave to be fast and nearly vertical. The next pullback will tell us more.
Secondly, note the structure of the drop from the July high. It is clearly 5 waves, which has decreased the probabilities in the Green count and increased the probabilities of the Red count. The reason for this is because it builds the case for the C-wave. These patterns are fractal, so a smaller 5 wave pattern builds into the larger. We now have what can be counted as a smaller 5 wave pattern in place, which is concerning.
The Last Bounce
The above image sums up where I think the next move will take us. My primary count is Red, which means we will see another drop then push higher into the 4400 SPX region. If this count is in play, the next drop should hold the below red trend line, or even a little lower towards 4238 SPX, at most. This would be the retest of the trend channel breakout.
If we instead break below it, the odds will increase that the correction that started in July is not over. This is marked in Blue and has us making one more drop towards the 4000 SPX region before completing the larger 1st wave pointing down. If this plays out, the Green count will get removed from the board.
If we are in the Green count, we will not know until we break above 4490 SPX.
In conclusion, I only see one more bounce in the S&P 500. Whether that bounce takes us to the 4400 SPX region or towards the 4700 – 5000 SPX region, will not change the likely outcome – any bounce we see will likely get retraced plus all of the 2023 cyclical bull market in 2024. Each investor will need to determine their own risk tolerance, time horizon, and ability to be nimble if they want to play this developing bounce.
Positions Report of Nvidia, Microsoft, and Netflix
Nvidia (NVDA)
NVDA appears to be one of the stronger FAANGs, like AMZN, META, MSFT above – it appears to be working through an incomplete uptrend, suggesting a 5th wave higher is needed. What is concerning is that the red count provides that 5th wave higher, which suggests a bigger top is already in. This would support some of the institutional activity in the $440 region, which suggests selling.
As usual, the upcoming earnings report will be paramount to deterring what count is in place for NVDA, and the larger market. As long any further weakness holds $380, the green count is still active. Any move below $340 will fully confirm the top is in.
Microsoft (MSFT)
MSFT is very close to the upper targets we laid out weeks ago. At $378 and we should see a pullback. If that pullback is a 5-wave drop, it will signal a larger top is developing. However, it still needs a higher high to complete that 5th wave. Until we get that, this could play out in many ways. Any imminent drop below $324 will be concerning. Below $307 and the top is in.
Netflix (NFLX)
I’m still considering the July high as a bigger top. This doesn’t mean we can retest that level and even push slightly higher in the coming weeks/months. This would be my Green count below. Note how the drop from the July peak was a 3 wave pattern, followed by what looks like another 3 wave bounce. This lines up with the big picture that we are tracking, which is that NFLX is in a large degree 2nd wave retrace. If the next drop is a 5 wave move, it will line up with this thesis. If instead we get a 3 wave retrace, it will support the Green count. So, the next decline in NFLX will be very telling.
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For reference to terminology used, please look at technical analysis under our resources section here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.here. Regarding the horizontal lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave counts are meant to provide context. Each colored count represents the most probable paths given the current price data. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play, so that we can better manage risk.
Broad Market Analysis
The Larger Trend (S&P 500)
In last month’s report, I discussed the importance of holding the 4163 SPX level. This level would be the deciding line between how we approach risk for the rest of the year. My primary view was that the S&P 500 (SPX) would see one more swing higher into early 2024 as long as we held this region. We have broken this level since and found a low, so far, at the 4103 SPX level. This move has altered how I view this market, and also how we plan to manage our portfolio.
Because of this, I am maintaining the two general counts; however, I am shifting my primary count to the Red count, and having the Green count as an alternative.
Red
The bear market that started in January of 2022 is still playing out. In Elliott Wave speak, 2022 was the A wave, 2023 was the B wave, and we are starting the final leg of this secular bear market, called the C wave. In other words, 2023 was a cyclical bull market within a secular bear market.
C waves are relatively easy to track because they are always 5 wave patterns. Unlike a 3 wave pattern, they tend to follow set parameters, have little room for alternative interpretations and allow for precise targets. This is the good news. The bad news is that the C wave is the most dramatic and emotional part of a correction.
If this is playing out, then we are completing the 1st wave that makes up the larger C wave. What follows the 1st wave is the 2nd wave bounce, which I believe we are in. The 3rd wave drop is where the bulk of the destruction will happen. The fact that the drop off the July top is a 5 wave pattern, this potential is present and risk remains elevated.
As stated last month, I do not see a recession developing in Q3, and still do not today, based on the data. So, any top would mean an “event” would likely pull forward a recession, and therefore a market top. Since then, we have had another international event occur, which the market has used to push below our 4163 critical support, forcing us to alter our primary count.
Green
This is now my alternative scenario. It is still possible, especially after so many FAANGs reported favorable earnings. However, the only difference between the Red and Green count is how high this final bounce will go – the Green targets are anywhere between 300 – 600 SPX points above the Red targets.
While I do think the odds of SPX reaching a new high has diminished due to the depth of this correction, I do believe the NASDAQ-100 and a handful of FAANGs will still see higher highs, while most stocks and indexes see lower highs (more on this below).
2023 Uptrend and Top
If we zoom in on the structure of the 2023 cyclical bull market, there are a few visuals worth noting. For one, the depth of this drop has clearly broken through the trend channel that has held this move in place.
Fourth waves can, and sometimes do, break through the trend channel, but they need to reverse back into the channel quickly, which we have just seen. If this is a 4th wave, and it did temporarily break the trend channel, expect the 5th wave to be fast and nearly vertical. The next pullback will tell us more.
Secondly, note the structure of the drop from the July high. It is clearly 5 waves, which has decreased the probabilities in the Green count and increased the probabilities of the Red count. The reason for this is because it builds the case for the C-wave. These patterns are fractal, so a smaller 5 wave pattern builds into the larger. We now have what can be counted as a smaller 5 wave pattern in place, which is concerning.
The Last Bounce
The below image sums up where I think the next move will take us. My primary count is Red, which means we will see another drop then push higher into the 4400 SPX region. If this count is in play, the next drop should hold the below red trend line, or even a little lower towards 4238 SPX, at most. This would be the retest of the trend channel breakout.
If we instead break below it, the odds will increase that the correction that started in July is not over. This is marked in Blue and has us making one more drop towards the 4000 SPX region before completing the larger 1st wave pointing down. If this plays out, the Green count will get removed from the board.
If we are in the Green count, we will not know until we break above 4490 SPX.
In conclusion, I only see one more bounce in the S&P 500. Whether that bounce takes us to the 4400 SPX region or towards the 4700 – 5000 SPX region, will not change the likely outcome – any bounce we see will likely get retraced plus all of the 2023 cyclical bull market in 2024. Each investor will need to determine their own risk tolerance, time horizon, and ability to be nimble if they want to play this developing bounce.
Strong Supporting Markets
NASDAQ-100 (NDX)
While it is questionable whether the S&P 500 will push to new highs in the Green count, I think the odds are quite high that the NASDAQ-100 does. Note how NDX did not break below the trend channel. This was a prolonged and complex 4th wave, but it did not go deep enough to invalidate the larger count, which is pointing towards a 5th wave higher to complete large trend.
Amazon (AMZN)
Unlike many FAANGs, Amazon has, what appears to be, an incomplete pattern. It needs a 5th wave higher to complete the move off the January low. My primary target for this move is $155 – $160. Once Amazon gives us this 5th wave higher, it will be a big warning to the bulls, because it will have a complete pattern. If accurate, this should be followed by a larger drop.
Meta (META)
Meta is another FAANG that appears to have an incomplete uptrend. Note how the correction, so far, appears to be a 3 wave move that overlaps. This is characteristic of a corrective move, and also implies that we should see a 5th wave higher. Meta appears to have the most upside of all the remaining FAANGs.
Microsoft (MSFT)
MSFT is another FAANG that appears to have an incomplete uptrend. I’m showing the monthly chart here so you can see the larger trend in place. Many stocks within other sectors of the market have completed their very large 5 wave pattern off the 2009 low. A few, like MSFT, are behind, and still have one more high before completing this large pattern. My target for MSFT will around $378. Once this final leg is complete, I expect a deep retrace to begin.
The above charts in Big Tech are the clearest that I track. They have higher odds of making that final 5th wave move to new highs. Why this is important is because they can be our guides in better managing risk. Once these charts complete that 5th wave to new highs, the risk will be elevated for the bulls. On the other hand, if they instead fail, we will be able to pivot relatively quickly.
Weak Supporting Markets
Just as the above patterns can be a guide to help determine heightened risk, so can some of the weaker markets. The below markets have the same pattern is place – a large top (B wave), followed by a 5 wave decline from the recent high (early start of the C wave). So, these markets are farther along in their drawdown than the healthier ones above.
Equal Weight S&P 500 (RSP)
RSP proves that the weighting of the same stocks matters a lot. While SPX is a contender for one more high in 2023, RSP failed to break above the February highs. What’s notable is that we have broken through the lower trend line in a 5 wave move. The next bounce, which we are currently in, should be a 3 wave move that hits the above targets on the chart.
Transportation (IYT)
This index has also broken the major trend line in a deep 5 wave move. We should see one minor drop followed by a final push higher. This index, along with many of its constituents, looks quite unhealthy and tends to lead the market.
Regional Banks (KRE)
This index is the cleanest. We have a clear 5 wave drop, followed what looks like the start of the 2nd wave bounce. We will likely see a little more downside before getting that final push higher into our wave 2 targets.
Ark Innovation (ARKK)
Though ARKK has the same 5 wave pattern from the recent high, it isn’t as clean as the above charts. There is the potential for a bigger move higher, which would line up with the SPX Green count. This ETF will help determine where the broader market goes, and the next pullback will tell us a lot. However, even if we do see a bigger move higher, this ETF has topped and it will be years before it sees new highs.
In conclusion, the bifurcation in this market is only growing. While some stocks have incomplete uptrends, suggesting one more high, others have topped and are looking to make another lower low soon. All provide key clues on when this already risky market will approach maximum risk. As stated before, we are already quite defensive and ready to hedge 100% of our portfolio when our signal flips, but we will use the above patterns to help us de-risk even more in the coming weeks.
Macro
We have warned our members all year that the fight against inflation is far from over. The disinflation that we saw was not only historic, but it was driven predominantly by a deep deceleration in energy prices, as noted by the 3-month annualized readings below.
Note how Core Inflation stayed within the 4%-5% range through most of 2022 and 2023. Instead, we saw food and energy decelerate, causing the disinflation that rallied equities into 2023.
As we warned since June, energy was putting in a big bottom, and it should put pressure on inflation numbers. This is exactly what has happened. We have seen the headline CPI numbers bottom well above the FED’s 2% target, followed by 3 months of reacceleration.
What’s concerning is that not only has energy prices reaccelerated, but so have core prices. Even though we believe the FED has paused their rate hike campaign, like in all instances throughout all of modern market history, a recession is needed to truly tame inflationary pressures. I do not believe this time is different.
However, the economy is not in agreement. While we are seeing some soft spots, employment remains relatively strong to claim an imminent recession is underway.
For one, continuing claims for unemployment are staying stable. Once we see a sharp jump here, it is a warning sign. Also, some other key employment metrics that I tracks – Private Sector Quits Index, Employment Cost Index, and Job Openings/Total Unemployment – are all well above the pre-COVID highs. Though they are weakening, they are still quite strong relative to the pre-COVID levels, suggesting that they are not recessionary, yet.
Heightened unemployment is necessary in recessions. Though we are seeing a resilient employment market, it’s worth noting that some of the leading indicators for employment are flashing warnings.
For one, Total hours Worked is trending down and now noticeably bellow the pre-COVID highs. Also, one of the first metrics to drop for employment is temp hours worked. This metric is seeing its fourth month of deceleration to the downside.
So, while the overall employment market is showing resilience, under the hood, we are starting to see cracks form. This further confirms that we are on the clock for a coming recession.
Another point worth mentioning is the relationship between Japan, Oil, and the NASDAQ-100. Next to the NASDAQ-100, the Japanese Nikkei is one of the strongest markets in the world. Interestingly, the Nikkei has been leading the NASDAQ-100 for some time. The below chart shows this phenomenon – the Nikkei is in red while the NASDAQ-100 is in blue. Note how the Nikkei tends to bottom and top before the NASDAQ-100.
The reason for this is academic. What really matters is that the correlation is still intact, as the Nikkei is also working on an incomplete uptrend pattern.
The drop in the Nikkei is quite a mess. Note the overlapping waves with no clear direction. This is typical of 4th waves, and supports that the Nikkei is setting up for that final swing higher.
Japan also imports all of their oil, which also supports this thesis. If oil prices continue higher, this will compress Japanese margins, and likely cause their stocks to go lower. The current state of oil appears to be in the sharpest part of its current correction. My targets for this drop are around $76 – $70.
If the current drop in oil holds $70, and then starts turning back up, it will also signal that we are close to the end of this push higher in equities. Note how the larger pattern is a 5 wave move off the low, now followed by a 3 wave retrace. This is threatening the return of a large uptrend in oil, as well as many other commodities, which will increase inflationary pressures.
So, how oil reacts around the $70 region will be very important. Though most investors are starting to accept the sticky inflation theme we have been warning about, few are aware that oil is setting up for a potential move to new all-time highs. This needs to be monitored daily for risk management purposes. If oil can push below $70, then this thesis will be negated. This will be very bullish for equities, and potentially be the catalyst for the Green count in SPX
In conclusion, while the market is starting to accept that inflation is stickier than previously thought, few are talking about some of the setups in key commodities, like oil, that have the potential to push to new highs. If this happens, it will catch the market off guard, as most expect a softening economy to lead into a recession, which will pull down commodity prices, and therefore inflation. The implication, if accurate, is a true stagflation environment, which would be the catalyst for the larger C-wave drop to fresh lows. A lot is riding on how oil trades over the coming weeks.
I/O Fund Portfolio
We are currently sitting on about 25% cash. This is very defensive, and if we continue to see the above markets and stocks hit their targets, we will continue to raise cash. The below pie chart is how we are allocating the other 75% of our funds. This represents all funds invested.
Advanced Micro Devices (AMD)
AMD has broken out above the downtrend channel. This further supports the Green count that has the $130 region as a final target before putting in a larger top. AMD is due for a pullback – note how the detrend oscillator is at the same amplitude that saw the 2018 and 2020 tops. Prior tops tend to mark current tops with this oscillator. As long as the pullback holds $93, I expect the $130 target to be met in the coming weeks. Below $93 and this thesis will be threatened in favor of the Red count below.
Nvidia (NVDA)
NVDA appears to be one of the stronger FAANGs, like AMZN, META, MSFT above – it appears to be working through an incomplete uptrend, suggesting a 5th wave higher is needed. What is concerning is that the red count provides that 5th wave higher, which suggests a bigger top is already in. This would support some of the institutional activity in the $440 region, which suggests selling.
As usual, the upcoming earnings report will be paramount to deterring what count is in place for NVDA, and the larger market. As long any further weakness holds $380, the green count is still active. Any move below $340 will fully confirm the top is in.
Microsoft (MSFT)
MSFT is very close to the upper targets we laid out weeks ago. At $378 and we should see a pullback. If that pullback is a 5-wave drop, it will signal a larger top is developing. However, it still needs a higher high to complete that 5th wave. Until we get that, this could play out in many ways. Any imminent drop below $324 will be concerning. Below $307 and the top is in.
Bitcoin (BTCUSD)
Bitcoin’s correlation to tech stocks has completely detached. It is on its own path, which seems to have more of a correlation to global liquidity as well as banking concerns. I’m not sure what the catalyst for this bullish count will be, but so far, it is still valid and playing out. We need to see a fresh vertical move up from here to further confirm this count. If Bitcoin instead gets below $30,000, it will get concerning, and put the below bull path in jeopardy.
CrowdStrike (CRWD)
So far, CRWD is following the bullish count we laid out months ago. It appears to be tracing a leading diagonal pattern for its 1st wave. If true, we still need a 4th wave drop and 5th wave push higher to confirm it. I’m looking for a top soon, followed by a 4th wave pullback to $166 – $150. As long as this pullback hold $147, I’m leaning into the bullish path, which has us targeting $215 before the bigger pullback takes hold.
Netflix (NFLX)
I’m still considering the July high as a bigger top. This doesn’t mean we can retest that level and even push slightly higher in the coming weeks/months. This would be my Green count below. Note how the drop from the July peak was a 3 wave pattern, followed by what looks like another 3 wave bounce. This lines up with the big picture that we are tracking, which is that NFLX is in a large degree 2nd wave retrace. If the next drop is a 5 wave move, it will line up with this thesis. If instead we get a 3 wave retrace, it will support the Green count. So, the next decline in NFLX will be very telling.
Aehr Test Systems (AEHR)
The one thing this drop does have going for it is that we only have a 3-wave drop from the high. If we see a bounce back into the $26-$28 level (4th wave), followed by another drop lower (5th wave), then we have reason to be concerned. If this happens, it would be the larger 1st wave pointing lower, which should be followed by a 2nd wave bounce. This would be used to de-risk. If the Green count has any chance, AEHR needs to get back above $35 and not make another low.
Ethereum (ETHUSD)
The bullish structure in ETHUSD continues to build. I wouldn’t be concerned about Ethereum not breaking out with Bitcoin, yet. It’s due for a slight pullback, which should hold $1635. Below here is concerning. If we do hold this support zone, the next move will need to be a vertical breakout.
Super Micro (SMCI)
SMCI continues to frustrate and confuse. The patterns are messy, and just when I think a have a handle on it, it gets more confusing. What I do know for certain is that the move down from the October high is a clear 5 waves. Either this is all of the C wave of the 4th wave correction (Green), and we are setting up for new highs, or this is the 1st wave of a larger C wave pointing down (Red). The bounce, so far, appears to be corrective, which elevates the risk here. A break below $230 – $222 will confirm the red count. We need to get above $275 to confirm the Green count.
Marvell (MRVL)
Once MRVL broke below the $52 level, the risk became elevated. What’s frustrating about the chart is that we have overlapping waves up and down. The current drop cannot be counted as the start of a larger drop, yet. If we get one more drop towards $46-$44, then we have this confirmation, and the top will likely be in for MRVL. If this happens, the next bounce is where you de-risk. If the Green count has any chance, this has to be a low, and we need to turn back up from here.
CloudFlare (NET)
This Gann chart tells the current story with NET. It’s in a very large resistance zone. The 1×1 line (45 degrees) from the top is around $64-$66. Also, two difference techniques that I use to find support and resistance confirm the same level, and all three of my moving averages are also in this zone. If NET can break above this zone at $66, retest it as support and hold it, I’d consider that quite bullish and would look to add. Instead, if we see a strong reversal here that takes us below the $54, I’d start getting concerned.
Chainlink (LINKUSD)
This is my general roadmap for LINKUSD. We should see some type of top around $14-$18. If the following pullback is a 3 wave move, then that will confirm the blue count presented. We would use that drop to add more to our position. If instead, we see a 5 wave drop from that high, it would be concerning, and we may use that to reduce our exposure. As of now, I see no reason to be pessimistic, as the next drop will tell us everything.
This article was originally published on Forbes on Nov 3, 2023,01:00am EDTForbes Forbes on Nov 3, 2023,01:00am EDT
Solar is arguably one of the market’s most sold-off industries at the moment, with the Invesco Solar ETF falling more than 42% YTD as the industry struggles to find growth in a high-rate environment. With implied Fed funds futures suggesting interest rates will remain above 5% through Q2 2024 before slowly dropping to the 3.75% range by year-end 2025, the industry is still facing a high-rate environment with more possible adverse demand effects for multiple quarters ahead.
SolarEdge and Enphase are among the S&P 500’s worst performers this year, falling more than 70% each; a significant weakening in US demand starting in Q2 worsened with weakening European demand in Q3, causing revenues to nosedive. Residential solar companies SunPower, Sunrun, and Maxeon have all declined more than 55% to 70%, as well.
SolarEdge Says Weak EU Demand Caused Q3 Revenue Slump
SolarEdge sent the solar sector for a tumble on October 20th as it pointed to significant weakening in EU demand for a major Q3 shortfall and lower Q4 revenues. Shares fell over -27% as the company cut its revenue guide nearly (20%) from $880M-$920M to $720M-$730M, its gross margin forecast from 28%-31% to 20.1%-21.1%, and its operating margin forecast from $115M-$135M to $12M-$31M. CEO Zvi Lando said the company “experienced substantial unexpected cancellations and pushouts of existing backlog from our European distributors” in the second half of Q3, while installation rates “were much slower at the end of the summer and in September.”
Q3 results reported on Wednesday showed a marginal beat in revenues to $725M, an 1190 bp contraction in gross margin, and a shift to negative EPS, but the focal point of the report was a brutal Q4 guide. Consensus estimates for Q4 heading into the report were floating between $660M to $675M – the actual guide was far lower, with SolarEdge pointing to $300M to $350M in total revenues, with $270M to $325M in solar revenues.
That correlates to a (55%) QoQ decline from Q3’s $725M, and (67%) lower than the nearly $1B in quarterly revenues SolarEdge generated in Q2. Non-GAAP gross margins are expected to decline another 1280 to 1580 bp from Q3’s 20.8% to just 5% to 8% in Q4, including a 130 bp benefit from IRA credits. Given the operating expense outlook and major gross margin contraction, SolarEdge could see Q4 non-GAAP EPS fall further from the ($0.55) reported in Q3 to ($2.40) or lower in Q3 — not even in the same universe at the $0.63 consensus estimate.
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Enphase Earnings Echo Demand Woes
Enphase echoed SolarEdge’s commentary about weakening EU demand, as European revenues fell (34%) sequentially in Q3, after recording +25% QoQ growth in Q2. That’s a pretty swift QoQ decline in European revenues, which Enphase attributed to “high inventory at our distribution partners along with a softening in demand in our key markets – the Netherlands, France, and Germany.”
US revenues fell (16%) sequentially in Q3, continuing a (12%) sequential decline in Q2 as high rates and the shift to NEM 3.0 continued to impact US demand. Management said that in California, the “sell-through of our microinverters was 25% lesser in Q3 compared to Q2 due to the NEM 3.0 transition. It will take a few more quarters for our installers to fully transition to NEM 3.0 and normalize sales to NEM 2.0 levels.”
For Enphase, US revenues have been declining, and Europe’s stronger growth is not enough to absorb the losses in the US; now, that picture is even clearer: California is set to drag on US growth until NEM 3.0’s normalization completes sometime in 2024, while European demand has weakened substantially. Combined, this is causing a snowballing decline in revenues that may not bottom until Q1 or even Q2 2024, one to two quarters later than previously expected.
Enphase guided a nearly (40%) QoQ revenue decline for Q4: $300M to $350M, compared to $551M in Q3 and $711M in Q2. Management provided some clarity on the very low Q4 guide, saying it “reflects approximately $150M of channel inventory correction in the U.S. and Europe. In other words, we are under shipping to the end market demand for our products by approximately $150M. We anticipate under shipment will continue in Q1 and expect our channel inventory to normalize in Q2.”
That raises some doubts about when microinverter shipments will bottom, as shipments are plummeting, falling (24.9%) sequentially from more than 5.1M in Q2 to just over 3.9M in Q3. Q4’s revenue guide suggests microinverter shipments could fall by ~1.5M QoQ to ~2.4M, or the lowest level since Q2 2021.
Source: I/O FUND
A quick V-shaped recovery in early 2024 for microinverter shipments and revenues looks to be out of the picture, based on management’s commentary around inventories and California’s normalization trend. In addition, US residential installations are projected to decline next year, while demand in the Netherlands may have peaked last year and fall through 2025 to 2026.
US Residential Growth Forecast to Decline In 2024
The near-term outlook for solar has definitely taken a hit from high rates impacting demand – a forecast from Wood Mackenzie/SEIA is pointing to a YoY decline in US residential solar installations in 2024, weighed down by a sharp contraction in California. Overall, the group expects installations to drop (4%) in 2024, dragged down by a (38%) contraction in California primarily due to the shift to NEM 3.0.
Q2 recorded growth of +6% QoQ and +30% YoY to 1.77 GW installed, reaching a new record. However, SEIA noted that “growth has not been as strong in traditionally larger markets with lower retail rates like Arizona and Texas, where high interest rates are creating headwinds.” That interest rate headwind has persisted through Q3, into Q4, and most likely will cause demand softening through much of 2024. Combined with a “lower urgency to go solar due to the ITC extension” and heightened recession fears, the broader macro backdrop for solar remains muddled, reflected by Enphase’s and SolarEdge’s troublesome revenue guides.
The long-term outlook for residential is more positive, as growth is expected to pick back up to about +8% on average from 2025 through 2028, boosted by IRA benefits and more projects qualifying for ITC adders. However, that inflection back to growth in 2025 is not set in stone and may not occur as quickly as anticipated, should rates remain at or above 4% heading into the first half of the year.
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EU Key Market Demand at Risk in the Near-Term
SolarEdge cited weakening demand across the EU, while Enphase pointed out softened demand in three key markets: the Netherlands, France, and Germany. These three markets are expected to account for a lion’s share of annual capacity in Western Europe over the next decade, so softening demand in the three nations is not something to be taken lightly.
Source: WOOD MACKENZIE
In the Netherlands, annual installed capacity is forecast to have peaked in 2022 to about 1.8 GW. A further decline from the peak is projected to occur in 2024 before stabilizing around 1.4 GW per year, nearly (22%) lower than 2022’s levels. This decline to stagnation in capacity installed would be a stark contrast to the strong growth seen from 2018 through 2022.
Source: HOLLAND SOLAR
Germany is also seeing some near-term effects to solar demand, although its medium-term and long-term view remains brighter than that of the Netherlands. Germany saw 3.4 GW of solar capacity installed in Q3, a (5.5%) sequential decline from 3.6 GW in Q2 as rooftop solar installations pulled back. September’s installed capacity was just 0.92 GW, a (32%) decline from July’s 1.35 GW additions and the lowest monthly level since February. While this slump in installations is likely to continue through Q4 and possibly extend into 2024, residential’s outlook over the decade is strong: Wood Mackenzie sees Germany’s “residential segment will experience the most growth, with cumulative installed capacity expected to grow fivefold” through 2032.
France witnessed 12% growth in installed capacity in the first half of 2023, with total installed capacity of 1.37 GW. Nearly 42% of the installed capacity in 1H came from fully or partially self-consumed systems, while 94% of installations in Q2 were systems smaller than 9 kW, suggesting the residential market had been relatively robust heading into 2H. Over the long-run, France is expected to see residential solar installations climb, with projections for “cumulative totals for home solar in France to quadruple by 2032.”
Valuations at Multi-Year Lows
Residential solar stocks have seen valuations drop to multi-year lows. Enphase currently trades at 3.77x EV/revenue and 4.4x forward EV/revenue, far below its 5-year median 12.11x multiple and far below the high double-digit multiples it commanded in 2021 and late 2022. SolarEdge’s 1.04x EV/revenue and 1.15x forward EV/revenue also sit far below its 5-year median multiple of 5.17x. Forward P/E ratios for the two have dropped to the teens, nearly 70% lower than their 5-year averages, respectively.
Source: I/O FUND
However, forward revenue projections have pulled back substantially – revenue targets have essentially shifted back by one to two fiscal years.
Source: YCHARTS
As of June 30, Enphase was projected to generate revenues of $3.04B in FY23, before growing to $3.80B in FY24 and $4.72B in FY25. As of October 30, just 4 months later, Enphase’s forward revenue forecast has plunged around (40%): FY24’s forecast has declined by more than $1.6B to just $2.15B, below FY23’s projected $2.3B, while FY25’s forecast has pulled back $1.8B to below $3B– a figure that Enphase was previously expected to hit this year.
SolarEdge was projected to see similar growth, with revenues rising from $4.13B in FY23 to $5.05B in FY24 and $5.89B in FY25. Again, forward projections have pulled back significantly, with FY24’s estimate now just $3.74B, around (26%) lower than it had been on June 30.
Near-term demand weakness in multiple major end markets is the main theme for solar stocks heading into 2024. Forward revenue projections have plummeted as a result, while valuations have reached multi-year lows – Enphase and SolarEdge are trading at deep discounts in anticipation of a bottom in revenues occurring over the next two to three quarters.
By respecting our risk management, the I/O Fund closed Enphase twice with minimal losses. When the fundamental picture changed, we stepped aside. If there is any lesson 2022 has taught tech investors, it’s that long-term buy and hold can create unnecessary losses. In April, we closed Enphase for a (-15%) loss following an earnings analysis for our premium members, avoiding a (-64%) loss from the original cost basis. When we attempted again in September, we closed the position when the setup failed, avoiding the losses from the solar sector selloff and Enphase’s most recent report. We share our trades in real time with our research members.
I/O Fund Equity Analyst Damien Robbins contributed to this report.
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.
Apple posted Q4 results that were roughly in line with expectations: revenues of $89.49 billion met consensus estimates, while EPS of $1.46 beat estimates by about 5.0%. iPhone revenues accelerated sequentially to reach a September quarter record, while Services revenue also rose to a new record, reaccelerating to the high-teens after four quarters of single-digit YoY growth.
Installed devices reached a new all-time high across all geographies and products. CEO Tim Cook said Apple has its “strongest lineup of products ever heading into the holiday season, including the iPhone 15 lineup and our first carbon neutral Apple Watch models.” Supply constraints and reports of weak demand for the iPhone 15 may overshadow the strength of that lineup, but Apple is expecting iPhone sales to rise in the December quarter, while other product revenue will weigh on revenue that is forecast to be similar to last year’s numbers.
Q4 Revenue and EPS:
Q4 revenue of $89.49 billion marginally beat expectations of $89.28 billion, representing a YoY decline of (0.7%).
iPhone revenue of $43.81 billion met expectations, growing by +2.8% YoY and +10.4% QoQ.
Services revenue of $22.31 billion grew by +16.3% YoY.
GAAP EPS of $1.46, up 13.2% YoY, driven by an improvement in net margin and a (2.8%) reduction in share count.
Margins:
Gross margin was 45.2%, 20 bp above management’s guidance of 44% to 45%. Gross margin improved 65 bp QoQ.
Operating margin was 30.1%, an improvement of ~200 bp QoQ and ~250 bp YoY. The improvement was aided by growth in gross margin and operating expenses of $13.46 billion coming in slightly below guidance of $13.5 billion to $13.7 billion.
Net margin was 25.6%, an improvement of ~135 bp QoQ and ~265 bp YoY. Net margin improved to the highest level since fiscal Q2 2022.
FY23 Key Metrics:
Revenue declined (2.8%) YoY to $383.3 billion.
EPS of $6.13 improved +0.3% YoY.
Gross margin of 44.1% improved ~80 bp YoY from 43.3%.
Operating margin of 29.8% declined ~50 bp YoY from 30.3%.
iPhone revenue of $200.6 billion, representing a (2.4%) YoY decline from $205.5 billion.
Services revenue of $85.2 billion, representing a +9.1% increase from $78.1 billion.
Cash and Debt:
Apple had $162.1 billion in cash, equivalents and marketable securities at the end of the fiscal year, with total debt of $105.1 billion. Net cash on hand was $57.0 billion.
Operating cash flow for the full year was $110.5 billion, a YoY decline of (9.5%) from $122.2 billion.
Other Key Metrics:
Q4 saw Apple record a record September quarter for iPhone sales, while iPad and Mac sales declined as Apple lapped a tough comp where it fulfilled significant pent-up demand in the year-ago quarter following factory shutdowns. Mac sales missed estimates by nearly $1 billion, declining (33.8%) YoY to $7.61 billion. Cook said the Mac should have a “significantly better quarter” in the upcoming December quarter, helped by holiday sales and the newly released M3-powered Macs.
However, both Mac and iPad revenues increased about +11.3% sequentially: Mac revenues rose from $6.84 billion to that $7.61 billion figure, while iPad revenues rose from $5.79 billion to $6.44 billion. Wearables, Home & Accessories revenues increased more than $1 billion sequentially to $9.32 billion.
For FY23, product revenue declined (5.7%) YoY to $298.1 billion from $316.2 billion in the previous fiscal year, dragged lower by a ~($10.8) billion decline in Mac revenues, with some softness in iPhone and Wearables, Home & Accessories.
Services Shine Once More
Services stole the show in Q4 after posting four consecutive quarters with YoY growth rates between 5% to 9%, with revenues rising +16.3% YoY and +5.2% QoQ to $22.31 billion. This came in nearly 4.5% above analysts' expectations for $21.35 billion.
Reaching a new all-time high in its installed device base signals further growth lies ahead for Services, especially with the recent price hikes that Apple put into effect for News+, Arcade, and its One bundles. Combined, the price hikes could entail an additional ~$5 billion in annual revenue with just a 15% attach rate to Apple’s more than 1 billion paid subscriptions.
It’s well known that Apple has one of the most loyal customer bases in the world for its products; however, it’s also fair to say that Apple also holds one of the most loyal paying subscriber bases in the world. Paid subscribers have risen at more than 27% annually from 240 million at the start of FY18 to more than 1 billion at the end of FY23. As installed devices continue to grow, paying subscribers should continue to grow hand in hand, providing a strong growth lever for Services.
Services is also seeing its contribution to Apple’s bottom line surge because of that strong growth in paying subscribers. Services contributed $0.39 to each $1 of gross profit Apple generated in Q4; in FY23, Services contributed nearly $0.36 per $1, up +8.8% from the $0.33 per $1 it added in FY22.
Another way to put that: Services contributed almost 40% of gross profit in Q4 and nearly 36% in the full year, despite only contributing ~25% of revenue in Q4 and 22.2% in the full year. That outsized influence down the line is already evident – gross margins continue to expand, rising above 45% in Q4, helping drive +8.3% YoY growth in operating income. As Services begins to approach and surpass 30% of total revenue, that contribution should continue to rise, potentially towards the 50% range.
However, one risk to watch is Alphabet’s antitrust trial, as it could have direct implications for Apple in the event of a negative ruling. Alphabet’s multi-billion dollar payments to Apple for Google to be the primary search engine on Safari across Apple’s devices is at the center of the trial, and that payment is rumored to be ~$19 billion this year. Should the scale of those payments constitute monopolization of the search market, Apple could be set to lose on a lucrative Services revenue stream.
iPhone 15 Demand Under the Microscope
Apple’s new iPhone will be under the microscope, following Apple’s weaker December quarter revenue guide, uncertainties about supply, and lingering questions about China risks.
Speaking with CNBC prior to earnings, Cook said the iPhone 15’s Pro and Pro Max models were still constrained due to elevated demand — the iPhone 15 was estimated to have received 10% to 12% more pre-orders than the iPhone 14.
However, analysts remain cautious about the supply and demand environment: BofA said in mid-October that iPhone 15 availability was improving, UBS said that contracting wait times suggested demand for the new phone looked weak, while Morgan Stanley echoed UBS’ fears, pointing to moderating delivery lead times in late October as another sign of demand weakness.
Counterpoint Research data painted a split picture for early iPhone 15 demand: the research firm said that China sales were down (4.5%) YoY relative to the iPhone 14, while US sales were showing double-digit increases.
Estimates for the December quarter were projecting +4.9% YoY growth to $122.90 billion in revenue, but Apple signaled that the one-week-shorter quarter would see similar revenues, at the $117 billion range. Apple signaled that the extra week last year “added approximately 7 percentage points to the quarter's total revenue,” so it is understandable why Apple would forecast flatter sales YoY in a 13-week quarter this year compared to the 14-week quarter last year. Management did signal that they “expect iPhone revenue to grow year-over-year on an absolute basis.”
Normalization of supply constraints to meet demand and see iPhone sales grow to more than $66 billion would be a positive, although risks remain in China, primarily from high demand for Huawei’s new Mate 60 Pro. China’s sales will be scrutinized, given that the Mate 60 Pro was estimated to have sold 1.6 million units in its first six weeks, and 400,000 units in the two weeks following the iPhone 15 launch in the country.
Revenues had declined (2.5%) YoY and (4.3%) QoQ in the Greater China region in Q4, while December quarter sales last fiscal year also failed to impress, showing a (7.3%) YoY decline. As Apple’s third largest market, generating annual revenues around $70 billion or more, another weak holiday quarter would raise concerns that Huawei could overtake Apple in terms of market share, as it is quickly encroaching on Apple based on recent data from Canalys and Counterpoint Research.
Earnings Call:
Apple’s earnings call reflected the strength of Services, while talking up the growth opportunities in emerging markets and signaling more gross margin expansion.
Apple “achieved all-time revenue records across App Store, advertising, AppleCare, iCloud, payment services, and video, as well as the September quarter revenue record in Apple Music.” CFO Luca Maestri said Apple saw “growth coming from all categories and every geographic segment,” while its “installed base of over 2 billion active devices continues to grow at a nice pace and establishes a solid foundation for the future expansion of the ecosystem.”
In addition, “transacting accounts and paid accounts grew double-digits year-over-year, each reaching a new all-time high. Also our paid subscriptions showed strong growth. We have well over 1 billion paid subscriptions across the services on our platform, nearly double the number we had only three years ago.” That suggests Apple has more than 1.1 billion paid subscriptions, or a ratio of about 1 paid subscription per every 2 active devices.
The main takeaway from management’s commentary is that Services has many levers to drive growth, from the recent price hikes to constant increases in paid subscriptions driving record revenue across multiple offerings. At just over $85 billion in TTM revenue, the segment is poised to capture that $100 billion run rate sooner, potentially as soon as two to four quarters.
Apple guided gross margins to be “between 45% and 46%” from the coming quarter, versus the 45.2% just reported and a ~200 to 300 bp improvement YoY. Services will have a marginal impact on that expansion, but management pointed to “improved costs and improved mix” on the product side as a driver, while FX will continue to have an adverse impact on margins. Increasing gross margin from the low 43% range in FY22 to the 45% to 46% range in FY24 is no small feat at Apple’s scale.
Management added that they were “particularly pleased with our performance in emerging markets with revenue reaching an all-time record in fiscal 2023 and double-digit growth in constant currency.” Apple “achieved an all-time revenue record in India, as well as September quarter records in several countries, including Brazil, Canada, France, Indonesia, Mexico, the Philippines, Saudi Arabia, Turkey, the UAE, Vietnam and more.” iPhone sales also reached “quarterly records in many markets, including China mainland, Latin America, the Middle-East, South Asia and an all-time record in India.”
Conclusion:
Apple’s fiscal Q4 fell relatively in line with expectations, but Services shine as it surged back to double-digit revenue growth. iPhone revenues reached a September quarter record, but a weaker-than-expected December quarter guide and hints of demand weakness raise concerns about a return to growth in the upcoming fiscal Q1. Apple is showing a tremendous ability to expand gross margin at scale, which will ultimately be aided by Services in the long-run, which has multiple levers for continual growth in the double-digit range.
Damien Robbins, Equity Analyst at the I/O Fund, contributed to this article.
Cloudflare reported revenue and EPS above consensus. However, 4Q23 revenue guidance missed consensus by ~1% due to geopolitical uncertainty and macro headwinds. The other positive thing to note was that Dollar-Based Net Retention Rate (DBNR) improved to 116% for 3Q23. Management believes DBNR will stabilize near these levels and it will take some time for its efforts to improve Go-to-Market execution to be shown in DBNR, which we see as a positive.
Despite the same macro headwinds that Cloudflare is facing along with other software companies, we believe there is strong demand and need for Cloudflare’s products such as Area 1 and its developer platform, Cloudflare Workers. Longer term, we believe NET will significantly benefit from the AI inference opportunity, which we previously highlighted in our Cloudflare: Bringing AI Inference to the Edge note. Currently NET has inference optimized GPUs in 75 cities globally as of the end of October 2023 and is on track to be in 100 cities by end of CY23.
NET gave 4Q23 revenue guidance of $352.5M, at the midpoint below consensus of $356.3M (+30% Y/Y)
· Commentary from call: “Moving onto the guidance for the fourth quarter and the full year, with broadening geopolitical uncertainty and increasingly mixed macroeconomic data points across geographies. The business environment in which we operate remain challenging to predict, and as a result, we continue to remain prudent and cautious in our outlook for the fourth quarter”.
Non-GAAP EPS guide: $0.12 above consensus of $0.10.
Margins
Non-GAAP Gross Margin: 78.7% vs. 78.1% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Gross Margins expanded from 77.7% to 78.7%
Non-GAAP Operating Margin: 12.7% vs. 5.8% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Operating Margin expanded from 6.6% to 12.7% due to OpEx as a % of revenue going down 5% Q/Q and going down 6% Y/Y to 66% of revenue.
Cash Flow
$34.9M (10% FCF Margin) vs. ($4.6M) (-2% FCF Margin) in 3Q22
· From 2Q23 to 3Q23, FCF Margins expanded from 6% to 10%
· Commentary from call “This is a business that can generate significant cash, and in 2023, we expect we will generate more than $100 million in free cash flow, well ahead of our original goal when we started the year, and the direct result of improved execution across our entire business.”
· Network CapEx: 8% of revenue.
· FY23: expects network CapEx to be 8-10% of revenue vs. 10-12% previously. However, they expect network CapEx to return to normalized levels over a period. We had highlighted earlier in our analysis that network CapEx is the primary reason why FCF can be minimal at times.
Key Business Metrics
Paying customers: 182,027 (+17% Y/Y)
· Commentary from call: “We added a record number of net new customers year-over-year, spending more than $500,000 and $1 million on an annualized basis with Cloudflare”.
Paying customers with more than $100K ARR: 2,558 (+34% Y/Y)
Dollar-Based Net Retention (DBNR): 116%
· Commentary from call: “We continue to believe the recent decelerating trend in DNR stabilizing near these levels”.
DBNR expanded from 115% in 2Q23 to 116% in 3Q23.
Go-To-Market (GTM)
NET’s pipeline close rates held firm.
· Commentary from call: “During the quarter, the pipeline generated by this new cohort was 1.6 times higher than those brought on at the same time a year earlier. These new account executives achieved more than 130% of their activity goals for the quarter”.
NET’s salesforce productivity remained stable and linearity in terms of when deals were closed was similar to Q2.
· Commentary from call: “I think that we have been able to hold things steady while making significant organizational changes and improvements across our sales and marketing organization is very encouraging. Beyond that, we’re beginning to see positive early signs from the sales team members we’ve brought on over the six months to replace underperformers.”
Conclusion
Cloudflare may require more than one entry. Cloud has been volatile, and NET can produce choppy reports. We plan to use technical analysis to its fullest.
Supermicro beat this quarter and raised for next quarter. The fiscal year was raised, as well. Overall, the quarter was strong with the only blemish a vague comment that AI revenue was “over 50%.” Management did not give an exact number, and there are reasons to believe that due to a low quarter seasonally, that AI revenue was below the 52% it was last quarter.
There was not an exact confirmation on the number, but I lay reasons below as to why it’s likely it was between 50% to 52% (lower than last quarter). The most obvious one is that revenue decelerated QoQ, and at half of the company’s revenue, it’s likely AI-related revenue tracks total revenue and also decelerated QoQ. Semiconductor companies are lumpy. For example, next quarter SMCI will grow 32.1% QoQ. Therefore, by my estimation, this is not a concern within the scope of a seasonally low quarter, and it should resume growth along with total revenue for the December quarter.
The gross margin and operating margin declined both QoQ and YoY, yet it’s the expectation these will improve over time. Given the strong earnings, this is less of a concern as the company is certainly GAAP profitable. Management indicated that gross margin will improve as AI continues to ramp, and as they expand facilities in Malaysia and Taiwan. Cash came in strong, which is what we wanted to see.
By far, the most important question on the call was if management was being conservative in their fiscal year guide OR are there challenges ahead for the March and June quarter? Management provided a straightforward answer that Q4 and the fiscal year guides are conservative, implying that we have chance for a beat again in the near-term. I’ve included this part of the transcript below.
Revenue and EPS:
Revenue of $2.12 billion for growth of 14% YoY came in above expectations of $2.06 billion for 11.4% growth.
For the next quarter, the company guided $2.80B at the midpoint, for growth of 55.6% compared to expectations of $2.52B for growth of 40%.
The combined beat and raise were for $340 million in revenue. Meanwhile, management raised guidance for the fiscal year by $500 million. The previous guide was for $10B at the midpoint, and is now at $10.5B at the midpoint.
Adjusted EPS of $3.43 beat expectations of $3.25 and beat management guidance of $3.13 at the midpoint. GAAP EPS of $2.75 also beat management guidance for $2.41, at the midpoint.
For the next quarter, management came in above consensus with guidance of $4.64 EPS at the midpoint compared to $4.11 EPS expected. You can easily see why a gross margin and operating margin that is a bit lower is less of a problem with this kind of earnings strength.
Margins:
There are some puts and takes with the margins. Gross margin was down by 30 basis points QoQ and down YoY by 210 basis points.
Adjusted operating margin was in line at 10.8%, however, the GAAP operating margin was lower QoQ by 230 basis points at 8.1%. Both were down YoY – adjusted OM was down 170 basis points and GAAP OM was down 380 basis points. Stock based compensation increased to $57.38 million, up from $11 million in the year ago quarter. This is at 2.7% of revenue compared to 0.59% in the year ago quarter.
The net margin of 7.4% was in line for GAAP profits of $157M, and as stated, EPS was strong.
Cash Flow:
Operating cash flow was strong at $270.5 million for a margin of 12.7%. This is a seasonally strong quarter for free cash flow with $268 million and $3 million in capex. This is low capex compared to what we can expect the rest of the year. Next quarter, capex is expected to increase to $22 million, at the midpoint, and will be at $110 million for the fiscal year, at the midpoint.
Key Segments:
The OEM appliance and large data center revenue of $1.17B was up 26% YoY and was flat QoQ.
Enterprise and channel vertical reported $917M for 43% of revenue, down (-6%) QoQ by 200 basis points, and was up 10% YoY due to seasonally lower enterprise spending
5G, Telco and Edge/IoT reported $31M and was 2% of total revenue
These flat to negative QoQ growth in these segments helps illustrate why management may have declined to give an exact number for AI-related revenue until the seasonally low quarter is behind them.
The exact statement was this: "AI/GPU and rack-scale solutions again represented over 50% of our total revenues this quarter with AI/GPU revenues in both the enterprise/channel and the OEM appliance and large data center verticals."
The United States region was up 25% YoY yet was down 3% QoQ. Another hint that AI revenue may have been down QoQ is that all regions declined QoQ except Rest of World, which was up 38%. It’s likely AI revenue is coming from more developed regions, such as United States, Europe and APAC.
Server and storage systems are 93% of revenue while subsystems are 7% of revenue.
Inventory increased to 91 days, up from 75 days. Per management: “we built inventory for a seasonally strong Q2.”
Earnings Call & Additional Notes:
The headline of my post-ER write-up last quarter was Half of Revenue is from AI with a focus on the 52% AI-related revenue that was posted last quarter. Therefore, I immediately noticed the “AI, GPU and rack-scale solutions again represented over 50% of our total revenues this quarter” was a change from providing a precise number.
As stated under the Key Metrics section, the September quarter is seasonally soft, as it was down (-3%) QoQ. Therefore, this number may have not improved due to seasonal reasons and they didn’t want to spook the market given the outsized pressure on AI mentions. In this case, the number may have been between 50.1% and 51.9% and they felt it wasn’t necessary to highlight this considering it will improve quickly next quarter and beyond. Needless to say, we are monitoring this closely.
It was asked about on the call but to no avail:
“Nehal Choski
Okay. And can you give a little bit more precise number as far as what the exposure was in the September quarter other than greater than 50%?
David Weigand
That’s — we are giving that approximate figure and that’s our guide.”
By far, the most important question on the call was about the Q4 guide and fiscal year guide and whether management consider it to be conservative. Here is what was stated:
“Ananda Baruah
That’s actually really helpful context. I appreciate it. And then, I guess, sort of dovetailing from that, Charles. So the midpoint of the implied guide for the fiscal year, the raised guide, $10.5 billion, implies that the March quarter and June quarter would also be about $2.8 billion, which is the midpoint of your December quarter guide. And then you also, though, made mention of growth accelerating. And so — and that — and it seems like supply is getting better. You also have co-op capacity coming on, going into the year. So I guess the question is, is there conservatism built in into even the implied fiscal year guide that’s been raised or is there some pull-forward in December quarter that you think might be challenging to duplicate in the March and June quarter? It seems like conservatism, but just wanted to check that? Thanks.
Charles Liang
Yeah. Thank you. Again, we continue to gain lots of design win. So our back order has been growing faster than what we forecast in reality. So at this moment, $2.7 billion to $2.9 billion for December should be a very conservative number. And for our whole fiscal year, $10 billion to $11 billion, again, should be a conservative number. So I feel very optimistic to continue to grow quickly and that’s why we continue to grow our rack-scale, including a difficulty rack-scale rather than production capacity. Likewise, just, before we have 4,000 rack per month capacity and now pretty much we will grow to 5,000 rack per month capacity very soon. So we are very optimistic for the future growth.”
Conclusion:
This was a straight forward report, and we are not concerned with the 100 or 200 basis points that may be in question for AI revenue given the 300 basis point decline QoQ in total revenue. Next quarter will quickly resolve the issue with 32.1% QoQ total revenue growth. Management stating they are being conservative was a nice bonus to the raise and beat. This report helps us firm up SMCI as a 2024 position.
Initially, AMD sold off (-5%) based on the missed Q4 revenue guide. After hours, the stock recouped and ended up flat once management clarified the miss is not from the data center segment. Rather, it was confirmed the Q4 data center will grow 50% QoQ, and perhaps most importantly, management guided for $2B in GPU sales in 2024 from AI rather than supercomputing. This was the moment the price action reversed, and is a positive as it translates to broader hyperscaler customers driving the $2B rather than the Department of Energy’s supercomputer El Capitan.
We had stated in our pre-earnings write-up: “[The 50% revenue growth in Q4] is exciting, yet the market will want to see more balanced, commercial demand beyond the government-owned supercomputer.” AMD’s management went out of their way to provide additional color on hyperscalers driving the 2024 revenue, and I’ve included that part of the transcript below.
Roughly speaking, the data center is a $6 billion segment for AMD after 10 years of Lisa Su being the CEO (she became CEO in 2014). This means within one or two quarters of the GPUs shipping; sales will be the equivalent to 30% of today’s data center revenue right out the gate. Lisa Su stated the MI300 will be the fastest product they’ve had reach $1 billion in sales – which is saying a lot because the EPYC CPUs are popular.
Per the opening comments: “Based on the rapid progress we are making with our AI road map execution and purchase commitments from cloud customers, we now expect Data Center GPU revenue to be approximately $400 million in the fourth quarter and exceed $2 billion in 2024 as revenue ramps throughout the year. This growth would make MI300 the fastest product to ramp to $1 billion in sales in AMD history.”
Notably, it’s out of character for this management team to discuss forward revenue beyond one quarter. I find this break in style interesting, and I also take this to mean the $2 billion is a baseline. We will see, but that’s how I interpret a very early guide that would normally come in February.
What is a bit unfortunate is that the gaming segment and embedded is weak, and these two segments overshadow AMD continuing to take market share on the CPU data center, and the company’s highly anticipated answer to Nvidia’s H100s. Per the CFO’s opening remarks: “In the fourth quarter, we expect to benefit from strong Data Center and Client momentum, driven by MI300 AI accelerated ramp and the strength of our high-performance leadership Zen 4 family of products despite lower sales in the Gaming segment and additional softening of demand in the embedded market.”
What is quite fortunate, however, is that some of AMD’s AI story is undercover, which is the PC and mobile market. There’s a bonus waiting for AMD investors as the AI story plays out, and while data center GPUs take up all of the attention, there is another powerful AI trend that is silently building strength in the background. I mentioned this in a previous write-up: “When discussing AMD’s AI opportunity, it is vitally important that we not lose sight of the opportunity AMD will have to expand its AI portfolio to the Client Segment.” This has already begun with the Ryzen AI on-chip accelerator contributing to the rebound in the client segment this quarter.
Revenue and EPS:
Revenue and EPS for Q3 came in a tad higher than expected at 4% growth for revenue of $5.8 billion. The company reported EPS of $0.70 versus $0.68 expected.
The guide for next quarter was problematic as it was a miss with management guiding for $6.1B in revenue versus $6.39B expected. However, the miss is not coming from the data center, and the market is digesting whether AMD is a “buy” given two of its segments are quite weak (gaming and embedded).
Margins:
Overall, the company came in as expected on margins. Gross margin came in at 47% which is a positive. On the call, it was mentioned that as the GPUs ramp, the revenue will be accretive to gross margin.
Adjusted gross margin of 51% was in line with management guidance for adjusted gross profits of $2.963B
Operating margin of 4% for operating profit of $224M is an improvement over the past few quarters of single digit negative GAAP operating margin. Per the CFO during those quarters, GAAP OM would improve with the Client segment recovery.
Adjusted OM came in as expected at 22% for Adj operating profits of $1.27B
GAAP net income was $299M with a margin of 5%
The CFO said the following about continued margin expansion:
“And in Q3, we saw very significant improvement with our client segment gross margin. I think going forward, the pace of Client segment improvement will moderate, but it will continue to drive incremental gross margin improvement in Client segment […] I think going forward, it's really mix, primarily mix, is driving our gross margin, but we feel pretty good about second half next year when we can expand the Data Center significantly and especially Embedded segment start to recover, we should be able to drive more meaningful gross margin improvement in second half.”
Cash Flow:
Operating cash flow has improved from last quarter although is still quite a bit lower than AMD’s peak in 2022. Operating cash flow of $421M is up from $379M last quarter, but is down from $965M in the year ago quarter. This should continue to improve with the Client segment bottoming.
Free cash flow of $297M is similar – an improvement from last quarter at $254M yet down from $842M in the year ago quarter.
The company has $5.8 billion in cash and short-term investments with $2.467B in debt. The company repurchased $511 million in shares.
Revenue Segments:
Data Center:
Data center came in as expected for Q3 at $1.6 billion in revenue, driven by the 4th Gen EPYC CPUs which offset a decline in adaptive SoC products. Per the opening remarks: “EPYC CPU revenue grew by a strong double-digit percentage sequentially” and also “we gained server CPU revenue share in the quarter as fourth-gen EPYC CPU revenue grew more than 50% sequentially, crossing over to represent a majority of our server processor revenue and unit shipments.”
Management has confirmed Q4 will be 50% sequential growth, or $2.4 billion in revenue. Of this, $400 million is from GPUs.
Client Segment:
The Client segment looks to have bottomed in a big way. Revenue of $1.5B was up 42% year-over-year and was up 46% QoQ. A full recovery would be in the $2.5B range. AMD released the Ryzen 7000 Series, which has helped CPU sales. Management also indicated that their partnership with Microsoft is a catalyst on the horizon as the Ryzen 7000 Series will power the biggest advancement in Windows in over 20 years.
Per management’s opening remarks: “Looking forward, we are executing on a multiyear Ryzen AI road map to deliver leadership compute capabilities built on top of Microsoft's Windows software ecosystem to enable the new generation of AI PCs that will fundamentally redefine the computing experience over the coming years.”
The Client Segment is expected to be strong next quarter, as well.
Gaming:
Gaming revenue of $1.5B was down (-8%) YoY due to a decline in semi-custom revenue but was offset by AMD Radeon GPUs. This segment is expected to decline next quarter due to a steep console cycle.
Embedded:
This segment is weighing on AMD as it’s lapping very high comps. As stated in our Pre-ER writeup, embedded is lapping a quarter with 1868% growth. Per the opening remarks: “Looking ahead, based on our current visibility, we expect Embedded segment revenue to decline sequentially as customers continue working through elevated inventory levels through the first half of 2024.”
The weakness in the gaming and embedded segments is expected to last (and perhaps worsen) through at least Q1. Per the CEO:
“And then from an Embedded and Gaming standpoint, we would say Embedded, think about it down similar levels sort of in the teens compared to sort of Q3 was down in the teens and Q4 will be down in the teens. And then Gaming, from a console standpoint, we do expect that to be down a bit more than that. And then as we go into Q1, again without being — there are lots of things that need to happen. We would expect that both gaming and embedded would be down into Q1 as well and sort of the other comments would be more around seasonality.”
Earnings Call:
It was key that management provide color on this call regarding the MI300 demand. The first question was centered the hyperscalers and how the MI300 is being used:
Toshiya Hari:
[…] My first one is on the Data Center GPU business. You talked about '24 revenue potentially exceeding $2 billion. I was hoping you could provide a little bit more color. What percentage of this is AI versus supercomputing or other applications?
Lisa Su:
Your question as to how the revenue evolves, so the way to think about it is, in the fourth quarter, we said revenue would be approximately $400 million, and that's mostly HPC with some — the start of our AI ramp. And then as we go into the first quarter, we actually expect revenue to be approximately similar in that $400 million range. And that will be mostly AI so with a very small piece being HPC. And as we go through 2024, we would expect revenue to continue to ramp quarterly, and again, it will be mostly AI.
The second question is when the stock price recovered after hours because this is when management made it clear the Q4 miss was not data center related. AMD had previously guided for 50% sequential data center growth (we covered this in great detail here) and this was reiterated:
Aaron Rakers:
[…] And how has that $400 million evolved underneath that? Has that — was it $300 million now going to $400 million? Just how has that changed over the course of the last quarter just to level set that Data Center expectation?
Jean Hu:
Yeah. So, I think for the second half, we said we expect Data Center business to grow approximately 50% versus first half. But right now, based on what we are seeing, we continue to see in that similar range of that 50%. So, we are very happy and pleased about the strong momentum of our Data Center business. On the GPU side, Lisa mentioned about $400 million, around $400 million […]”
The CEO let a comment slip that it would be “greater than $2 billion” for next year, and given how careful this management team is, I do think it’s important to note here:
Lisa Su:
Sure, Aaron. So, we've been planning the supply chain for the last year and we're always planning for success. So, certainly, for the current forecast of greater than $2 billion, we have adequate supply. But we have also planned for a supply chain forecast that could be significantly higher than that, and we would continue to work with customers to build that out.
For our purposes, as far as where this can go, the management team goes back to quoting 50% CAGR in this segment over the next few years: “So, I think we are big believers in the strength of the market. We previously said we believe that the compound annual growth rate could be 50% over the next three or four years.”
The March quarter is expected to be lumpy due to seasonality with the Client segment, Gaming, Embedded and then moving from El Capitan’s $400M in GPU revenue to $400M in Q1 from AI-driven GPU revenue (hyperscalers).
In regards to AMD’s AI-driven Client segment, here is a comment that helps solidify some of what our earlier analysis this year has discussed. From the CEO today: “What I'm most excited about in PCs is actually the AI PC. I think the AI PC opportunity is an opportunity to redefine what PCs are in terms of productivity tool and really sort of operating on sort of user data. And so, I think we're at the beginning of a wave there. We're investing heavily in Ryzen AI and the opportunity to really broaden sort of the AI capabilities of PCs going forward.”
Conclusion:
Gaming and Embedded will overshadow 4th Gen EPYC and also GPU sales in the near-term. However, we will be looking exclusively at the acceleration in the data center (EPYC and Instinct) and client segment (Ryzen AI) as the thesis. The market wanted to sell this report, yet AMD’s management team stood firm on their data center guide. For our purposes, some important hurdles were cleared – Q4 will come in as expected on the MI300s, Q1 will be the start of hyperscaler GPU sales, the margins will get better over time, and the Client segment is rebounding while also having its own AI story. Most importantly, we wanted to see AMD gain traction with hyperscalers, and that was confirmed this quarter for Q1.
Technically speaking, this report was stronger than Nvidia’s was this time last year despite the GPUs shipping at the same time seasonally – NVDA had 1% QoQ growth for data center revenue in the October quarter and then declined (-6%) QoQ in the Q4 January quarter. To jog your memory, it was the guide provided in May (for the July quarter) when Nvidia had its blowout quarter.
I don’t think AMD will take the exact path as Nvidia’s near-monopoly, rather, as was stated in the pre-earnings writeup, our goal is to see how this unfolds.
Second only to Nvidia, Super Micro is a stock that is reporting real AI revenue. As a percentage of revenue, SMCI is reporting 52% in AI revenue compared to Nvidia’s 76% as a percentage of total revenue (data center segment).
Super Micro is sandwiched in the AI trend between hyperscalers and major chip design companies. The company is a server maker that started off by making motherboards and other components before it began making complete systems. The company is unique in that it sits between being an equipment manufacturer (Dell, HP) and being a design manufacturer (Foxconn). Part of the company’s success is due to liquid cooling, which is a popular alternative to air cooling to sustain maximum performance with the added benefit of driving down costs for supercomputers. Liquid cooling is expected to grow from 10% of supercomputers to the “vast majority” due to improving data center power usage effectiveness (PUE) and total cost of ownership (TCO) “by over 40% on power costs.” Please reference our Super Micro overview here.
The AI and GPU rack-scale revenue accounted for 52% of the recent Q4 FY2023 revenue. It was up from 29% in Q3 FY2023 – so nearly doubling in the span of a quarter (!)
For Super Micro, AI-related revenue is expected to march onward with Barclays analyst George Wang expecting it to rise to 70% of revenue in FY2024 and further rise to 80% in FY2025. The management FY2024 revenue guidance of $10 billion at the mid-point was significantly higher than the estimates of $8.61 billion and represents a YoY growth of 40.45%, up from 37.1% in FY2023.
What could cause Super Micro to miss is supply constraints for components. This was outlined in the last earnings write-up when we stated “Supply is the primary headwind; not demand.” With that said, management seems to be confident in the current guide, with supply more of a factor as to whether they raise revenue guidance in the future. Anything can happen, but that was our interpretation in the last earnings write-up.
Here's a quote from management: “However, given the record high backlog, we see fiscal year 2024 revenue between $9.5 billion to $10.5 billion with room to deliver more depending on availability of supply.”
Revenue and EPS
The company’s Q4 FY2023 revenue grew by 33.6% YoY to $2.18 billion. The management Q1 guidance is in the range of $1.9 billion to $2.2 billion, representing YoY growth of 10.8% at the mid-point. The consensus analysts’ estimate is $2.06 billion, representing a YoY growth of 11.4%. The guidance was lower due to the key component supply shortages, and strong growth is expected for the remaining quarters of the fiscal year.
The management Q1 GAAP EPS guidance is $2.02 to $2.80 and adjusted EPS guidance is $2.75 to $3.50. The consensus adjusted EPS estimate is $3.22, representing a YoY decline of (-5.8%). The EPS also follows a similar trend of solid growth like revenue for the remaining quarters of the fiscal year.
Margins
The adjusted gross margin was 17.1% compared to 17.7% in Q3 and 17.6% in the same period last year. The gross margin was lower as the company focused on market share gains. The management expects the September quarter adjusted gross margin to be similar to Q4.
The operating margin improved 30 basis points YoY to 10.4%. The adjusted operating margin improved 30 basis points YoY and 230 basis points QoQ to 11%. The strong QoQ improvement in margins was due to higher revenues that outpaced increases in operating expenses.
The operating margin guide for the next quarter is 8% and adjusted operating margin is 10.4%. The lower operating margin is due to higher operating expenses from a continued increase in R&D expenses and higher personnel costs.
The net margin improved 30 basis points YoY to 8.9%.
Overall, these margins are slim and this is always a focus in the earnings calls. The 10%+ OM is strong enough to be acceptable on a GAAP basis, yet is also thin enough to have to monitor quarterly.
Cash Flow and Balance Sheet
Operating cash outflow in Q4 FY23 was (-$9 million) compared to cash flow of $198 million in Q3 and cash outflow of (-$25 million) in the same quarter last year. The drop in cash flow was mainly due to higher accounts receivable. We will look for improved cash flow in the upcoming quarter.
The free cash flow outflow was (-$17 million) compared to free cash flow of $190 million in Q3 and free cash outflow of (-$36 million) in the same quarter last year. Lumpy is okay as long as fiscal year is positive. For FY2022, the company reported negative cash flow of (-$485 million). For FY2023 ending in June, the company reported positive cash flow of $626.8 million.
The company has cash of $440 million and debt of $290 million. It has a net cash position of $150 million, down from a net cash position of $176 million in the previous quarter. Per management: “we utilized our bank lines of credit to support higher revenues and accounts receivable as we ramped up production of new AI/GPU design wins.”
Key Metrics:
The AI and GPU rack-scale revenue accounted for 52% of the recent Q4 FY2023 revenue. It was up from 29% in Q3 FY2023. Barclays initiated coverage on the company with an overweight rating citing company’s exposure to AI. "Against the backdrop of AI investment trends, we believe SMCI is well positioned to capture the rising AI server opportunity with more share gains ahead driven by its superior design capability and strong AI partnerships." with more share gains ahead driven by its superior design capability and strong AI partnerships." The analyst also believes that AI-related revenue will increase to 70% in FY2024 and further to 80% in FY2025.
The OEM appliance and large data center revenue of $1.17 billion grew 59% year-over-year and 94% QoQ. The boom in AI-related data center sales helped to push this segment to over 100% growth in FY2023.
The Enterprise and channel vertical, which also includes AI/ML revenue, was up 19% year-over-year and 51% QoQ to $976 million.
What to look for in the earnings report:
1) Visibility on Supply:
Charles Liang, Founder and CEO of the company, said in the last earnings call, “Due to the current key components supply shortages, we forecast revenue in the range of $1.9 billion to $2.2 billion for the September quarter. However, given the record high backlog, we see fiscal year 2024 revenue between $9.5 billion to $10.5 billion with room to deliver more depending on availability of supply.” “Due to the current key components supply shortages, we forecast revenue in the range of $1.9 billion to $2.2 billion for the September quarter. However, given the record high backlog, we see fiscal year 2024 revenue between $9.5 billion to $10.5 billion with room to deliver more depending on availability of supply.”
Regarding the possibility high revenue (all dependent on supply), this was what was discussed on the call – with the CEO making it abundantly clear the revenue will follow the supply outlook.
Ananda Baruah:
“[…] And so I guess the first question is, is what's the opportunity do you see to maybe even do teach stronger than the fiscal '24 guidance. I guess, what would be the puts and takes there? And, if you were to be able to exceed the 2024 guidance, what would be some of the things you think would need to occur?”
Charles Liang
“[..] And for sure, they need 10 times 20 time more system. And we just cannot ship at this moment, because of supply chain […] So I mean, we are on the right track, yes expecting supply chain can improve so that we can grow our revenue.
2) Nvidia Relationship:
You can expect Supermicro to continue to play up its relationship with Nvidia in the upcoming earnings call.
The company recently announced the shipment of Nvidia GH200 Grace Hopper Superchip-based servers. So, there could be more updates in the earnings call regarding the company’s capabilities in AI. In the last earnings call, Charles Liang said, “Couple of months ago, I was honored to have my close friend, NVIDIA CEO Jensen Huang, join me on stage at Computex to highlight our optimized new generation GPU solutions for this AI era. We are deploying not just systems, but complete rack-scale total solutions to large generative AI innovators.”
3) Cash flow and Margins need to be decent.
Cash flow was negative in the recent quarter due to high accounts receivable. However, we will keep an eye on cash flow in the upcoming quarter. There was a question in the earnings call about working capital needs and whether they can generate positive cash flow going forward. Per management: “Yes, John. We see the business generating good cash flows, as it has historically. And we think that the — especially in this constrained supply market, where we could deliver more if we had more supply. But we're so really, the constrained supply ends up moderating the working capital. And so we grew our business last quarter quite a bit and grew our ARR. So that utilized a lot of working capital, but we have no concerns about working capital.”
As stated, operating margins are always a point of focus for SMCI on the earnings calls.
Conclusion:
Investing is a sum of calculated bets. AI will continue to be a powerful trend into the foreseeable future and our plan is to position for this. Supermicro is the #2 company for AI-related revenue (as a percentage of revenue), and this is not an easy achievement given the other companies that are gunning for AI-related revenue are juggernauts with billions in cash. However, we are no stranger to the ups/downs of sentiment in the tech sector. Strong companies with perfect earnings reports will selloff, sometimes drastically, and then often power higher. You can expect us to use all the technical analysis tools at our disposal to manage this position: setting stops, hedging at times, layering in more, trimming at the top. We think SMCI is well worth the effort.
Notably with SMCI and all of our positions, what would get us to change our mind is a material change to the margins and cash flow. We respect the FED, we don’t fight the FED. You can look for our post-ER write-up Wed night!
Read our deep-dive analysis on the company here and our past coverage here and here.
Royston Roche Equity Analyst at the I/O Fund contributed to this analysis
