"Now Or Never" - It's 'Crunch Week' For Earnings Season (& The Market's Dissonance)

One thing that January has proved - fun-durr-mentals don't matter...

But, with the week ahead one of the busiest of the current earnings season (around 331 companies reporting earnings out of the 2,000 companies that Saxo Bank covers), it's "put up or shut up" for reality and perception to recouple.

As Saxo's Peter Garnry notes, US earnings have so far been good against estimates, which is not a big surprise given the lagging nature of earnings. As the chart below suggests, the EBITDA (operating income) growth is slowing, based on the initial data but  is still around +5% y/y.

This week is a bumper one for technology with earnings from Apple, Facebook, Microsoft, Alibaba and Amazon.

Apple

Growth uncertainty rose dramatically in Q4 for Apple as one supplier after another reported weakness related to the tech giant. It was therefore not that shocking when the CEO, Tim Cook, announced after New Year that demand was much weaker than estimated and especially that coming from China. Apple reports FY19 Q1 earnings tomorrow after the close with analysts expecting EPS $4.17 up 7% y/y but the consensus estimate is down 14% in the past six months.

Revenue is expected at $84bn down 5% y/y. The big focus point for investors will be any update on Chinese demand constituting around 20% of overall revenue. With the smartphone market saturating faster than expected globally and users extending the average lives of their phones, Apple has to focus on the two businesses Services and Other Products (which is mostly the Apple Watch) contributing around 22% of total revenue. Future growth is likely to come from these two streams. Within the next five years Apple will have to decide whether it wants to descend into a stable and predictable technology company with average valuation and low growth or bet big for a renewed growth path build on some new product category.

Facebook

2018 was annus horribilis for Facebook that seems to be going from one scandal to the next. Despite all the trouble revenue is still up 42% the past year (12-month trailing numbers) as Facebook’s industry power continues to take market share in online advertising. Operating margins are no longer expanding as the company is forced to invest heavily in moderators monitoring content on the platform.

The company reports Q4 earnings on Wednesday after the close with analysts expecting EPS $2.52 up 5% y/y and revenue of $16.4bn up 26% compared to a y/y growth rate of 47% in FY17 Q4. Investors will focus on the growth impact in 2019 from the transition to unify Messenger and WhatsApp with Instagram to deliver Live Stories across all channels as the News Feed is maturing faster as a growth channel due to recent changes following last year’s data scandals.

Alibaba

The Chinese economy is arguably slowing down and this is hurting online retail sales in the process. Alibaba has so far reported better numbers than JD.com which has been rewarded by investors, but it also is the biggest risk to Alibaba going into the Q4 earnings report.

JD.com numbers suggest a bigger slowdown than what Alibaba has previously communicated so we see downside risk to Alibaba’s Q4 numbers. Alibaba reports Q4 earnings on Wednesday before the market opens with analysts expecting EPS CNY 11.47 up 8% y/y and revenue of CNY 119.5bn up 44% y/y. As the estimates suggest the company is experiencing margin pressure due to bigger offline investments, this obviously will be a big focus point for investors and analysts during the conference call.

Amazon

The previously almost indestructible e-commerce and cloud giant Amazon had one of its roughest quarters in Q4 due to economic slowdown concerns but also increased nervousness over the putative slowdown in its international business relative to its US business.

The international business is also increasingly bleeding with negative operating income the past three fiscal years as the company has ramped up investments. Investors will focus on the Whole Foods integration, AWS growth and the international e-commerce business. With AWS now at $27bn in revenue in the past 12 months and driving the majority of the operating income for Amazon there has been increasing talks about a spin-off given that AWS has very little stand-alone synergies with the rest of the business. Amazon reports Q4 earnings on Thursday after the close with analysts expecting EPS $7.79 up 111% y/y and revenue of $77.9bn up 19% y/y.

And while optimism is alive and well, we are reminded of Morgan Stanley's Michael Wilson's warning

Exhibit 8 shows the relationship between the net Y/Y change in earnings revisions breadth and the Y/Y change in NTM EPS. We like this chart because the change in earnings revisions breadth series leads by 26 weeks.

The steep decline in the leading revisions series points to more meaningful downside for NTM EPS growth by mid 2019. A couple of caveats here: (1) these relationships are never precise in terms of predicting the magnitude of the decline (e.g. NTM EPS growth overshot the trend in change of revisions during the financial crisis); and (2) tax reform provided a significant, but mechanical boost to EPS revisions in January of 2018, making the comparisons in January of 2019 appear particularly extreme to the downside. What's really important here is the direction of the rate of change on earnings revisions and what that implies for the rate of change on earnings growth.

Bottom line, this is just one more piece of evidence suggesting that NTM EPS growth faces a steep decline ahead, which may take several quarters to play out. If so, we are confident this early year rally will fade.