Where to find the best value in tech, macro datapoints, earnings takeaways from Nvidia, Snowflake, Zscaler, Autodesk and Snap
In this week’s Weekly Insights we focus opportunities in consumer vs. industrial technology, weak macro, and earnings from Nvidia, Snowflake, Zscaler, Autodesk and Snap
Stocks and Focus Areas
- Is it time to buy industrial technology?
- Bifurcation between industrial and consumer technology
- Tech companies announcing hiring freezes and massive layoffs
- Weak new home sales following other disappointing housing datapoints
- Deteriorating used truck prices at auctions
STOCKS AND FOCUS AREAS
Is it time to buy industrial technology?
We believe that industrial technology stocks were “last in” the downturn, but will be the first to come out. Earnings reports from Nvidia, Snowflake, Zscaler, and Autodesk last week, support our long term positive thesis. These companies are growing topline at impressive rates (15%-80%+) and have positive operating and free cash flow margins. Consequently they are able to satisfy the “Rule of 40”, a commonly used principle in assessing the quality of a growth business, by a wide margin.
The “Rule of 40” states that, at scale, a company’s revenue growth rate plus profitability margin should be equal to or greater than 40%. The rule is therefore an aggregate measure of growth and profitability. There is no generally agreed-upon measure of profitability — most commonly used metrics comprise EBITDA margins, EBIT margins and/or FCF margins.
Most early-stage companies may satisfy the “Rule of 40” by growing at 40+% and having negative margins. The unique aspect of this set of companies is that they can easily satisfy the “Rule of 40” while having positive operating margins and >20% FCF margins. Consequently, through downturns, these companies can be “on the offence”, investing aggressively and gaining market share.
Earnings details and tepid guidance
While industrial technology companies reported strong results, almost provided some level of tepid commentary. Even the companies that increased their guidance and provided strong outlook (e.g. cybersecurity) are not beating/raising by as much as they have historically. Consequently, our underlying assumption is that every company we cover will give up few points of growth as a result of this economic downturn.
However, it is critical to understand that for companies that are growing their topline at 20%+ rates, a point of revenue growth is significantly less impactful than 1% interest rate increase. In turn, as weakening economic datapoints cap the potential for the Fed to aggressively raise rates, growth stocks may start forming valuation floors.
Industrial vs. consumer tech
While industrial tech earnings were extremally strong, the same has not been the case for consumer tech. Each company is citing a different challenge, some blame the economy, advertising budgets, others competition.
- The latest one to warn last week was SNAP — noting potential for revenue and adjusted EBITDA to be below the low-end of their 2Q22 guidance range citing deteriorating macro environment (further and faster than anticipated). For reference, Snap revenue grew 38% y/y in Q1 and the company had originally guided to 20–25% y/y for revenue growth and breakeven to $50mn for adjusted EBITDA in Q2.
- Needless to say: “teens revenue growth” + “close to 0 margin” does not come close to satisfying the “Rule of 40”.
Adding this report to a long list of challenged companies from the prior two quarters: Facebook, Netflix, Carvana, Amazon, Peloton, Zoom, Upstart, and many others. While some of the consumer tech companies are just facing tough comps, we believe that many experienced a surge from covid-related demand which masked the weakness in the underlying fundamentals (i.e lack of innovation, limited differentiation, increased competition, etc).
Quote from Snowflake CEO: “Last year, we saw certain customers experience much higher-than-expected consumption…Today, some customers face a more challenging operating environment. Specific customers consume less than we anticipated amid shifting economic circumstances we believe are unique to their businesses, most notably consumer-facing cloud companies. Although these customers are still growing, we believe as long as they are impacted by macroeconomic headwinds, their consumption will be impacted.” When asked, the CEO mentioned that Facebook, Netflix, Peloton, Snap, Amazon, Walmart, Target were not among the customers they called out, implying broader pressures across consumer technology.
Last week we highlighted weak retail earnings, excess inventory, weakening contract truck pricing etc. (Weekly Insights). This week we have hiring freezes, weak new home sales and declining used truck pricing.
Hiring freezes and massive layoffs
Tech companies are slowing hiring and some announced drastic cuts:
- Amazon expected to cut 30% of its workforce (in select areas) — change in language compared to the “optimization” the company referred to on the earnings call.
- Nvidia, Microsoft, companies that are very well positioned to weather the downturn, are slowing hiring.
- Expect to see more drastic measures from Lyft, Uber, Snap, Meta, Coinbase — all of which have challenged fundamentals.
- Klarna, Carvana, Peloton, and Better are cutting 10%, 12%, 20% and 50% of their workforce, respectively.
- Interestingly, Snowflake and Zscaler were among few to note that they are not slowing hiring driven by the strength of their business.
Weak new home sales
Sales of newly built homes fell 16.6% in April, according to U.S. Census data released last week. This is in addition to declining mortgage applications and weaker existing home sales.
Deteriorating used truck prices
Used trucks sold at auctions in the second quarter of 2022 are already 20% cheaper than those sold during auctions in this year’s first quarter, according to FreightWaves.
We expect that deteriorating economic datapoints will continue to emerge. Our objective is to find the companies that will emerge stronger from the downturn.
For more research visit out website spear-invest.com.