Slowing economy squeezing Microsoft and other tech giants’ earnings

Slowing economy squeezing Microsoft and other tech giants’ earnings

Microsoft personal computer sales fell sharplyThe advertising market continues to weaken

A quick rebound in the tech sector looks even more unlikely, as the US giants used December quarter earnings announcements to give investors a realistic view of this year’s trading conditions. Even though Microsoft’s (US:MSFT) quarterly earnings beat analysts’ expectations last week, a bleak forecast on the earnings call spooked the market. This was soon followed by disastrous results from chipmaker Intel (US:INTC) and some negative advice from Snap (US:SNAP) that cast new doubts on the US advertising market.

Personal and mobile computing is weakening

Microsoft’s revenue rose 2% in the final quarter of 2022, but its operating profit fell 8% to $20.4bn (£16.6bn). However, much of the hit came from higher research and development spending (up $1.1 billion), so gross margin was largely unaffected. The diverse nature of the business meant that there were large differences in performance between the divisions. Busy consumers are spending less, with personal computing revenue dropping 19% and Xbox content and services down 12%.

On the other hand, business services all continued to grow. The cloud computing business, Azure, grew 31%. It’s slower than previous quarters, but still much faster than the overall US economy. All of this contributed to Microsoft beating analysts’ profit expectations.

The stock price initially rose, but Microsoft took a cautious tone on the earnings call. Azure cloud growth is expected to slow again as customers moderate spending. “We expect growth in the third quarter to decelerate by around four to five points in constant currency,” Chief Financial Officer Amy Hood said.

At Intel, the results were much worse. Fourth-quarter revenue was down 32% year-on-year and gross margin fell 14.5 percentage points to 39.2%. Client Computing revenue fell 36% and Data Center and AI fell 33%. Compared to broader growth in cloud computing, this shows a sharp decline in market share.

A shortage of chips and electronics last year quickly turned into oversupply. “The PC ecosystem continued to deplete inventory throughout calendar year 2022,” Intel Chief Executive Patrick Gelsinger said.

Intel expects this to continue into 2023, with a miserable forecast for the current quarter. The company expects revenue of between $10.5 billion and $11.5 billion, which would be down 20% from the fourth quarter. Gross margin is also expected to decline to 34.1%.

Apple (US:AAPL) has been the most robust of the big tech companies so far and the only company yet to make layoffs. However, analysts now expect slowing consumer electronics demand to impact sales. The consensus analyst forecast according to FactSet is for $121.5 billion in sales, down 2% from a year ago. This is due to lower demand for iPhones, which could lead to a 6% drop in sales.

Samsung’s results (KR:005930), released this week, aren’t promising for Apple, which was expected to report post-release on Thursday, February 2. The Korean company supplies DRAM memory chips for iPhones and saw operating profits drop 70% in the fourth quarter. Memory division vice president Jaejune Kim said that for PCs and mobiles “the decline in demand is deepening across the industry.”

Advertising still suffers

Alphabet (US:GOOGL) and Meta (US:META) both derive more than 80% of their revenue from advertising, and sentiment plummeted last year due to the advertising slowdown. Alphabet’s sales are expected to increase 1% year on year, while operating profit is expected to fall 16%. The outlook is worse at Meta, which is suffering from Apple’s new privacy laws as well as the economic downturn. Sales are expected to fall 6% to $31.6 billion, with operating profit down 40% as virtual reality losses rise to $4.4 billion.

Snap, another social media and advertising company, saw its share price drop 12% this week after forecasting revenue would fall between 2% and 10% year-on-year in the next quarter. In a letter to investors, the company said this was due to “weaker demand for brand-driven advertising.”

Amazon (US: AMZN) is the most diverse of the tech giants. It is a retail business but also increasingly an advertising business. It also has its growing cloud computing division, Amazon Web Services. Analysts expect lower consumer retail sales, but higher advertising and cloud sales will more than offset it, with the group’s revenue expected to rise 6%. However, rising labor costs mean that operating profit is expected to fall by 23%. The company doubled its workforce during the pandemic before downsizing late last year.

The tech story of 2022 was interest rate hikes, but now that the inflation rate in the United States is falling, all eyes are on earnings. Most of these companies have already started cutting costs, but investors will mostly favor companies with pricing power. Microsoft’s focus on enterprise software and cloud computing makes it more defensive; customers will cut advertising budgets before spending on software. The legendary strength of the Apple brand helps, but there’s a limit to how far consumers can stretch their wealth for a new iPad or Apple Watch. The 2021 chip shortage seems a long way off now.

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