Last week marked an important week for the US technology sector, as major tech players reported quarterly earnings results. The technology sector has stood as one of the most loved sectors during the pandemic.
The top five industry players, Microsoft, Apple, Amazon, Alphabet and Facebook represent approximately 20 per cent exposure in the S&P 500, and are the main contributors to the relative outperformance of the US equity market index during this crisis.
Unsurprisingly, Amazon recorded a surge in first quarter revenue following a strong increase in demand for its services, yet recorded a six per cent decline in operating income and a 29 per cent fall in profits. Higher costs related to COVID-19 safety measures and higher labour costs put downward pressure on its first quarter margins and are also expected to wipe out second quarter profits.
However, the company is well positioned to continue to benefit from solid, long-term industry fundamentals, mainly e-commerce and cloud demand. Amazon’s cloud segment, AWS, scored a 38 per cent yearly increase in operating income and now accounts for 13 per cent of its total sales as overall demand for cloud services accelerated over the past weeks.
Microsoft also lived up to expectations with management highlighting that COVID-19 had a minimal net impact on financial performance. Microsoft, benefitted from the shift to remote working as social distancing measures were put in place, recording a 15 per cent increase in its top line, including a 39 per cent growth in commercial cloud revenue year-on-year.
Microsoft reported a 25 per cent boost to its operating income when compared to the same period of last year, benefitting from its market position to serve businesses’ adaptation to the new normal. Towards the end of the quarter, Microsoft recorded a reduction in traditional licensing especially for small and medium sized businesses and lower advertising income on LinkedIn. Management noted that the full effects of COVID-19 within its personal computing segment is expected to be better captured in future periods.
Despite the strong sector drivers underpinning the outperformance of the technology sector, a bottom up analysis of key company developments highlights the divergence among the tech giants. Technology companies more reliant on retail sales and advertising revenues stand to be more exposed to the recessionary environment brought about by the COVID-19 pandemic, with near term weaknesses highlighted during earnings results.
Case in point, Alphabet, the parent company of Google, reported a slowdown in ad revenues during the month of March. Despite its significant dependency on ad revenues, first quarter results were not as bad as expected, with the company reporting top line growth of 15 per cent on a constant currency basis. In the short-term, the COVID-19 pandemic is expected to continue to put pressure on marketing budgets which in return impacts the advertising revenue for Alphabet.
Nonetheless, the company has maintained its buyback program and is implementing cost containment measures, including a reduction in capital expenditure and a slowdown in pace of hiring, while seeking to optimise resources. This could drive further efficiency in its processes and position the company to gain from improved margins when strong ad revenue growth returns.
Similarly, Facebook managed to beat its downgraded expectations, as the company reported 17 per cent growth in revenue on a yearly basis, but noted lower demand for advertising and a decline in price of adverts from the second week of March.
Even so, the company reported record active users of more than three billion people across Facebook, Instagram, WhatsApp and Messenger each month and an increase in engagement across virus-hit countries. Facebook was quick to adapt, improving its video call offering including the launch of Messenger Rooms on Facebook and doubling video calling capacity on WhatsApp.
Meanwhile, Apple managed to report revenue growth due to its services arm, as the quarter was characterised by both demand and supply chain disruptions. Management noted supply chains have now normalised, and the focus has now shifted on the demand side. Apple has already launched a cheaper iPhone model, iPhone SE and delayed the production of the newer model by one month as continued weakness in product demand remains a major headwind.
Disclaimer: This article was issued by Rachel Meilak, CFA equity analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.