Several big tech bellwethers are getting set to release their quarterly results. Jim Kelleher, Director of Research at Argus Research, tells Greg Bonnell why he thinks the tech sector may outperform market expectations.
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[AUDIO LOGO] It is a big week for tech. Apple, Amazon, Alphabet getting ready to report their latest quarterly results. We've already heard from the likes of Snap, IBM, and others. Well, joining us now for more on the big takeaways so far, Jim Kelleher, Director of Research from Argus Research. Jim, a pleasure to have you on the program. Thank you. Good morning, and happy to be here. And thank you for having us. All right, so let's talk tech. Obviously, this is the big week for some of the megacap tech stocks. But we've seen some earnings so far. What's your big takeaway? What feeling are you getting from the sector this quarter? I think the sector will probably outperform expectations a little bit. There's a feeling that technology earnings in the United States will be down slightly. I think they'll end up being up slightly. Recently, IBM reported. They're a pretty good example of the kind of head fake you might be getting with earnings. Their adjusted earnings were reported down about 2%. However, that purely reflected the fact that IBM had a tax benefit a year ago and a big tax bill this time. So if you look at their adjusted pretax income, it was up a very nice 20%. But that's not the number that gets reported, and that's not the number that gets counted. But I think you'll see overall, this is, as you mentioned, a big earnings week for not just formal technology sector names but other big names in consumer discretionary, like Amazon and like some of the communications services, media stocks that, at one time, were all considered tech stocks. And I think they're all going to do fairly well this time around. Obviously, this has been a pretty tough market across most asset classes. Tech has been hit very hard after the big run-up we saw during the pandemic. One of the concerns was, I guess, the strength of the US dollar, though. A lot of these big companies do a lot of business overseas. You repatriate those foreign currencies into US bucks. And it's not a good thing. Has the market sort of priced that in already? Because it's been pretty clearly communicated. That's a great question. I would say that you have two countervailing effects here. One is that inflation does have a-- we call it a dirty little secret. And that is, it tends to lead to pretty good revenue growth. So we're getting-- as we've seen revenue growth tending to run ahead of earnings growth in recent quarters, running up in the upper single digits, whereas the earnings growth has moderated to that kind of low single digit area. And that's because companies are succeeding in passing along costs. But for the US-based large multinationals, currency is a really difficult problem. It's running at 600 to 800 basis points negative on currency for some of these companies that have-- the IBMs of the world or Intels that have 60% or 70% of their revenues derived overseas. So I think the inflation impact on the upside to revenue is pretty much being a little more than offset by the currency headwind. So I wouldn't call it a neutral event. But we are continuing to see earnings growth-- I'm sorry, we are continuing to see revenue growth which tells me that, despite the currency repatriation headwind, there's some pretty solid sales growth out there. In terms of the technology space, I mean, it is a big one. It encompasses a lot of different kind of companies. As investors, do we start to start separating those who perhaps sell software or cloud services from those who sell hardware to those who rely pretty heavily on online advertising to make their models work? Mm-hmm, yeah. Right, so it's a very big tent. And so because it's a big-tent sector, you need to look at all the different parts and pieces. We've been seeing pressure in the online advertising space going back a minimum of six months. And for those social media and search companies that are dependent on digital spending, digital advertising spending, the pressure has been real. Also, many, if not most, consumers access social media sites, such as Snap or Twitter, on their phones. And in North America in particular, where iPhone is dominant, there have been changes in iPhones, the iOS advertising tracking practices from Apple. And these have been a real headwind. These were announced as much as-- more than a year ago, really. And Snap was among the first to call them out. But it's impacted Twitter and Meta and all the social media platforms. So the lack of advertising tracking, so to speak and privacy-- it's a legitimate privacy concern-- has made companies more reticent about expanding their online advertising sales. And now we're coming into a more challenging economic period. And companies are really taking their time to think about where do they want to allocate their digital ad dollars. And if you dive into the Snap numbers, you would see that the advertising per user is coming down for them. I'm one of those iPhone users that, when I'm asked, can we track you across the internet, I say no. And I've been saying no for quite some time. And I figured at some point-- and maybe this is just being a little jaundiced in my view-- at some point, they're going to figure out a way around this and still figure out what I'm up to. But it sounds like so far at this point, not being able to track those eyeballs across the internet for advertising dollars, they haven't figured out a way around that sort of problem. Well, both Twitter and Snap have said they are working on workarounds to make sure that, without violating user privacy, they're still giving their advertisers a bigger read on where their ad spending is effective. The bigger issue right now, I just think, is economic. If you were to look at Snap's numbers, for example, they grew their user base pretty nicely in the third quarter. Off the top of my head, I'd say they grew it in the high teen percentages year over year, the number of users up around 363 million. But their advertising revenue grew 6%. And if you look at the ARPU, the average revenue per user, it's really in a downtrend, particularly in Europe. And again, there could be a currency impact there as well, probably is. But that was negative year over year, and sequentially negative too. Another issue for them is the greatest growth Snap is having is in the rest of the world. It's more than-- or it's roughly about half their users. But the average revenue per user in North America is 10 times the average revenue per user in rest of world, that meaning outside of the US and Europe. And that's a big problem because they're getting these-- you can almost call them empty calories, adding all these users that aren't bringing in a lot of revenue dollars. And the fact that Snap suspended their revenue guidance for 4Q tells me we're going to see even deeper declines in average revenue per user. [AUDIO LOGO]