Opinion: Tech revenues are about to take a dive and there’s no lifeline in sight

What a difference a year makes.

Now, a slow release of air from a balloon would be a welcome relief from the sonic boom of collapsing tech stocks and piling up profit warnings. Tech companies are expected to post steep profit declines after more than two years of gains during the COVID-19 pandemic as inflation and fears of a looming recession lead consumers and businesses to cut spending.

Following the collapse in personal computer sales, the entire IT sector is expected to see profits fall by almost 5%, thanks to the semiconductor industry. After going from a shortage to a glut, chipmakers are expected to see their profits fall by more than 15%. As companies seek to cut ad spend, online advertising giants are expected to see profits fall by more than 20%, and e-commerce companies that consumers have depended on during the shutdowns are expected to see profits drop by more than 20%. more than 25%.

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Even areas expected to show growth are likely to experience anemic progress relative to past performance, as software growth is modeled for less than a 2% increase in earnings.

Brendan Connaughton, founder and managing partner of Catalyst Private Wealth, thinks tech executives are going to use this quarter and the next as “kitchen sink” quarters, where they can add whatever writedowns or excuses they can, then try to beat their own reduced expectations.

The forecast for the holiday season shouldn’t be much better – tech investors brace themselves for several weeks for caveats, missed numbers and outright pessimism, as tech executives try to shake off all the company baggage before next year.

“Leadership is going to be very, very conservative,” Connaughton said. “I think the foresight is going to be very lousy.”

Ugly comparisons with a year ago

This will lead to ugly numbers in the coming weeks, and with good reason. Compared to a year ago, when the third quarter was the third quarter of highest earnings growth in the pandemic boom, the September quarter of this year is looking bleak. FactSet estimates indicate that mixed earnings for the entire information technology sector – which includes semiconductors, hardware and software, including tech giant Apple Inc. AAPL,
+0.94%
— will be down 4.6%, compared to growth of 38% a year ago.

Revenues, on the other hand, will continue to grow, but only fractionally. The IT sector is expected to see overall mixed revenue growth of 4.7%, compared to growth of 19.8% a year ago. Surprisingly, tech is still doing better than the entire S&P 500, at least on the earnings side. FactSet now shows the overall S&P 500 SPX,
+1.14%
will post mixed earnings growth of 1.2% in the third quarter, which would mark the weakest year-over-year earnings growth since the third quarter of 2020, and revenue growth of 8.7%.

These drops may seem small compared to what is expected of the biggest names in the Internet – Alphabet Inc. GOOG,
+0.61%
GOOGL,
+0.80%,
Meta Platforms Inc. META,
-0.93%,
Twitter Inc. TWTR,
+2.05%
and Match Group Inc. MTCH,
+3.75%.
These companies are part of the interactive services segment of the communications services industry and analysts expect their third-quarter earnings to fall 20.4% and their mixed revenues to rise 6.4%. A year ago, these companies as a group saw profits soar 43.3%, fueled mostly by Alphabet’s earnings, while revenues jumped 39.8%.

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The current earnings season will be held back by both the overall advertising environment and Meta results, which are expected to show increased competition from ByteDance’s TikTok, lower ad revenue from its short-form video offering Reels, and discussions on cost reduction.

“Meta stock is down 62.1% year-to-date and around 25% since printing in 2Q22, as the advertising industry slows amid various macro headwinds, changes privacy concerns, growing competition and shifting user engagement to Reels, which is currently monetizing at a lower rate,” John Blackledge, an analyst at Cowen & Co., wrote in a note Thursday, cutting estimates. The consensus on Wall Street is that Meta’s revenue is down 4.8%.

And while Alphabet’s Google is expected to see revenue growth in the quarter, that single-digit growth rate of 9% is expected due to the advertising climate and competition from TikTok on YouTube. In the last quarter, YouTube’s revenue growth slowed, due to competition from TikTok and other video streaming rivals.

Chips and hardware hit by falling PC demand

While internet companies will also talk about the broader macroeconomic environment, including the impact of global supply chain issues on online advertising, the industry most impacted by supply chain issues is the semiconductor industry.

Supply chain issues, which have plagued the industry for a few years, aren’t the biggest problem for chip companies right now. The sudden drop in demand for personal computers, after a huge pandemic boom for remote work and school, is hurting both PC makers and their suppliers.

Over the past month, Micron Technology Inc. MU,
-1.78%,
Nvidia Corp. NVDA,
+0.66%
and Advanced Micro Devices Inc. AMD,
-0.07%
all warned or lowered their revenue forecasts, citing too much inventory and the sudden drop in demand in the PC sector. Last week, Bloomberg reported that chip giant Intel Corp. INTC,
-2.08%
plans to downsize and will likely lay off thousands of workers by the end of the month, around the same time it is expected to announce results.

“It appears end demand has deteriorated significantly in recent weeks and end customers appear to be aggressively depleting inventory,” Bernstein Research analyst Stacy Rasgon wrote in a recent note after AMD lowered its outlook.

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The semiconductor and hardware segments are spoiling the momentum for the rest of the IT sector. Estimates compiled by FactSet indicate that the semiconductor industry is expected to see overall profits fall by 15.7%, compared to monstrous profit growth of 57.7% a year ago. Sales are expected to rise 4.7% in the third quarter, a far cry from the 24.7% growth in the year-ago quarter. The main contributors to lower earnings growth are expected to be Intel, Nvidia and Applied Materials AMAT,
+1.10%,
Intel predicts a nearly 80% drop in profits.

Hardware companies fare even worse, as storage makers and PC makers, with the exception of Apple Inc. AAPL,
+0.94%,
should see their profits and revenues plummet. HP Inc. HPQ,
-0.54%,
which does not report until November 22, is expected to see its revenues fall by almost 12%. And storage manufacturers Seagate Technology STX,
-0.17%
and Western Digital Corp. WDC,
-0.83%,
with revenue forecasts down 32.5% and 27.9% respectively, both raised new fears about a slowdown in demand for cloud computing, a topic this column also recently warned about.

Also read: Seagate sends ominous warning over cloud computing spending

“Seagate and Western Digital have both reported that they are both seeing more cautious buying behavior from some of their cloud and enterprise customers,” said Benchmark Research analyst Mark Miller. “We see this trend developing.”

Software and e-commerce hit by rising costs

For now, software should be among the few highlights of the quarter, with a rather anemic earnings growth forecast of around 1.9% and revenue growth of 11.8%. MicrosoftMSFT,
+0.41%,
with its large PC business and high exposure to currency fluctuations as the dollar strengthens in Europe, should see revenue growth of around 9.9%, while its Windows business slows and its Azure cloud business continues to grow grow, although at a slower pace of around 44%.

“We expect Microsoft to report [fiscal] Q1 revenue broadly in line with our $49.8 billion (up 10% year-over-year, up 16% constant currency), with Azure and O expected[ffice]365 higher, offset by weakness in PC/Windows,” BofA Securities analyst Brad Sills said in a note.

E-commerce businesses are still seeing sales increase, but those slower growth rates began last year, after the end of shutdowns around the world brought consumers back to physical stores. Labor, transportation and goods costs implode, so incomes fall sharply. In the Consumer Discretionary/Internet Retail sector, profits are expected to fall 25.6%, while revenue is expected to increase 14.7%, compared to revenue growth of 14.8% in the quarter of the previous year.

Amazon.com Inc. AMZN,
+2.26%
is on track to see total revenue growth of 15.7%, with more growth coming from its AWS cloud computing business of around 31%. This total revenue growth, investors will recall, is down from when net sales soared 37% in the third quarter of 2020, fueled by pandemic online shopping.

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Evercore ISI analysts note downside risk to Amazon’s operating estimates, as the e-commerce giant has increased hourly raises for warehouse and delivery workers, and faces rising costs. shipping, gas prices and ongoing supply chain issues. FactSet says Amazon’s revenue is expected to drop 27.7%.

Investors are going to see a huge mix of issues this quarter, but they shouldn’t expect things to improve too quickly either. As Connaughton tells its clients, this may be a good time to consider getting offers in the underdog sector, looking at their price-earnings ratios.

“Everyone wants to make money tomorrow, but if you can look beyond that, there’s incredible value in technology,” he said. For example, he said, “If I’m betting long on Amazon, that’s a good time to buy.”

With profits expected to be tough during the holiday shopping season and as the risk of recession looms in 2023, it will be hard to make money and easy to misjudge buying opportunities.

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