Editor's Note: Tech Check is a new Real Money blog on tech stocks. Every trading day, Eric Jhonsa will provide insights and takeaways regarding major tech stories and trends.
Making Sense of a Big Chip Stock Rally That Came Amid Bad News
Over the last two trading days, as markets digested soft outlooks from several major chip industry firms, the Philadelphia Semiconductor Index rose 8%. The gains came even though Intel (INTC) , which makes up 8% of the index, lost ground due to its Thursday Q4 report, and Qualcomm (QCOM) , which makes up 7% of the index, fell following a bearish report from Kerrisdale Capital.
A number of firms posted double-digit gains. Between Wednesday and Friday's closes, Applied Materials (AMAT) , Micron (MU) and ON Semiconductor (ON) , none of which reported this week, rose 14% apiece.
In late 2018, as many quality chip developers and equipment makers approached or achieved single-digit earnings multiples, I thought markets had gotten too pessimistic -- that they were pricing in a giant industry downturn that was far from certain to happen, even if demand could weaken some. Paradoxically, it took a week that delivered a fair amount of bad news -- from Texas Instruments (TXN) and STMicroelectronics' (STM) comments about the impact of trade and macro worries on Chinese demand, to Intel's remarks about a first-half cloud spending slowdown, to Lam's expectations for 2019 memory capital spending to tumble (good for memory makers, not so much for equipment suppliers) -- for many investors to come around.
This week's reversal, of course, doesn't guarantee that chip stocks will continue trekking higher in the coming weeks. With Chinese trade and macro uncertainty still an overhang, smartphone demand soft and (though this could easily change later in the year) cloud capex under pressure, shares could pull back as more bad news arrives.
But with that said, this week's rebound against a backdrop of (with the exception of Xilinx's (XLNX) upbeat forecast) negative outlooks does suggest many of the investors who had helped bring chip stock earnings multiples to very low levels were looking at the industry through the lens of past downturns in which demand cratered. And that when news arrived that suggested demand (though weakening) generally isn't cratering, it sparked a change in sentiment.
Good Earnings, Huawei/ZTE Woes Bode Well for Ericsson and Nokia
One of my 2019 tech predictions was that telecom hardware spending (long pressured) would pick up this year as enterprise IT hardware spending slumps following a strong 2018. Mobile infrastructure giant Ericsson's (ERIC) Friday Q4 report, together with recent reports from Texas Instruments (TXN) and Xilinx (XLNX) in which each chip developer disclosed its sales to mobile infrastructure clients are growing rapidly as 5G rollouts get underway, bodes well for the near-term telecom capex environment.
Ericsson, whose shares are up over 4% on Friday, topped revenue estimates while stating its sales rose 10% in Swedish krone and 4% when adjusted for "comparable units and currency." Though nothing spectacular, such growth is a nice change of pace for a company that saw its revenue drop 10% on both a reported and adjusted basis in 2017 amid a weak telecom capex environment and stiff competition from China's Huawei and ZTE. Ericsson added that 2018 was the first year in which it saw positive organic growth since 2013.
Notably, Ericsson's "Networks" (hardware and software) sales rose 6% on an adjusted basis in Q4 and 3% for the whole of 2013. And on its earnings call, the company forecast modest 2019 growth for the mobile radio access network (RAN) equipment market, while also talking up its ability to further grow a "Digital Services" segment that grew 5% on an adjusted basis in Q4.
Separately, Vodafone (VOD) offered fresh proof on Friday that security concerns about the use of Huawei and ZTE's hardware extend beyond the U.S.. The global telecom giant announced it's pausing its deployment of Huawei gear in European network cores as its talks with government officials about potential security risks. The move comes shortly after the U.K.'s defense minister said he had "grave concerns" about the use of Huawei's gear in 5G rollouts.
Ericsson rival Nokia (NOK) , which reports on Jan. 31, is up over 7% on Friday amid the news. Neither Ericsson nor Nokia is anyone's idea of a high-growth momentum tech play. However, with shares of both companies down relative to where they traded five years ago today, neither company is priced like a high-growth momentum play either. And between 5G ramps and Huawei and ZTE's issues, the demand environment for both firms arguably looks better than it has in a while.
Sign of the Times: Beaten-Up Western Digital Gains in Spite of Weak Guidance
Western Digital's (WDC) latest numbers aren't anything to write home about. Sales and EPS both missed expectations amid a 21% annual revenue drop, and the company set March quarter revenue guidance that's below expectation and implies a 26% annual drop at the midpoint. Non-GAAP EPS, meanwhile, is expected to drop to a range of $0.40 to $0.60 from a year-ago level of $3.63, as tumbling NAND flash memory prices ding Western's margins and a capital spending pause among cloud giants (also signaled by Intel INTC and others) weighs on Western's sales of high-capacity enterprise hard drives.
Nonetheless, just as Lam Research (LRCX) , Texas Instruments (TXN) and STMicroelectronics (STM) shot higher on Thursday in spite of outlooks that were hardly stellar, Western's battered shares are up 6% in mid-day trading on Friday following its December quarter report, and are taking hard drive archrival Seagate (STX) and NAND rival Micron (MU) higher with it.
Expectations are everything here: Western went into earnings trading for less than three times its fiscal 2018 EPS of $14.73. To be fair, it's far from certain that Western's EPS, forecast by analysts to be below $6 in both fiscal 2019 and 2020, will rebound to fiscal 2018 levels anytime soon. Specifically, not when NAND prices appear set to fall further thanks to strong industry supply growth and solid-state drives (a market in which Western is just one of several notable players) steadily cannibalize hard drives (a market in which Western and Seagate have a near-duopoly).
For that reason, I think the long-term risk/reward in Micron is probably better. Like Western, Micron carries very low trailing EPS multiples and is getting stung by falling memory prices. However, unlike Western, Micron gets the lion's share of its gross profit from a highly consolidated DRAM market that's likely to see a measure of demand growth.
But assuming Western's EPS stabilizes around, say, $8, as its SSD sales grow and cloud hard drive orders rebound, its stock would admittedly still be far from expensive. And markets seem to realize this.Facebook Reportedly Is Making a Long Overdue Move
This feels like one of those moves that (with the benefit of hindsight) probably should've been carried out a while ago. The New York Times reports that Facebook (FB) , under orders from Mark Zuckerberg, is working to integrate the underlying infrastructure for WhatsApp, Facebook Messenger and Instagram's messaging platforms by the end of 2019 or early 2020, albeit while keeping the apps themselves separate. It adds Messenger and Instagram will be updated to support end-to-end encryption, a feature already provided by WhatsApp.
Some context: WhatsApp and Messenger have been reported to have over 1.5 billion and 1.3 billion monthly active users (MAUs), respectively, and Instagram's messaging service (known as Direct) had 375 million MAUs as of the spring of 2017. By allowing users on one messaging app to communicate with users on another, Facebook increases the total network effect claimed by the platforms, leaving them on better competitive footing relative to rivals such as Snap's (SNAP) Snapchat and Apple's (AAPL) iMessage, and perhaps also growing its total messaging activity (already over 100 billion messages per day).
The project also, of course, comes at a time when Facebook is seeing user growth and engagement for its core app, which still drives the lion's share of its revenue, come under pressure, and is taking initial steps to monetize Messenger and WhatsApp via ads and business messaging services. Recently, app analytics firm App Annie estimated that WhatsApp's MAU count has surpassed core Facebook's, and that total time spent on social and communications apps rose 35% from 2016 to 2018. It also stated Facebook still claimed four of the category's five most popular apps in terms of downloads.
Facebook shares were up 2.1% to $148.96 on Friday in late morning trading; it reports quarterly earnings after the close on Wednesday.
