Market Snapshot
briefing.com
| Dow | 34405.23 | +4.88 | (0.01%) | | Nasdaq | 11379.24 | -43.06 | (-0.38%) | | SP 500 | 4068.62 | -8.37 | (-0.21%) | | 10-yr Note | 0/32 | 3.51 |
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| | NYSE | Adv 1636 | Dec 1385 | Vol 826 mln | | Nasdaq | Adv 2563 | Dec 1999 | Vol 4.4 bln |
Industry Watch
| Strong: Materials, Industrials, Consumer Staples |
| | Weak: Information Technology, Real Estate, Utilities, Financials |
Moving the Market
-- Stronger-than-expected jobs report
-- Treasury yields and U.S. Dollar Index pulled back from post-jobs report highs
-- Weak mega cap stocks weighing on index performance
-- S&P 500 lifting back above its 200-day moving average (4046)
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Closing Summary
02-Dec-22 16:30 ET
Dow +34.87 at 34435.22, Nasdaq -20.95 at 11401.35, S&P -4.87 at 4072.12
[BRIEFING.COM] It shaped up to be a pretty good day for the bulls, all things considered. The session started on a decidedly downbeat note, though, after market participants digested a generally positive November employment report.
The employment report featured stronger-than-expected nonfarm payrolls growth (263,000), higher-than-expected average hourly earnings growth (0.6%), and an in-line unemployment rate of 3.7% that held steady near a 50-year low.
Sellers stepped up their efforts on the heels of the release since this good news seemed likely to defer any eventual pivot by the Fed with its monetary policy, suggesting the target range for the fed funds rate will go higher yet and remain higher for longer, as Fed Chair Powell and other officials have suggested will be the case.
The Dow Jones Industrial Average, S&P 500, and Nasdaq were down 1.0%, 1.2%, and 1.6%, respectively, right out of the gate and the S&P 500 breached support at its 200-day moving average (4,046).
Buyers got back involved following that breach and brought the S&P 500 back above that key level where it vacillated for much of the day.
Things improved markedly, however, with about 90 minutes to go as the S&P 500 refused to drop back below its 200-day moving average and as Treasury yields continued with a sharp reversal from their post-employment report highs.
The 2-yr note yield, which hit 4.38% earlier, settled at 4.29%. The 10-yr note yield, which hit 3.60% earlier, settled at 3.51%. The U.S. Dollar Index, which was up as much as 0.8% following the employment report, ended down 0.2% at 104.53.
Notably, the Russell 2000 closed with a 0.6% gain and the Dow Jones Industrial Average made its way back above the unchanged line.
Roughly half of the 11 S&P 500 sectors closed in the green. Materials (+1.1%) enjoyed the biggest gain while energy (-0.6%) fell to the bottom of the pack.
- Dow Jones Industrial Average: -5.3% YTD
- S&P Midcap 400: -9.4% YTD
- Russell 2000: -15.7% YTD
- S&P 500: -14.6% YTD
- Nasdaq Composite: -26.7% YTD
Reviewing today's economic data:
- November nonfarm payrolls rose by 263,000 (Briefing.com consensus 200,000) following a revised 284,000 increase in October (from 261,000). Nonfarm private payrolls increased by 221,000 (Briefing.com consensus 200,000) following a revised 248,000 increase in October (from 233,000).
- Average hourly earnings were up 0.6% (Briefing.com consensus 0.3%) versus a prior revised 0.5% increase (from 0.4%).
- The unemployment rate was unchanged at 3.7%. The average workweek fell to 34.4 hours from 34.5 in October.
- The key takeaway from the report is mixed. The report itself is good news from an economic standpoint, yet the market sees it as bad news, thinking it will push out any eventual pivot by the Fed with its monetary policy. In brief, it is a report that screams higher for longer with respect to the target range for the fed funds rate.
Looking ahead to Monday, market participants will receive the following economic data:
- 9:45 a.m. ET: November IHS Markit Services PMI - Final (prior 46.1)
- 10:00 a.m. ET: October Factory Orders (prior 0.3%)
- 10:00 a.m. ET: November ISM Non-Manufacturing Index (prior 46.6%)
Main indices reach flat lines ahead of the close
02-Dec-22 15:35 ET
Dow +0.22 at 34400.57, Nasdaq -30.09 at 11392.21, S&P -8.60 at 4068.39
[BRIEFING.COM] For a brief moment, all three of the main indices were in positive territory. Now, the DJIA trades just above its flat line while the S&P 500 and Nasdaq trade just below theirs.
Treasury yields settled mixed. The 2-yr note yield rose six basis points to 4.29% while the 10-yr note yield fell two basis points to 3.51%.
Looking ahead to Monday, market participants will receive the following economic data:
- 9:45 a.m. ET: November IHS Markit Services PMI - Final (prior 46.1)
- 10:00 a.m. ET: October Factory Orders (prior 0.3%)
- 10:00 a.m. ET: November ISM Non-Manufacturing Index (prior 46.6%)
DJIA reaches positive territory
02-Dec-22 15:00 ET
Dow +4.88 at 34405.23, Nasdaq -43.06 at 11379.24, S&P -8.37 at 4068.62
[BRIEFING.COM] The Dow Jones Industrial Average tipped into positive territory recently.
Market breadth has flipped around compared to earlier in the session when declining issues outpaced advancing issues. Now, advancers lead decliners by a slim margin at both the NYSE and the Nasdaq.
Energy complex futures settled the session lower today. WTI crude oil futures fell 1.5% to $80.13/bbl and natural gas futures fell 7.4% to $6.27/mmbtu.
Solar names outperforming after scathing Commerce Dept. report on Chinese competitors
02-Dec-22 14:25 ET
Dow -99.78 at 34300.57, Nasdaq -88.07 at 11334.23, S&P -22.44 at 4054.55
[BRIEFING.COM] The S&P 500 (-0.55%) is in the middle of today's standings, down just 22 points.
S&P 500 constituents PayPal (PYPL 74.87, -3.66, -4.66%), Advanced Micro (AMD 74.63, -2.85, -3.68%), and Whirlpool (WHR 144.08, -4.94, -3.31%) pepper the bottom of the standings despite a dearth of corporate news.
Meanwhile, California-based solar solutions firm Enphase Energy (ENPH 336.21, +22.21, +7.07%) is today's top performer, strong alongside other solar names, after a Commerce Dept. report which suggested that Chinese solar manufacturers were skirting tariffs.
Gold trims weekly gains on Friday
02-Dec-22 14:00 ET
Dow -107.87 at 34292.48, Nasdaq -87.75 at 11334.55, S&P -22.42 at 4054.57
[BRIEFING.COM] With about two hours to go on Friday the tech-heavy Nasdaq Composite (-0.76%) remains the worst-performing major average.
Gold futures settled $5.60 lower (-0.3%) to $1,809.60/oz, up more than 3% on the week, helped by a dip in both the dollar and treasury yields this week.
Meanwhile, the U.S. Dollar Index is down about -0.1% to $104.60.
The Big Picture
Last Updated: 02-Dec-22 15:31 ET | Archive
Valuation matters and that won't change in 2023
2022 has been challenging year for investors to say the least. Rising interest rates have been at the heart of the challenges, yet they may soon give way to declining earnings estimates as a driving force.
No matter the challenge -- rising interest rates or declining earnings estimates -- the connection all year has been that valuation matters. We don't see that changing in 2023.
How Things Have Changed
Entering 2022, the S&P 500 traded at 21.5x forward 12-month earnings. It did so with the target range for the fed funds rate at 0.00-0.25%, the 10-yr note yield at 1.51%, and the Federal Reserve still buying at least $40 billion per month of Treasury securities and at least $20 billion per month of agency mortgage-backed securities.
That was also a time when the Fed's median estimate for 2022 PCE inflation was 2.6% and 2.7% for core-PCE inflation. The median estimate for the terminal rate, meanwhile, was 2.1%.
Oh, how things have changed.
The target range for the fed funds rate is now 3.75-4.00% (and headed higher), the 10-yr note yield is 3.51% (but it had been as high as 4.23%), and the Federal Reserve is letting $60 billion per month of Treasury securities and $35 billion per month of agency mortgage-backed securities roll off its balance sheet.
The Fed's median estimate for 2022 PCE inflation has changed to 2.8% and 3.1% for core-CPE inflation. The median estimate for the terminal rate is 4.60%, but Fed Chair Powell recently said that is likely to be revised higher with the updated Summary of Economic Projections later this month. The fed funds futures market for its part sees a terminal rate in the neighborhood of 5.00% by mid-2023, according to the CME FedWatch Tool.
Today, the S&P 500 trades at 17.7x forward twelve-month earnings. The sticking point as we enter 2023 is that the stock market still isn't "cheap." In fact, it trades at a slight premium to its 10-year historical average of 17.1x, according to FactSet.
That's a sticking point because the earnings estimates for the next 12 months are not static. They are dynamic and we believe they will be subject to downward revision as the lag effect of the Fed's rate hikes hits home for borrowers, employee layoffs increase, the housing market weakens, excess personal savings dwindle, and other countries feel the strain as well of rising interest rates, high inflation, and reductions in discretionary spending.
What Recession?
2022 has proven to be a tougher year for the stock market than it has for the economy. Granted we saw GDP contract in the first and second quarters, driven in large part by weakness in government spending and the change in inventories, yet the contraction occurred at a time of undeniable strength in the labor market. In the first and second quarters, the unemployment rate averaged 3.8% and 3.6%, respectively.
Note the unemployment rate was lower in June (3.6%) than it was in January (4.0%), and yet real GDP was negative for the first two quarters. That's why many market watchers pooh-poohed the idea of the U.S. economy being in a recession.
Real GDP growth ran at an annualized 2.9% in the third quarter, and as of this writing, the Atlanta Fed GDPNow model is estimating 2.8% real GDP growth for the fourth quarter.
The road ahead, however, is expected to get bumpier, again as the lag effect of the Fed's rate hikes, and the rate hikes by central banks in other developed markets like the eurozone, Australia, the UK, and Canada, hit home. We can't forget either that an intended aim of the Fed's rate hikes is to weaken demand and that the Fed sees a necessary weakening of the labor market as part of the solution for getting inflation under control.
The Fed has been playing catch up all year with its rate hikes, taking the unprecedented route of raising the target range for the fed funds rate by 75 basis points at four consecutive meetings. That's why the market sees it as a relief that the Fed is apt to raise the target range for the fed funds rate by "only" 50 basis points at the December 13-14 FOMC meeting.
That would pull the target range to 4.25-4.50%. If the fed funds futures market has it right and the terminal rate is in the neighborhood of 5.00%, then it can be said today that the Fed is almost done with this rate-hike cycle. What can't be said today is that the Fed will be cutting rates soon.
The Fed certainly isn't saying that. The party line is that it will reach a higher terminal rate and then hold it there for a while to be sure inflation is coming back down to its 2.00% target.
Earnings Estimates Being Reined In
Market rates have adjusted to the Fed's hawkish mindset. That has hurt stocks and it has helped savers (finally!). Those higher rates, though, will remain a competitive headwind for stocks in 2023 and a constant headwind for the economy.
Inversions all along the Treasury yield curve, whereby short-term rates yield more than long-term rates, are being viewed by many participants as ominous harbingers of the economic environment since inversions typically occur in front of recessions.
And recessions bode poorly for earnings growth.
Citing Yale University professor Robert Shiller's data, Bloomberg notes that the average peak-to-trough earnings drop in a recession since 1960 has been about 31%. According to FactSet, the current consensus calendar 2023 earnings estimate for the S&P 500 ($230.98) computes to 5.7% growth versus calendar 2022.
It is evident in the chart above that analysts have been reining in their 2023 earnings expectations since the middle of 2022 when the estimate approximated $250.00. Even so, there is still headway above 2022 expectations that does not line up with a recession environment. The Treasury market, therefore, is either overly pessimistic about where the economy is headed in coming months or equity analysts are overly optimistic.
This dichotomy will be the basis for a market that moves in fits and starts in 2023.
What It All Means
It is hard to see a market trading at 17.5x calendar 2023 earnings as trading at a true value given the economic writing on the wall, a Fed that is still intent on raising rates, and knowing that many companies have yet to issue FY23 earnings guidance.
That guidance will start flowing in late January during the fourth quarter earnings reporting period and we expect to hear a lot of cautious-sounding guidance tied to the macroeconomic environment that forces estimates lower.
How low they go is the $64,000 question. The answer will depend on just how weak the economy gets. What China does with its zero-COVID policy, what Russia does with its war on Ukraine, and what the Fed does with its monetary policy are some wild cards for the growth outlook. They can be game changers for the stock market -- for better or worse.
2022 has been a major struggle for the stock market and it isn't over yet. Fortunately, December has a good reputation for typically being a good month for the stock market, so perhaps a bad 2022 can end on a high note.
Stocks will still have their share of struggles in 2023, presumably more so in the first half of the year than the second half as deteriorating economic conditions collide with inflated earnings estimates. Nevertheless, we expect the economy to have a bigger struggle in 2023 than the stock market for several important reasons:
- The stock market has wrung out a lot of excess from the pandemic stimulus bubble already in 2022.
- In a tougher economic environment, higher-quality companies that are profitable, have solid free cash flow, and pay dividends should exhibit relative strength -- and that generally encompasses more large-cap companies.
- Deeper cuts to earnings estimates will hurt at first and that will be reflected in lower stock prices, but they should ultimately invite better stock performance as the year unfolds since investors will have more confidence that they are buying stocks at a true value in front of an inflection in earnings growth (and monetary policy) as opposed to buying into value traps that exist before there is a deeper cut to earnings estimates.
The stock market is entering 2023 at a lower valuation than it entered 2022, but it isn't cheap yet. It will have to wrestle with more cuts to earnings estimates, which means there will be more cuts to stock prices. There will be opportunity in those cuts, however, knowing that it is always darkest before dawn.
To that end, low valuations matter just like high valuations, only they matter more in producing better long-term returns for investors.
-- Patrick J. O'Hare, Briefing.com
Page One
Last Updated: 02-Dec-22 09:02 ET | Archive
November jobs report says higher for longer
It was a subdued equity futures trade in front of the November Employment Situation Report. Most of the action was happening at the individual stock level, yet that action was not really having any impact on the index futures, which were all trading close to fair value.
That isn't the case anymore.
Currently, the S&P 500 futures are down 54 points and are trading 1.2% below fair value, the Nasdaq 100 futures are down 247 points and are trading 2.0% below fair value, and the Dow Jones Industrial Average futures are down 361 points and are trading 1.1% below fair value.
One can probably surmise that the employment report didn't go the way market participants had hoped it would go, which, when we tell you more about it, is a bit silly. The reason being is that it was a good report. Nonfarm payroll growth was higher than expected, the unemployment rate held near a 50-year low of 3.7%, and average hourly earnings increased at a robust 0.6% month-over-month, leaving them up 5.1% year-over-year.
The key takeaway from the report is mixed. The report itself is good news from an economic standpoint, yet the market sees it as bad news, thinking it will push out any eventual pivot by the Fed with its monetary policy. In brief, it is a report that screams higher for longer with respect to the target range for the fed funds rate.
The 2-yr note yield, which was at 4.19% just before the release, is up 10 basis points to 4.34% (but it had reached 4.41%), and the 10-yr note yield, which was at 3.51% just before the release, is up seven basis points to 3.60% (but it had reached 3.63%). The U.S. Dollar Index, down 0.2% just before the release, is up 0.6% to 105.33.
Other notable headlines from the Employment Situation Report are as follows:
- November nonfarm payrolls increased by 263,000 (Briefing.com consensus 200,000). The 3-month average for total nonfarm payrolls decreased to 272,000 from 282,000.
- October nonfarm payrolls revised to 284,000 from 261,000
- September nonfarm payrolls revised to 269,000 from 315,000
- November private sector payrolls increased by 221,000 (Briefing.com consensus 200,000)
- October private sector payrolls revised to 248,000 from 233,000
- September private sector payrolls revised to 255,000 from 319,000
- November unemployment rate was 3.7% (Briefing.com consensus 3.7%), versus 3.7% in October
- Persons unemployed for 27 weeks or more accounted for 20.6% of the unemployed versus 19.5% in October
- The U6 unemployment rate, which accounts for unemployed and underemployed workers, was 6.7% versus 6.8% in October
- November average hourly earnings were up 0.6% (Briefing.com consensus 0.3%) versus an upwardly revised 0.5% (from 0.4%) in October
- Over the last 12 months, average hourly earnings have risen 5.1%, versus 4.9% for the 12 months ending in October
- The average workweek in November was 34.4 hours (Briefing.com consensus 34.5), versus 34.5 hours in October
- Manufacturing workweek decreased 0.2 hour to 40.2 hours
- Factory overtime declined 0.1 hour to 3.1 hours
- The labor force participation rate dipped to 62.1% from 62.2% in October
- The employment-population ratio slipped to 59.9% from 60.0% in October
The early selling will bring a test of the S&P 500's 200-day moving average (4,046) into play. Participants will be anxiously watching to see if buying support arrives with a breach of that key support level or if things break down further on the added consideration that this relatively strong employment report, which is not bad for the soft landing argument, suggests the market overreacted to what it heard from Fed Chair Powell on Wednesday.
-- Patrick J. O'Hare, Briefing.com
UiPath topples its prior expectations in Q3, sending shares to their 100-day moving average (PATH)
Shares of UiPath (PATH +11%) are making a solid push today as better-than-feared Q3 (Oct) numbers are propelling a breakout from the consolidation pattern the stock has been stuck in since PATH's previous earnings report. The past few quarters have been a story of intense foreign exchange (FX) headwinds, weighing heavily on the robotic process automation (RPA) software developer's financials. Although FX impacts were worse than PATH anticipated in Q3, it persevered, battling this obstacle and exceeding its guidance in the process.
- Revs expanded 19% yr/yr to $262.74 mln, despite a strong U.S. dollar clipping around $22 mln of sales, nicely surpassing PATH's $243-245 mln forecast, which incorporated a $10 mln FX headwind.
- A significant contributor was PATH's larger customer cohort, those with over $100K in annualized recurring revenue (ARR), which grew a respectable 3% sequentially to 1,711. PATH noted that these customers utilize its software not just to reduce or remove tedious work but also as part of their long-term growth plan and operating model. This comment highlights the importance placed on RPA, a bullish sign for the long-term health of PATH.
- Meanwhile, PATH shattered its prior adjusted operating income forecast of negative $30 mln to negative $25 mln, delivering operating income of positive $18 mln in Q3. Two factors contributed to this massive beat: excellent top-line growth and early success from PATH's ongoing reorganization where it implemented a hiring freeze.
- Looking ahead to Q4 (Jan), PATH may have guided revs slightly below consensus, predicting $277-279 mln. However, the company upped its ARR forecast slightly, expecting $1.174-1.176 bln from $1.153-1.158 bln.
- Going beyond Q4, PATH did not provide further details on its FY24 guidance, first outlined during its Investor Day in late September. At that time, PATH noted that the anchor point for sales and ARR growth was +18%, as well as operating margin expansion of around 300-400 bps. However, we suspect its anchor points remain sturdy after upbeat Q3 numbers and decent Q4 guidance.
Although today's favorable reaction is helping PATH shares break out, economic battles are far from over. Most of PATH's revenue stems from overseas, primarily in Europe, where economic conditions are worse than domestically, and war is ongoing in Ukraine. Still, it was encouraging to hear that PATH's European business is now in good shape, with its sales force ready to overcome a tricky demand backdrop.
Bottom line, PATH's Q3 results are giving its shares much-needed relief after tumbling around 70% on the year. Although the path ahead is anything but easy, there are encouraging developments on the horizon, enabling PATH to wade through the choppy macroeconomic environment.
Zscaler's tepid billings guidance has investors scaling out of the stock (ZS)
ZScaler (ZS), a zero trust cybersecurity company, issued another beat-and-raise quarterly report for 1Q23 as revenue grew by a healthy 54% on a yr/yr basis. Beat-and-raise performances have become commonplace for ZS, thanks to the strong demand across its platform, but the upside results and outlook weren't enough to stave off a sharp selloff today.
- The main issue is that the company only nudged the low end of its FY23 billings guidance higher to $1.93 bln from $1.92 bln, while maintaining the high end at $1.94 bln. At the mid-point of this guidance range, billings are forecasted to grow by about 31% yr/yr, representing a significant deceleration from the 59% billings growth achieved in FY22.
- When combined with the stock's exorbitant valuation -- shares are currently trading with a P/S north of 17x -- the slowing growth and accompanying macro-related headwinds are reason enough for some investors to head for the exits.
On the topic of macro-related challenges, ZS echoed the same concerns about lengthening sales cycles that CrowdStrike (CRWD) cited a couple of days ago during its earnings call.
- ZS's CFO, Remo Canessa, stated that the Q1 billings duration was above the midpoint of the normal 10-14 months, negatively impacting billings growth by approximately five percentage points.
- Like many other cloud software companies have recently acknowledged, ZS also noted that companies are closely scrutinizing deals while they tighten their budgets.
However, there's also a more positive reason why deals are taking longer to close for ZS.
- More companies are looking to consolidate their cybersecurity technology into a single platform, and many are prioritizing zero trust applications as hybrid work and public cloud adoption accelerates.
- Therefore, the average deal size is increasing, prompting ZS to focus on winning more large, multi-year opportunities that require approval from higher level executives.
- This trend is evident in the growth of ZS's large customer base. In Q1, the number of customers paying ZS more than $1 mln annually increased by 124 from last year to 348.
- Furthermore, the company's net retention rate has exceeded 125% for eight consecutive quarters, illustrating that customers continue to transition from a single use case to a much broader approach that utilizes ZS's full platform.
ZS's profitability is also improving as deal sizes increase and as it keeps a lid on expenses.
- Operating margin expanded by 150 bps to 12% in Q1 and the company's FY23 outlook assumes that operating margin will expand by another 150 bps. In the long-term, ZS believes it can reach operating margin of 20-22%.
Overall, it was a pretty solid report from ZS, but the stock's rich valuation leaves no room for disappointment in this environment. The company's tepid billings guidance, which qualifies as a disappointment, has investors in "sell now, ask questions later" mindset.
Ulta Beauty pulls back slightly after setting 52-week highs following a beat-and-raise in Q3 (ULTA)
Ulta Beauty (ULTA -1%) is no longer looking as radiant as it did immediately after reporting exceptional Q3 (Oct) numbers, including a triple-digit earnings beat, accelerated comps, and raised FY23 guidance. The broader sell-off in the market on better-than-expected jobs figures is playing a significant role in the beauty retailer giving up its earlier gains. Furthermore, the stock may have also become overextended, appreciating roughly 24% from October 20 lows on the backs of strong quarterly results from many of its peers. Investors may have also already priced in ULTA's exceptional results after Target (TGT) noted that Ulta Beauty at Target nearly tripled total sales volume yr/yr in OctQ.
Still, ULTA's Q3 report shined, piling on additional evidence that the cosmetic industry is well-defended against inflationary pressures.
- Adjusted earnings surged 35.5% yr/yr to $5.34, crushing estimates in the process, while revs gained 17.2% to $2.34 bln, a slight acceleration from the +16.8% posted last quarter. Even more notable was same-store sales growth of +14.6%, fueled by a nearly 11% jump in transactions on a 3.5% increase in average ticket size.
- With inflationary pressures squeezing consumer budgets, we were nervous that transactions could dip for the second-straight quarter, making ULTA's double-digit jump quite impressive.
- Broad-based strength lifted ULTA's Q3 numbers, as did the company's continual focus on adding newness to its product assortment, which tends to comprise around 20-30% of total sales. Additionally, ULTA's buy online and pickup in-store saw an 18% improvement in orders, contributing to nearly a quarter of all e-commerce sales, up around 3 pts yr/yr. Meanwhile, ULTA's loyalty program ended the quarter with a 9% bump in active members, partly helping keep transactions and average ticket higher.
- ULTA is optimistic about the opportunities present during the holiday season, illuminated by the company's significantly raised FY23 guidance. ULTA expects earnings of $22.60-22.90, up $1.80 at the midpoint from its prior guidance, and comps of +12.6-13.2%, up from +9.5-10.5%.
The main takeaway is that cosmetics demand remains sound, affirming what we witnessed from many others operating in this industry, including Sephora (LVMUY), Coty (COTY), and e.l.f. Beauty (ELF). ULTA also commands a key advantage over these other firms in that they are not exposed to volatile economic conditions overseas, including China, which clipped Estee Lauder (EL) and took some sales away from COTY.
As a result, even though ULTA's 21x forward earnings multiple represents a premium relative to many of its peers, including Macy's (M) at ~7x, Kohl's (KSS) at ~10x, and TGT at ~20x, we see ULTA as a solid choice during the inflationary environment.
Marvell heads lower following Q3 miss and guide down; demand likely to soften in Q4 (MRVL)
Marvell (MRVL -6%) is under pressure after the chip company missed slightly on both EPS and revenue for Q3 (Oct). However, the Q4 (Jan) guidance was even more troubling with EPS and revs both well below analyst expectations.
- Revenue growth was driven by its cloud, 5G and auto business, as well as share/content gains in enterprise networking. Early in Q3, MRVL was still dealing with supply disruptions, but late in the quarter, customers started requesting to push out shipments and reschedule orders to manage their inventory in a changing demand environment. Customers are focused on reducing their current inventory rather than buying new chips. This dynamic started in Q3 but should have an even greater impact in Q4.
- The problem is more acute in China as demand for Marvell's products has come down significantly. For example, MRVL estimates that its Q4 revenue from OEM customers in China will decrease by more than 33% sequentially. Revenue from China OEMs is expected to account for less than 10% of total revenue in Q4.
- Data Center is Marvell's largest end market by far at 41% of OctQ sales. Segment revenue rose 26% yr/yr but fell 3% sequentially to $627.3 mln due to softness in its on-premise business. Its storage products, including fiber channel, HDD and SSD, all saw demand decline during the quarter. However, its cloud business continued to grow sequentially.
- Unfortunately, Data Center growth is decelerating as MRVL says customers have started adjusting their inventory to address the changing demand picture. As a result, Data Center revenue in Q4 is expected to decline yr/yr in the mid to high-teens and in the mid-20% range sequentially with storage being impacted the most. MRVL is projecting a very large reduction in shipments of HDD controllers and preamps. Data Center is a key vertical, so the big sequential drop is spooking investors today.
- On a more positive note, its Carrier Infrastructure segment grew revenue by 26% yr/yr to $271 mln, although that is down 5% sequentially. The vast majority of growth is being driven by its wireless business which is benefitting from 5G adoption. Another bright spot was Enterprise Networking, which grew 52% yr/yr and 10% sequentially. However, as the quarter progressed, its Chinese customers started to turn cautious, which should lead to a low single-digit sequential decline in Q4.
Overall, this was a rough quarter for Marvell, especially the Q4 guidance. Given the pretty dire comments made about Q4 especially relating to its Data Center vertical, we were expecting an even bigger drop. However, we think a lot of negativity is priced in already. The stock has been trending lower over the past year. Nevertheless, we would be cautious about bottom fishing down here until we get a clearer picture on next fiscal year.
Elastic gets pulled lower as slowdown in SMB customer base weighs on revenue outlook (ESTC)
Elastic (ESTC) had managed to withstand the macro-related adversities that have impacted many cloud software companies over the past few months, but those difficulties finally caught up to the company in 2Q23. While the quarter started off on a strong note, ESTC began to see the well-documented budget tightening from its customers in October, especially from the SMB crowd.
Compounding the problem, foreign exchange impacts are causing the sales cycle to lengthen in countries where the strengthening dollar has created adverse conditions. As a result, the company issued downside Q3 revenue guidance and cut its FY23 revenue outlook, sending its shares spiraling lower today.
The headline EPS and revenue numbers for Q2, both of which exceeded expectations, would suggest that its business as usual for ESTC. However, a pair of other key metrics tell a different story.
- While still strong, ESTC's net expansion rate dipped to 125% in Q2 from just under 130% in Q1. This decline reflects a slight moderation or pause in spending from some of the company's existing customers.
- The total number of customer additions slowed in Q3 relative to Q2. Specifically, ESTC added 400 total subscription customers this quarter, compared to 700 last quarter. The slowdown is entirely due to the softness in the SMB customer segment.
Looking beyond the SMB troubles, there were plenty of positives from the earnings report.
- Demand from the larger customer segment remained resilient, as illustrated by ESTC adding about 80 customers with ACV over $10,000, and 40 customers with ACV north of $100,000. Both of those figures are consistent with the prior quarter. Relatedly, revenue in the hyperscaler space was robust again, more than doubling on a yr/yr basis, with strength seen in Amazon (AMZN) Web Services, Microsoft (MSFT) Azure, and Google (GOOG) Cloud.
- The company continues to take a balanced approach in terms of driving growth and improving profitability. In Q2, adjusted operating margin reached nearly 2%, easily beating its prior guidance of -0.6% to -0.2%. CEO Ash Kulkarni credits the operating leverage that's inherent in the business for the margin outperformance.
- With business conditions becoming more challenging, ESTC plans to accelerate its profitability aspirations, while optimizing its investments in strategic areas. To that end, the company also announced a plan to reduce its workforce by 13% and to implement more automated self-service capabilities for its SMB customers. The company believes that these initiatives will put it on a path to achieve a Non-GAAP operating margin of 10% in FY24.
- A major growth catalyst for ESTC is the emergence of Elastic Cloud, which is the company's family of hosted offerings. In Q2, Elastic Cloud revenue grew by a healthy 50% yr/yr to $103.2 mln, accounting for nearly 40% of total revenue. In the year-ago period, Elastic Cloud represented about 34% of total revenue.
While the soft revenue guidance is disappointing, we believe that the story remains mostly positive for ESTC in the big picture. Demand from the company's larger customer base is still healthy and it's making significant strides on the bottom line. With these thoughts in mind, it's not overly surprising that the stock has bounced back and is well off its lows for the day.
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