So far, the latest earnings season in the US has seen the majority of companies — 82% of the 37% of companies on the Standard & Poor’s 500 index that have reported, according to data provider FactSet — beating analyst estimates, and by a wider-than-average margin. At this pace, earnings decline for 2020 will be only around 12%, far better than the more-than-20% contraction forecast during the worst of the Covid-19 pandemic fears last year. Sectors reporting the most positive surprises include IT, healthcare and financials.
The market is not rewarding many of the earnings beats, however, suggesting that many believe share prices have run ahead of the anticipated earnings recovery. We had previously written about some of the main reasons fuelling the remarkable rally in stocks — including massive liquidity (from stimulus cheques), historic low interest rates (almost free money), zero commission, fractional shares trading and the surge in participation of retail investors.
The confluence of these factors is manifesting in some never-before-seen phenomena, such as the remarkable short squeeze on hedge funds instigated by retail investors banding over the WallStreetBets forum on social media platform Reddit.
The drama surrounding the short squeeze on shares such as GameStop has raised many questions for regulators and may yet have wider market implications. Many see this as more evidence of irrational exuberance, excessive risk-taking and bubble valuations, all of which quite likely portend more volatility ahead. We will explore this topic in greater depth next week. The saga has even overshadowed some of the positive earnings results, including those of Microsoft Corp.
The company reported a strong set of numbers for the quarter ended December 2020, with sales up 17% y-o-y to US$43.1 billion ($57.9 billion) and net income rising 33% y-o-y — a remarkable pace of growth for a company with a market capitalisation of US$1.8 trillion.
Microsoft expects to maintain double-digit top-line growth and an outsized bottom-line increase on operating margin expansion for financial year 2021 ending June. Despite worries over broader market valuations, we believe the stock is still decently valued relative to its prospective growth, currently trading at forward price-to-earnings multiples of less than 32 times. In the past five years, earnings per share have risen at a compound annual growth rate of nearly 30%.
Indeed, its shares have performed very well since the company embraced a “mobile first, cloud first” strategy in 2014, which was later sharpened to focus on intelligent cloud. The strategic shift transformed it from a maturing software business to one that is well positioned to gain from the long-term secular trend of digital transformation. And it is paying off handsomely.
To be sure, growth in the last few quarters was boosted, in part, by strong sales in laptops and tablets, thanks to the work-from-home trend as a result of the pandemic. Demand is likely to slow as the economy gradually normalises, with the increase in vaccination rates.
Critically, though, there remain many strong growth drivers for the foreseeable future.
The intelligent cloud segment reported the strongest gains among the three major business segments, up 23% y-o-y. In the last quarter, revenue for the Azure cloud platform grew 50% y-o-y whereas that for server products and cloud services rose 26%.
One of Microsoft’s recent notable strategic partnerships is with Cruise, the autonomous vehicle arm of General Motors Co. Under the deal, Cruise will use the Azure platform for its autonomous taxi fleet while Azure will be the preferred cloud provider for GM.
Revenue for the gaming sub-segment grew 51% y-o-y to a quarterly record high of US$5 billion, driven by hardware sales as well as content and online gaming services. Again, Microsoft benefited from robust demand for its latest Xbox Series X and S consoles, boosted by widespread restrictive movement measures that left people with more time on their hands and fewer entertainment avenues. Nevertheless, gaming — and cloud gaming in particular — remains a huge market with more growth ahead.
Microsoft reported more than 100 million Xbox Live active monthly users and 18 million subscribers for Game Pass. The company plans to expand cloud gaming and Game Pass to iOS devices and Windows PCs over the next few months.
Similarly, the transition from licensing to the Subscription-as-a-Service model for its software business is paying dividends. Subscriptions to Office 365 — and the wider Microsoft 365 bundle that includes Enterprise Mobility + Security tools — for both commercial and retail customers are seeing good traction on the back of the secular shift to cloud services and on-demand models. Subscriptions provide the company with steady recurring income.
On the home front, we see similar characteristics in Telekom Malaysia. In fact, we think the company offers one of the best exposures to the digitalisation trend.
In the past, TM’s main thrust was providing high-speed broadband connectivity to both households and businesses. Currently, its fibre network reaches some five million premises, which will expand by 2.5 million within the next two years. But while Unifi generates a steady cash-flow stream — and is currently the company’s biggest business segment in terms of revenue — this is a maturing business, with rapidly slowing net customer additions.
Like Microsoft, however, we see huge growth potential for TM in cloud. As we have written before, the pandemic has accelerated digital transformation. We see digitisation and onboarding to cloud by both the domestic private sector and government as imminent. It is already happening.
TM will be a formidable competitor in this space. The company already has a substantial head start — it owns and operates the most extensive network infrastructure and global connectivity in the country, including more than 560,000km and 246,000km of fibre-optic and copper cables respectively, 10 data centres and 20 submarine cable systems with direct connectivity to more than 60 countries.
It is collaborating with Huawei Technologies to offer end-to-end full-stack cloud services, spanning the standard Infrastructure-as-a-Service (IaaS), Platform-as-a-Service (PaaS) and Software-as-a-Service (SaaS), covering Industry Solutions, Enterprise Application Services, Big Data and Internet of Things (IoT) solutions and many more. TM’s extensive network coverage, together with Huawei’s technological innovation, will make it a winner in Malaysia’s digital transformation.
TM also offers cloud services from all the major cloud providers, including Amazon Web Services, Azure and Google Cloud, to cater to simpler/less customised solutions for small and medium enterprises.
The potential of its cloud business is massive — and will rejuvenate previously stagnating growth for years to come. Remember, this is also the highest-margin business among the company’s major business segments. Best of all, the stock is trading at less than 23 times forward earnings. That makes TM one of the cheapest telcos in the country and the region, taking into account growth prospects and risks outlook. And that is why TM is our single-largest holding in the Malaysian Portfolio.
Microsoft and TM are companies with real digital value propositions. Both companies already have significant market shares in their product segments — TM has near-monopoly status in Malaysia. Importantly, they have enduring competitive advantages that support a real and sustainable business model. This is in stark contrast to exuberant valuations for tech companies such as Tesla. Elon Musk justifies its lofty valuations with even loftier ambitions that we think are built on little more than a wing and a prayer.
The Global Portfolio closed 3.6% higher for the week ended Feb 3, lifting total returns to 56.9% since inception. The portfolio continues to outperform the MSCI World Net Return index, which is up 37.6% over the same period.
The top gainers for the week were Alphabet (+13.2%), ServiceNow (+11.6%) and Okta (+9.9%) while shares for Geely Automobile Holdings (-7.1%), Vertex Pharmaceuticals (-6.3%) and Johnson & Johnson (-4.4%) succumbed to some selling pressure.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
