by David Aurelio.
The first quarter of 2018 is one of the most heavily anticipated earnings seasons, due to high expectations for YoY earnings growth (20.0%). Amidst a high bar, S&P 500 companies have not disappointed and are on track to set a new record, with 79.3% of companies reporting earnings above expectations. With the information technology sector accounting for roughly 22% of 18Q1 earnings, one area of focus will be details about mega-trends as tech companies report 18Q1 results.
Typically analysts become more bearish heading into earnings season and make downward revisions to earnings estimates, which results in an average decrease of 4 percentage points in S&P 500 YoY earnings growth expectations from the start of the quarter to the start of earnings season. This quarter positive sentiment related to global growth and tax reform drove analysts to increase YoY earnings expectations for the S&P 500 by 6.3 percentage points from 12.2% on January 1 to 18.5% on April 1, 2018, which set the bar for 18Q1 to post the highest earnings growth in seven years. As a result, investors anxiously awaited the first set of earnings reports to see if companies could deliver on elevated estimates.
While expectations are high, earnings have not disappointed. As of Apr. 20, 2018, 17% (87 companies) of the S&P 500 have reported 18Q1 earnings. Of these 79.3% have beat earnings expectations. If this holds, it will be the highest percentage of companies to beat earnings on record (going back to 1994). As a result, YoY earnings expectations have increased to 20.0%, which would make it the best quarter since 10Q4.
Exhibit 2: Semiconductor & Semiconductor Equipment YoY Earnings Growth Rates
The S&P 500’s semiconductors & semiconductor equipment industry constituents are expected to see 18Q1 YoY earnings increase 30.8%. Three influential names within the industry reported earnings during the week of April 15 (Lam Research Corporation (LRCX.O), ASML Holding NV (ASML.AS), and Taiwan Semiconductor Manufacturing Company Limited (2330.TW)). While YoY earnings growth is decelerating, three mega-trends echoed across the companies: increased demand for data storage (i.e. memory), artificial intelligence (A.I.), and 5G communication.
Martin B. Anstice, Lam Research Corporation – CEO, had this to say about the macro environment, “Turning to the macro and wafer fabrication equipment, WFE, spending environment. Expectations for global economic growth remain strong and are healthy. We believe that content growth remains a powerful multiyear driver of demand in the data economy. Context for multiyear customer investments is not simply a byproduct of market efficiency from consolidation and disciplined operational execution through the semiconductor supply chain. It is more fundamentally endorsed by the evergreen verticals of climate change, education, food and water, health care, security and transportation that together, define the opportunity for silicon-based artificial intelligence, AI technologies and applications and services innovation globally.
In the smartphone end markets, innovative data-intensive services will increasingly be deployed, leveraging AI and using a range of enabling artificial and virtual reality technologies. The deployments of 5G networks will improve the quality of these services. But to deliver the best user experience, the smartphones themselves will require a combination of higher screen resolution, faster refresh cycles and lower power. This will drive the need for nearly 2 times the DRAM contents in smartphones relative to the current global average. Additionally, density increases associated with higher layer counts in 3D NAND create the opportunity for terabyte-level storage in smartphones within the next few years.”
C. C. Wei, Taiwan Semiconductor Manufacturing Company Limited – Co-CEO, President & Additional Director, said the following of these mega-trends, “Let me talk about the long-term business growth driver. We are optimistic about the development of some of the industries’ mega trends, particularly AI and 5G communication. We believe these 2 will help semiconductor to spread its pervasiveness to our daily lives. Both AI and 5G will create the new usage models and spur new waves of demand for both of the existing and emerging applications with the increasing silicon content. We expect TSMC to benefit from these industry mega trends in all 4 of our growth platforms. In mobile, silicon content of the smartphones will increase due to increasing functionality such as facial recognition and new usage such as AR, VR and 3D video. In HPC, we expect AI will boost the attach rate of accelerators used in data center from today’s mid-teens level to about 50% by 2020. In automotive, the use of the new safety-related functionalities such as ADAS and eventually autonomous driving will drive the increasing silicon usage. In IoT, AI will proliferate into broad-based client devices across many applications, such as the smart voice assistance or electronics appliance management. These, again, will increase silicon content. We believe our 4 growth platforms are well positioned to benefit from the longer-term mega trend of AI and 5G. Our leadership in advanced and specialty technologies as well as our advanced packaging solutions should enable us to capture the future growth opportunities well.”
Despite the positive megatrends, one area that may not be as strong as expected is Apple, Inc.’s (AAPL.O) super-cycle for iPhones. TSMC implied a softer market for Apple’s high end iphones. C.C. Wei said, “We do see China as a market start to pick up in the smartphone. But in TSMC, we — in our smartphone market segment, some very high end smartphone is a little bit soft. So that’s why we projected that is going to be continuous softness. Okay. It’s not because of the China market that’s — that start[ing] to pick up slowly.”
Apple accounts for 4% of the S&P 500’s 18Q1 earnings and 20% of the information technology sector’s first quarter earnings. Therefore, if the softness is not made up for through services, lower end models, or margins, Apple could negatively impact both the index and sector’s growth this quarter.
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