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Q1 Earnings Season- An Early Read on the AI Chip Space

AInvestTuesday, Apr 23, 2024 6:11 pm ET
7min read

Q1 earnings season is underway. It will provide investors with a treasure trove of data. The news will give investors a brief respite from macro and geopolitical news. While these will continue to factor into decision making, and plenty of the earnings news, the reports will provide participants the opportunity to see who is thriving in this environment.

In our earnings season preview, we provide a list of three key storylines to follow this earnings season.

1)   Artificial intelligence (AI) continues to propel market segments, particularly within the semiconductor and AI infrastructure sectors, with companies like NVDA $NVDA(NVDA)expected to lead with a staggering 239% sales increase year-over-year. This trend is highlighted by 36% of S&P 500 companies discussing AI on their earnings calls, signaling its growing influence across various industries. Can this group continue to lead the way?

 2)   Consumer strength remains a focal point, evidenced by robust spending and employment data; however, concerns loom due to subdued consumer confidence and cautious guidance from major consumer-facing corporations.

 3)   The performance disparity within the S&P 500 is notable, as the top 10 companies, including giants like NVDA and META$META(META), are expected to outperform substantially with a 15% increase in sales and 32% in EPS, compared to modest gains or declines among the other 490 companies. This bifurcation raises questions about sustainability and potential market corrections reminiscent of the Tech Bubble era, underscoring the importance of upcoming quarterly results in shaping market trajectories.

We are still in the early stages of earnings so all three subjects would be given an "Incomplete" on the report card. This week, there will be several of the top 10 companies (MSFT $MSFT(MSFT), GOOG $GOOG(GOOG), TSLA $TSLA(TSLA), and META) reporting which will help define the third question. Today, we wanted to focus on the early returns from the AI space. We will look at Taiwan Semi $TSM(TSM), ASML $ASML(ASML), and Cadence Systems (CDNS) for an early read on market reactions to the report.

Taiwan Semiconductor (TSM)

Taiwan Semiconductor, the world's leading chipmaker, delivered a mixed bag of results in Q1. Despite achieving better-than-expected top and bottom-line results and raising Q2 revenue forecasts, TSM adjusted its outlook on the broader semiconductor market growth downwards, reflecting a slower recovery than anticipated. The revision is particularly pointed towards traditional sectors like servers, IoT, consumer electronics, and automotive, with the latter experiencing the most significant pullback.

AI remained a robust growth driver for TSM. The unit is expected to more than double server AI revenues this year and is projected to contribute over a fifth of the company's total revenue by 2028 with a 50% CAGR over the next five years. This growth is underpinned by strong demand and TSM"s strategic expansions, including plans for new fabs in strategic international locations such as Arizona, Japan, and Germany.

The overall semiconductor market, excluding memory, is now expected to grow by approximately 10% year-over-year, a downward revision from previous forecasts. This contrasts with the foundry industry growth, which is anticipated to be in the mid-teens, signaling specific challenges in core mobile and high-performance computing (HPC) segments that form 65-70% of sales.

Despite a cautious market outlook, TSM reaffirmed its commitment to significant capital expenditures ranging from $28 to $32 billion for FY24. The substantial investment underscores its strategic intent to maintain leadership, especially as it leverages a $6.6 billion grant from the U.S. government for its expansion in Arizona. The spend is significant, especially for the semi cap equipment players (ASML, TER, KLAC).

Despite solid quarterly performance, TSM's stock experienced a 4% decline in early trading, reflecting broader market sentiments rather than company-specific fundamentals. Analysts, however, view the sell-off as an overreaction, with recommendations to buy on weakness given TSM"s strong AI-driven growth outlook and strategic investments.

TSM remains at the forefront of the AI revolution, possessing a competitive edge over rivals like Intel, which struggles to match TSM's investment and innovation pace. This

advantage is fortified by TSM"s role as a critical supplier to leading technology firms such as AMD, NVIDIA, Apple, and Qualcomm, which are heavily invested in AI chip design.

Shares of TSM fell 8% in reaction to its earnings report. The results were fine, but the price reaction highlighted the issues around these AI chip plays. Most of these stocks have seen a significant rally into earnings. TSM ran from $90 in early November to the $158 area in March. The stock fell from $145 to $126 following its earnings results. It is finding support at the $125 area and has rallied back to $133. This marks a critical level as it offers gap down resistance for the stock. If it can break above this area, it should fill that gap back to the 4142 level.

ASML Holding (ASML)

ASML, a Dutch-based leader in photolithography systems essential for semiconductor production, finds itself navigating a complex market environment despite exceeding Q1 earnings expectations. Although the company achieved an earnings beat and managed to hit the midpoint of its revenue forecast range, broader concerns emerged due to a downturn in net bookings and a cautious revenue outlook that missed analyst expectations.

ASML reported a revenue of €5.29 billion in Q1, marking a 21.6% decline year-over-year and slightly missing analyst projections. The more concerning figure was the €3.6 billion in net bookings, representing a 5.3% drop from the previous year, signaling potential hesitancy among its customer base.

Despite the revenue shortfall, ASML maintained a healthy gross margin of 51.0%, reflecting a 40-basis point improvement year-over-year. This, combined with lower-than-expected operating expenses, contributed to the company's third consecutive earnings beat. It also suggests pricing power given the demand for Ai chips.

ASML reaffirmed its FY24 revenue forecast to mirror FY23's €27.6 billion, with expectations for a stronger second half of the year. This forecast aligns with management"s anticipation of a significant industry recovery slated for 2025, hinting at a gradual resurgence from current market challenges.

The semiconductor industry's broader trends, including energy transition, electrification, and AI, continue to serve as secular growth drivers. These elements, coupled with the global construction of new semiconductor fabs, underscore the ongoing demand for ASML's advanced photolithography systems.

The company's logic business is currently experiencing a period of adjustment as customers absorb capacity expansions from the past year. This has resulted in a subdued order flow, which ASML expects to overcome as the market moves towards recovery in 2025.

With significant technological expertise and minimal competition in high-performance chip manufacturing, ASML is well-placed to benefit from the expansion of semiconductor manufacturing facilities worldwide, especially in regions like China, which continues to account for a substantial portion of the company"s order backlog.

Despite near-term market volatility, analysts remain bullish on ASML's prospects. Projections for 2025 suggest a robust recovery, with order rates expected to exceed €4 billion per quarter in 2024, paving the way for revenue targets around €35 billion. Analyst upgrades and price targets reflect confidence in ASML"s market position and its ability to capitalize on upcoming industry upturns.

ASML shares dove lower in reaction to the bookings miss. Analysts did come to the company"s defense, noting that the bookings miss and weaker Q2 outlook was temporary, and the demand remained strong. Still, investors had high expectations as evidenced by the fall from $970 to $870 in ASML shares. The stock did find support at the 20-weekly moving average ($869) and is attempting to bounce back. There will be resistance at the $950 area on any recovery attempt. We would view this as a "prove it" stock, meaning it will need to post a solid Q2 and improved outlook before it can retest that $1000 area barring a broader market rally.

Cadence Systems (CDNS)

CDNS reported Q1 earnings of $1.17 per share, edging out the consensus by $0.04. The company's revenue dipped by 1.2% year-over-year to $1.01 billion, aligning closely with analyst expectations but highlighting slight market contraction. This decline was particularly pronounced in the product and maintenance segment, which decreased by 5.2% year-over-year, underscoring a broader slowdown in hardware demand.

CDNS posted a non-GAAP operating margin of 38%, a decrease from 42% in Q1 2023. This margin performance demonstrates effective cost management and operational efficiency.

For Q2, CDNS set a conservative guidance with EPS expected between $1.20 and $1.24, significantly below the prior consensus of $1.43. Similarly, revenue forecasts for Q2 were set between $1.03 billion and $1.05 billion, reflecting continued cautiousness in near-term market conditions. The full-year guidance remains steady with EPS projected between $5.88 and $5.98, and revenue forecasts ranging from $4.56 billion to $4.62 billion.

Analysts noted the mixed results but remained optimistic about CDNS's core strengths and market position. The introduction of new products like the Z3/X3 platforms is expected to catalyze a recovery in hardware demand, particularly in the second half of 2024, positioning CDNS well for a potential upswing in market conditions. The launch of the Z3/X3 series is anticipated to revitalize demand, particularly as customers transition from older models. This strategic product refresh is expected to drive future revenue growth and reinforce CDNS's competitive edge in the semiconductor design market.

CDNS shares have experienced an 8% drop, influenced by broader market sentiments and the cautious industry outlook. This reaction highlights the current sensitivity of tech stocks to both operational performance and forward-looking guidance.

With a backlog of $6.0 billion and significant remaining performance obligations, CDNS is well-positioned to sustain its market leadership and capitalize on long-term industry trends, including the ongoing expansion of AI and electrification across multiple sectors.

 The market's response to Cadence Design Systems' (CDNS) earnings report presents a notable contrast in timing compared to its peers TSM and ASML, who reported their results last week during a market downturn. In contrast, CDNS released its earnings on Monday night amid signs of an oversold market rebound.

This context is crucial for understanding CDNS' stock movements today. The stock had previously dropped from $327 on March 21 to $285 just before the earnings announcement. Following the release, it initially fell below the 200-day moving average ($265) during after-hours trading. However, it rallied significantly during Tuesday's trading session, at one point recovering all its earlier losses for the day, and eventually closed at $281, down just 1.1%. This price action was somewhat positive, indicating that the selling pressure might have abated.

Conclusion

As mentioned earlier, it's too soon to draw definitive conclusions with several earnings reports still pending. Nonetheless, early indications from the AI sector are worth noting:

  • Demand for AI chips remains robust without any significant signs of a slowdown.

  • There are indications of short-term saturation in the equipment and software markets, as suggested by less optimistic forecasts from companies like ASML and CDNS.

  • TSM has reported a downturn in demand for traditional PC and mobile chips, although AI chips continue to be a strong growth driver.

  • Investors have been quick to sell off shares if earnings reports or guidance, particularly future outlooks, don"t meet expectations, hinting at widespread concern about a potential peak in demand.

  • It seems that these stocks may have reached a point of seller exhaustion, which could prompt investors to seek out undervalued stocks. 

  • The key question remains: will investors wait for actual results or begin to buy in anticipation of positive earnings?

  • Moving forward, we will keep an eye on trends in investor behavior. From recent market activity, it appears there may be some exhaustion among sellers, potentially giving bulls an opportunity to capitalize on select names, especially if the recent surge in rates begins to subside.

Disclaimer: the above is a summary showing certain market information. AInvest is not responsible for any data errors, omissions or other information that may be displayed incorrectly as the data is derived from a third party source. Communications displaying market prices, data and other information available in this post are meant for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of any security. Please do your own research when investing. All investments involve risk and the past performance of a security, or financial product does not guarantee future results or returns. Keep in mind that while diversification may help spread risk, it does not assure a profit, or protect against loss in a down market.