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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Meta plunges on weak outlook; Amazon earnings key risk
Peter Garnry
Chief Investment Strategist
Summary: In today's equity update we focus on Meta, the parent company of Facebook, which surprised investors last night with a much weaker than estimated guidance on Q1 revenue due to rising pricing pressures in its ads business and more competition from TikTok. The revenue guidance will make it difficult for Meta to hit the 15% revenue growth in 2022 that analysts were expecting. Combined with higher investments in 2022 driven by its Metaverse bet, the ROIC will likely also begin trending down adding pressure to the share price. Finally, we are looking at Amazon ahead of its Q4 earnings release tonight which is the biggest risk to equities overnight.
Meta shares down 22% in pre-market trading
US equities are weaker following the recent rebound with Nasdaq 100 futures 2.9% lower from yesterday’s intraday high. The reason for the rolling over in equities is the weaker than expected outlook from Facebook’s parent company Meta.
Meta reported Q4 MAU figures of 2.91bn vs est. 2.95bn and EPS of $3.67 vs est. $3.84 with revenue of $33.7bn in line with estimates. However, it was the Q1 revenue guidance of $27-29bn vs est. $30.3bn that spooked the market and an accelerating operating loss of $3.3bn in its Reality Labs segment which covers the new Metaverse bet. The reasons behind the lower than expected revenue in Q1 are headwinds on impression and pricing, which is a function of increased competition from among other TikTok and Facebook being on the backside of front-loaded advertising spending by customers.
If Meta hits revenue of $28bn in Q1 it would translate into a meager 6.9% y/y growth which is a sharp decline in growth from 19.9% y/y in Q4. With estimates looking for 15% revenue growth in 2022 it means that growth expectations will have to be lowered. This is in itself negative for equity valuations relative to the implied market expectation but the increased investments in the Metaverse combined with pricing pressure in the ads business could cause ROIC to roll over from the current ROIC of 33.3% in Q4 (see chart). If both ROIC and revenue growth are coming lower vs expectations then it is poison for the equity valuation and it that light the pre-market trading makes sense.
Meta shares are down 22% in pre-market trading (red line in chart below) and given its 2% weight in the S&P 500, the indicated decline alone with contribute 0.44%-point negative impact on S&P 500. With the indicated decline the current free cash flow yield is 5.6%.
Amazon earnings is a key market risk tonight
The next earnings risk to US equities is Amazon reporting Q4 earnings tonight. Analysts are expecting revenue growth to decline to 9.8% y/y down from 15.3% in Q3 as pandemic tailwinds are fading. Massive investments in fulfillment centers and other logistical operations have caused free cash flow to plunge to around $-2.3bn in the past 12 months. Investors will likely want to see signs of investments coming down and free cash flows up or otherwise the equity valuation could come under pressure. The two key things to watch tonight is guidance on revenue growth and operating margin with the latter posing the biggest downside risk for the company due to rising input costs on wages and logistics.
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