Visible Alpha Technology

Netflix Inc. (NASDAQ: NFLX) will report Q3 2024 results on Thursday, October 17, 2024. Here are the key numbers that we’re watching.

 Figure 1: Netflix: Consensus Expectations for Q3, Past Earnings Surprises, Revisions, and CAGR

Source: Visible Alpha consensus (October 10, 2024). “Surprise” indicates the direction that specific line items beat or missed. “Revisions” show the trajectory of line items from a given date.

Netflix Q3 2024 Earnings Preview and Outlook

Q3 2024 expectations: Revenues are expected to be supported by continued paid-sharing, growth of the ads business, and further monetization. After the disappointment in Q2 2024, questions remain around the investments in the ad tier, increased competition, and its impact on paid sharing.

According to Visible Alpha consensus, the 28% margin is expected to be driven by total revenues of $9.8 billion and operating income of $2.7 billion in Q3 2024. These estimates have not changed much since last quarter. These projections are driven by consistent expectations for U.S. streaming and an uptick in ad-supported revenue. It is worth highlighting that since the July quarter, ad-supported revenue has moved back up to $549 million, but is still lower than the initial expectation at the beginning of FY 2024.

While there does not appear to be a meaningful shift in overall top-line and operating profit expectations from the July quarter, earnings estimates have moved up from $5.05/share to now $5.12/share.

The stock has traded up around 13% to $727 since last quarter’s release, driven by the resilience in the company’s net adds. Will the outlook for the rest of 2024 support the upward trajectory of Netflix’s stock price?

Q4 2024 expectations: Currently, the Q4 2024 revenue is expected to be $10 billion. Revenues are expected to be supported by price increases, growth of the ads business, and further monetization. Operating margin is expected to be 21%, a year-over-year improvement of 400 bps.

FY 2024 expectations: The company expects to grow revenues by increasing engagement trends and reducing churn with a more diverse entertainment offering. Gaming and the growth of ads could be key drivers in H2 2024. According to consensus, analysts expect the company to generate a 26% margin from revenue of $38.7 billion and $10 billion in operating profit in FY 2024, which has not changed much since April 2024 and is in line with Netflix’s guidance.

 Figure 2: The Direction of Key Netflix Estimates

Source: Visible Alpha consensus (October 10, 2024). Stock price data courtesy of FactSet. Netflix stock price is as of the market close on October 11, 2024.

Key Takeaways and Questions

• According to Visible Alpha consensus, Reality Labs’ sales are projected to hit $2.2 billion by the end of FY 2024, but losses are expected to continue.
  • Priced at $299.99, will Quest 3S start to increase sales and reduce losses?
• Smart glasses are taking off.
  • How long will it take for this category to grow sales and break even?
• Llama 3.2 is multi-modal.
  • What impact could this have on Meta’s business model?

Meta Platforms (NASDAQ: META) hosted its Meta Connect 2024 conference on September 25-26, 2024. In the opening keynote speech, CEO Mark Zuckerberg highlighted new product innovations all geared toward making people feel closer and strengthening relationships. On the hardware side, the company showcased a faster, smoother Quest 3S VR headset and a prototype of an upgraded pair of smart glasses called Orion. In addition, Zuckerberg discussed the new Meta AI innovations.

Meta Quest 3S

Source: Meta Connect 2024 on September 25, 2024

Quest 3S Mixed Reality Headset

Meta’s Quest 3S mixed reality headset will ship on October 15 for $299.99, down from $499.99, a fraction of Apple’s $3,499. The game, Batman Arkham Shadow, will be included with Quest 3/3S this fall. Will these improvements and the $200 price drop help to stimulate sales this holiday season?

Improvements and optimization to the tech stack supported the Quest 3S mixed reality experience upgrade. The passthrough has also improved, but probably still trails Apple’s Vision Pro. Meta expanded its content and will integrate Dolby Atmos. Meta’s social apps have been rebuilt to benefit from the mixed reality experience. While gaming and consumer markets are important, Meta’s objective is to lay the groundwork for a general computing platform within the headset and to bring in many more users.

In addition to its core segments, Meta is also going after the enterprise market. Quest is going to be a natural extension of the PC. Meta has been working with Microsoft on remote desktop to take mixed reality to the workplace at scale.

How big could this opportunity be for Meta?

Orion

Source: Meta Connect 2024 on September 25, 2024

Smart Glasses

CEO Zuckerberg highlighted that smart glasses are taking off faster than expected. The next-gen smart glasses featured enhancements, including live translation and multi-modal integration to the AI assistant.

While these improvements to the Ray-bans are interesting, the next-generation augmented reality holographic glasses prototype, Orion, seemed to steal the show. A video showed Nvidia CEO Jensen Huang trying out Orion and commenting on the functionality and lightweight. 

Orion and Nvidia

Source: Meta Connect 2024 on September 25, 2024

Implications for Reality Labs

With these new product releases, how they will help to drive revenues and reduce losses in this segment will be key. Reality Labs has been a meaningful drag on the company’s total operating profit margin with little visibility into when this drag will improve.

According to Visible Alpha consensus, Reality Labs’ sales expectations have been trending down. Since last quarter, analyst estimates for Reality Labs revenues have declined from $2.3 billion to $2.2 billion for FY 2024 and from $2.7 billion to $2.6 billion for FY 2025. In contrast, Analysts’ forecasts of operating losses at Reality Labs have improved from -$18.9 billion to -$18.5 billion in FY 2024 and from -$21.5 billion to -$19.9 billion in FY 2025. However, there is significant debate about the future level of losses for Reality Labs and a wide range of loss estimates.

The Stack

Source: Meta Connect 2024 on September 25, 2024

Llama 3.2

Meta featured its stack for its open-source Llama to support developers with a set of Reference APIs designed to help drive the adoption of the Llama models. To support Open Source AI, Meta also released Llama models which include small text (1B and 3B) for edge and mobile and multi-modal (11B and 90B) models.

The significantly declining cost was highlighted too. However, it is unclear how this will continue in the future with higher computing needs for future Llama upgrades.

Meta AI

Meta AI’s capabilities were in focus at the conference. Meta AI is an assistant to help answer questions and requests that will now be powered by Llama 3.2. CEO Zuckerberg called out that Meta AI has ~500 million users and will expand business AIs to companies.

Meta will roll out Meta AI Voice, translation, and enhanced multi-modal features that will enable users to share and ask questions in natural language. Meta AI will also expand to create content and images with AI.

Will these enhancements help to drive engagement in Meta’s family of apps, leading to higher sales in FY 2025?

META Segment Revenue and Income Consensus

Source: Visible Alpha consensus (September 26, 2024). Stock price data courtesy of FactSet. Meta’s current stock price is as of the market close on September 25, 2024

Introduction

I went to Japan this August for two weeks. In addition to meeting the intense heat, I sat down with many high-level executives, bureaucrats, and investors to discuss Japan’s future. I have been investing in Japan for many years and was surprised by my observations.

With a very favorable Yen/$ rate, it was refreshing how inexpensive everything Japanese seemed to be in dollar terms. In contrast, imported items, especially from the U.S., were pricey in Yen. Therefore it is no surprise that foreign tourists, especially from the U.S. have increased significantly, helping drive economic activity in the notoriously low-growth market. Japan is importing inflation and consumption.

As the Yen weakened and the dollar strengthened, it was also no surprise that Japan’s $1.8 trillion pension fund, GPIF, has benefited from its 25% allocation to foreign equities benchmarked to MSCI ACWI. This large position benefited from significant exposure to the U.S. and a 20% concentration in U.S. mega-cap technology stocks over the past few years.

In addition, U.S. imports of computers and accessories have jumped on the back of the AI boom. U.S. companies have likely been taking advantage of the strong dollar and making investments in next-generation technology at better dollar prices, which has probably helped Japanese exporters.

Mrs. Watanabe is a term used to describe Japan’s foreign exchange investors collectively. This group is notorious for taking large positions to benefit from currency and macro moves. Given the extreme currency moves from the past two years, concerns loom about how Mrs. Watanabe and other investors may start to reposition their portfolios. Asset allocation and currencies might shift dramatically as the Fed looks poised to start a path of rate cuts in the U.S.

The Dawn of the AI Revolution

Mega-cap U.S. technology stocks have been a dominant market force since early 2023, driving a significant portion of the upside to U.S./Global indices. At the end of 2022, the Fed’s rate hikes to tame inflation were well underway, supporting dollar strength. Shares bottomed and many of the largest technology companies cut costs and trimmed their headcount in early 2023, while investing in the next generation of AI. Since then, the AI revolution has taken the markets by storm. Companies, like Nvidia (NASDAQ: NVDA) and Super Micro Computer (NASDAQ: SMCI), have seen their share prices explode, on the back of the massive surge in CapEx by cloud service providers.

Figure 1: Share Price Performance from January 2023 to July 2024

Top AI-exposed U.S. Technology Stocks

Source: Visible Alpha AI Monitor (September 4, 2024)

According to the S&P Global Market Intelligence economics team, “imports of computers and computer accessories, collectively, have increased by 60% since December to all-time highs. These two categories, along with semiconductors, account for about half of the 7% increase in nominal imports since December. This is related to massive investments U.S. high-tech companies are making in AI and businesses and consumers upgrading.”

In addition, U.S. technology companies are likely taking advantage of the strong dollar to make these investments. These companies may be able to procure and import next-generation computers and accessories from Japan at lower dollar prices.

Figure 2: Imports of Computers

Source: S&P Global Market Intelligence (September 4, 2024)

AI-exposed Companies at Crossroads: Squaring Revenues and CapEx

Since January 2024, SMCI + NVDA have driven over $100 billion in upward revisions to AI-exposed revenues. While these two companies have been a driving force behind the AI theme, Alphabet (NASDAQ: GOOG), Amazon (NASDAQ: AMZN), Dell (NYSE: DELL), and Microsoft (NASDAQ: MSFT) have seen estimates increase this year. Expectations have risen and the investment community has been grappling with how best to assess the risk and reward of the AI theme.

Figure 3: AI-exposed Revenue Revisions at Top U.S. Technology Firms

Source: Visible Alpha AI Monitor (September 5, 2024)

While revenues are likely to benefit from AI exposure, the cost structure and cash flow of these technology companies has changed. Compared to previous years, expected operating expense growth slowed for most of the top AI-exposed firms since early 2023. Companies overhauled talent and reevaluated their cost structures. However, CapEx growth expectations outpaced opex since 2023, as these same companies significantly ramped investment in next-generation GAI infrastructure. With CapEx increasing at a faster pace than AI-exposed revenues, there is concern that the revenue growth from GAI may not materialize with the current expectations.

At the moment, these stocks appear to be at a nexus, as analysts debate whether or not expectations will grind higher on the broad adoption of Generative AI (GAI), especially as Apple (NASDAQ: AAPL) has now entered the race. The world is waiting to see if GAI will deliver on its promises of higher productivity in ways that will generate revenues and an ROI that will justify the significant CapEx investments.

Figure 4: CapEx Growth Relative to Sales Growth Expectations

Source: Visible Alpha AI Monitor (September 5, 2024)

Shifting U.S. Macro Tides from July 2024

Since the beginning of July 2024, many of the mega-cap U.S. technology stocks that had been outperforming started to see underperformance, especially those most geared to the AI growth story. Mega-cap technology stocks missing expectations in their earnings releases and outlooks were punished in the most recent quarter. Many questions started to emerge about the drivers of the performance and the direction of expectations and upside going forward.

Figure 5: Share Price Performance from July 2024 to September 2024

Source: Visible Alpha AI Monitor (September 4, 2024)

Compounding the complexity of these investment dynamics, the macro backdrop has started to shift and has added to the already fragile situation with the U.S. mega-cap technology stocks. S&P Global Market Intelligence projects September 2024 for the first U.S. rate cut. In the U.S., inflation expectations have come down and there are concerns about the resilience of the labor market, which has contributed to some weakness in the dollar. This dollar decline may impact the investment in AI, as imports of computers and accessories may become more expensive in U.S. dollar terms going forward.

Figure 6: S&P Global Market Intelligence U.S. Outlook

Source: S&P Global Market Intelligence (September 5, 2024)

The Japan Factor: Significant Exposure to U.S. Mega Cap Tech

One factor that may be underappreciated by the market is the exposure of U.S. mega-cap tech to Japanese retail and institutional investors. As the Yen and Japanese growth receded over the past few years, Japanese investors were forced to look overseas for returns. This likely led to buying
in both well-known individual U.S. mega-cap technology stocks and the major U.S./global indices, which are heavily concentrated in the largest U.S. mega-cap technology stocks. Adding foreign exposure enabled Japanese investors to diversify their Yen assets both toward global growth and a strengthening U.S. dollar, as inflation surged in the U.S. This strategy has been overwhelmingly successful.

Since January 2021, the Yen has dramatically weakened from 103 to a peak low of 161 JPY for $1 USD and the S&P 500 returned around 50%, giving Japanese investors the double benefit of both stock outperformance coupled with an appreciating dollar. In addition, savvy investors have also leveraged this strategy by executing a carry trade by borrowing Yen at historically low rates and investing the proceeds in U.S. growth stocks.

Figure 7: Correlation of the Yen and the S&P 500 Index

Source: S&P Global Market Intelligence (August 30, 2024)

In July, the Yen hit a low at 161/$, a level not seen in decades, leading to whispers that the Bank of Japan may move to reduce the inflation on imported goods. In addition, the weak Yen has led to a surge in exports and foreign tourists that helped drive growth and consumption in Japan’s historically anemic economy, which some suggested was leading to overheating. The U.S. saw a whopping 70% increase in tourists to Japan, which was likely driven by the weaker Yen.

Figures 8: Tourism and Key Economic Indicators

Source: S&P Global Market Intelligence (August 19, 2024)

As rumored, the Bank of Japan raised interest rates for the first time in over ten years, surprising carry trade investors who did not believe it would happen. This rate move was followed by weaker-than-expected U.S. job growth, which led to a strengthening in the Yen. In addition, several key U.S. mega-cap tech earnings came in a bit below expectations leading to selling pressure. The combination of U.S. stocks and the currency both moving against carry trade investors forced selling in their positions, fueling volatility in global markets.

Since early August, the S&P 500 has stabilized, despite continued strengthening in the Yen. S&P Global Market Intelligence projects the Yen to continue to strengthen through 2026 and for the Bank of Japan to raise rates again in March 2025. This outlook may reignite volatility in U.S. mega-cap technology stocks and currency markets. However, this time it may not be prompted by a negative response to a carry trade gone wrong, but by a longer-term asset allocation decision by Japan’s retail and institutional investors.

Simply looking at the $1.8 trillion Japan Government Pension Fund (GPIF), 25% is allocated to the MSCI ACWI, approximately $450 billion. This index significantly outperformed the other asset classes, due to the 20% concentration in outperforming U.S. mega-cap technology stocks. GPIF’s approximately $90 billion exposure benefitted both from the AI theme and the strength of the U.S. dollar.

If the GPIF were to decrease its asset allocation to MSCI ACWI by 3%, that would lead to the selling of $10 billion in the U.S. mega-cap technology stocks concentrated in the MSCI ACWI.
While the exposure in GPIF is significant, it is only one example of the asset allocation impact. There is likely broad ownership of these U.S. mega caps across a variety of domestic Japanese retail and institutional investors, who have wanted to diversify their portfolios, benefit from dollar strength, and growth in the U.S. technology stocks. The full magnitude of the exposure to these stocks is difficult to aggregate and fully quantify. However, it is probably significant and may lead to future volatility.

Figures 9: Japan’s Government Pension Holds over $450 Billion in MSCI ACWI

Investment Assets and Portfolio Allocation
(Pension reserves managed by GPIF and the Pension Special Account）

Source: GPIF  (September 5, 2024)

GPIF Q1 2024 Asset Class Performance and MSCI ACWI Index Concentration

Source: GPIF and MSCI (September 5, 2024)

Cumulative Returns Since Fiscal 2001

Source: GPIF (September 5, 2024)

Final Thoughts

As the U.S. tamed inflation, the global macro outlook has started to change. This month, the Fed is expected to start a series of cuts. As the world prepares for this policy shift, we are likely entering a period of a weaker dollar and slower U.S. growth. At the same time, expectations for U.S. mega-cap technology stocks have increased. Their concentration in U.S./Global indices remains significant and may lead to underperformance if these expectations are not met or exceeded. Further compounding these trends, global investors may have to revisit their existing asset allocation and position for the next two years of possibly stronger growth and currencies outside the U.S. As we move into the Q4 of this year and gear up for 2025, will the U.S. mega-cap stocks and the AI trade continue to outperform?

Nvidia Corp. (NASDAQ: NVDA) reported fiscal Q2 2025 results on Wednesday, August 28, 2024. What happened during the release and earnings call, and what are the key points to focus on?

Nvidia’s Fiscal Q2 2025 Earnings Release

Nvidia delivered total revenues for Q2 of $30.0 billion, beating Visible Alpha’s consensus estimate of $28.7 billion by $1.3 billion, driven by continued revenue growth of Nvidia’s Data Center segment. The segment saw its Q2 revenue surge to $26.3 billion, $1.3 billion ahead of the $25.0 billion consensus estimate coming into the quarter and capturing all of the beat to expectations.

This revenue surge has continued to be driven by strong demand for Hopper GPUs, particularly from cloud service providers. On the earnings call, the company highlighted that Hopper supply and availability have improved. Blackwell demand is well above supply and is expected to continue into next year.

However, the Data Center segment’s non-GAAP gross margin dipped to 78% in Q2, in line with consensus. This muted the magnitude of the surprise to the EPS line with non-GAAP diluted EPS of $.68/share, exceeding the consensus of $.65 by 4.6%, less than previous beats. In addition, Nvidia announced approval of a $50 billion buyback, which some viewed as a bearish sign.

Figure 1: Nvidia estimate trends

Source: Visible Alpha consensus (August 30, 2023). Stock price data courtesy of FactSet. Nvidia’s current stock price is as of the market close on August 29, 2024

The Outlook

Near-term growth

For fiscal Q2 2025, Nvidia guided $1 billion ahead of expectations to $33.1 billion in total revenue, with analysts now projecting the Data Center segment to make up $29.1 billion, up from $28.0 billion. In addition, Nvidia guided total gross margin to continue to be around 75% levels, down 50bps from 75.5% last quarter, driven by a mix shift in the Data Center business.

Looking further out, analysts remain bullish on the Data Center segment. Since the Q2 release, analysts have increased their full-year Data Center revenue estimates by another $1 billion for FY 2025 to $110.6 billion, driven by continued optimism around GPU demand and the release of Blackwell. According to Visible Alpha consensus, Data Center revenues for FY 2026 are now expected to jump to $168 billion, up from $144 billion on May 22, 2024, with consensus EPS increasing over 15% to $4.10/share. It is worth noting that since last year, Data Center revenue revisions for Nvidia have increased by over $200 billion and reflect where current expectations are for the company’s outlook.

Figure 2: Nvidia Data Center revenue revisions

Source: Visible Alpha consensus (August 30, 2024). Stock price data courtesy of FactSet. Nvidia’s current stock price is as of the market close on August 29, 2024

On the earnings call, the company highlighted that the new Blackwell production ramp has been pushed out and is now scheduled to begin in the fourth quarter and continue into FY 2026. In Q4, Nvidia expects to get several billion dollars in Blackwell revenue. He also noted that ”demand for Blackwell is incredible” and that it “provides 3-5x more AI throughput in a power-limited data center than Hopper”. While analysts debate the quarterly pace and timing of the B-series and GB-series ramps, the long-term expected growth is projected to add to revenues in FY 2026 and FY 2027.

P/E debate: The range of Data Center estimates

The range of estimates has continued to narrow for the Data Center business in FY 2025, suggesting the market has increased conviction in the direction of this segment this year. For FY 2026, however, the range of estimates has narrowed slightly but remains substantial, implying that there is still significant debate about Nvidia’s growth outlook. The top-end estimate expects $212.5 billion, up from $189.9 billion, while the low-end estimate is now at $144.4 billion, up from $119.5 billion, driven by differing views about GPU demand and the ramping pace of new GPUs.

Non-GAAP diluted consensus EPS for FY 2026 is now projected to be $4.10/share, up 15% from Q1 2025. But there is a nearly $2.60/share range in expectations, from $5.46/share to $2.84/share. Current FY 2026 P/E ratios range from 23X to 44X. For FY 2027, the range expands from 17X to 68X, driven by different assumptions about the timing and magnitude of Data Center revenue growth.

NVDA stock has traded down over 6% since the earnings release, and is up nearly 24% since the Q1 release on May 22, 2024. Will the ramp of Blackwell drive the Data Center business to beat expectations in Q4 and into FY 2026?

Figure 3: Nvidia consensus estimates

Source: Visible Alpha consensus (August 30, 2024). Stock price data courtesy of FactSet. Nvidia’s current stock price is as of the market close on August 29, 2024

Long-term growth

Huang continued to emphasize that the industry is experiencing a major change. He expressed his optimism about the Data Center’s move to accelerated computing to create AI factories and noted that accelerated workloads will save power and cost. Leveraging Nvidia’s accelerated computing capabilities is enabling cloud service providers to provide a foundation for enterprises to begin integrating generative AI into their workflows. What will earnings look like in three years?