Time To Jump Back In The Pool?

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What a ride.

After collectively shedding over $2 Trillion in market cap over the last three weeks, it looked like megacap tried to stage a comeback before taking another dive down. Will the selloff be extended, or is there an opportunity to bounce back?

On Wednesday this week, Nvidia beat yet another record - adding the most marketcap of any stock in history in one day at a massive $330B. Days later it fell back near its recent lows.

After a little bit of a mixed bag when it came to results from Microsoft and Google, Meta put up an all-around massive quarter while Amazon was a disaster and Apple kept its head above water.

Beneath the surface, we uncovered a lot of crucial data points around the secular AI trend when it comes to CAPEX buildout and revenue metrics.

At the same time, the Fed Came out with dovish language around a near-certain rate cut in September while a disappointing jobs report fueled recession worries.

Who said summer was boring?

Let’s double-click in on this action-packed week, what it means for the market, and what it means for the preservation or deterioration of key trends going forward.

• Tying It All Together 👉 AI/Semi’s Takeaway

• Google👉 Ad Business, AI Metrics

• Microsoft 👉 Slowdown in Cloud vs. Capex

• Meta 👉 Strong Conversion of Core AI Capabilities

• Amazon 👉 Trouble in Paradise

• Apple 👉 Long and Strong

• FOMC 👉 Cut Imminent

Tying It All Together 👉 AI/Semi’s Takeaway

I’m going to start with the conclusion: AI is very important. What we needed to see this quarter was adoption curves accelerating when it came to actual implementation of AI. While we got a lot of very encouraging early metrics through revenue recognition, it looks like cost-saving is equally (if not more) important.

Megacaps will need to justify the massive amounts of Capex they have been spending to show tangible ROI on building out datacenters. Speaking of Capex, we got a lot of it, with no signs of slowing down.

All in, the tone from companies was that they would rather overspend on this now than get left behind, but its also going to take a while for adoption to increase. Getting ahead of curves is important. But so is patience.

However, there was a lot of froth in the system as we got off to a torrid start to the year. Cycles always undergo periods of euphoria followed by rationalization. We just got the rationalization in spades.

The balance of this note is the three most important takeaways from each company’s earnings and a brief summary of the dovish FOMC meeting.

Google👉 Ad Business, AI Metrics

Overview: The three most important things: 1) Ad Growth 2) Google Cloud Growth; 3) AI Opportunity

Ad Readthroughs: A positive on this side was the 14% search revenue growth on tougher comps, which highlighted strength in the core business. Durability to this business is essential, especially as the threat of competing products that attack Google’s search monopoly. By embedded AI Overviews native on the search app, it looks like google is playing solid defense here, as this product actually drives more search traffic. YouTube stood out as the lone disappointment in the quarter.

Google Cloud Growth: Cloud revenue saw modest acceleration, up to 29% YoY. This impressive growth was driven by increased demand for Google's AI infrastructure and generative AI solutions, which have now generated billions in revenue. The company has been investing heavily in its technical infrastructure, including servers and data centers, which accounted for a significant portion of Alphabet's $13 billion in capital expenditures for the quarter.

AI Opportunity: 1) In only 6 months, AI-driven improvements to quality, relevance and language have improved performance by 10% for advertisers using Smart Bidding. 2) AI Overviews are driving increased Search usage and satisfaction and even higher engagement from the 18-24 age cohort; 3) more than 1.5M developers are now using Gemini across Google’s developer tools

Key Graphic:

By the Numbers:

Microsoft 👉 Slowdown in Cloud vs. Capex

Overview: The three most important things: 1) Cloud Growth Disappoints; 2) Core Revenue/Margins Solid; 3) AI Opportunities

Cloud Growth Disappoints: Azure and other cloud services reported a 30% increase in revenue, which, while substantial, did not meet the higher growth rates seen in previous quarters. This marked both a deceleration from pervious quarters, and a lower number than the street was expecting. While AI-related products provided 8% of this growth (up from 7%), the numbers just didn’t clear a very high bar.

Core Revenue/Margins Solid: Microsoft's overall revenue growth was strong, with the company reporting $62.0 billion in revenue, an 18% increase year-over-year​. The company's net income also saw a significant rise, reaching $21.87 billion, up 33% from the same period last year. This name continues to be a long-term capital compounder.

AI Opportunities: Where to start… Microsoft is one of the most immediately monetizable opportunities in AI, through its OpenAI partnership, Azure AI Services, and Github Copilot to name a few. Azure AI Services run rate was up 900% YoY to $5B with 60k customers (+60% YoY). Github is now at a $2B revenue run rate with CoPilot accounting for 40% of overall GitHub growth, now at $300M ARR. Daily users of Office CoPilot also doubled QoQ while customers with over 10,000 seats also doubling QoQ. Tons of metrics. Tons of real growth here.

Key Graphic:

By the Numbers:

Meta 👉 Strong Conversion of Core AI Capabilities

Overview: The three most important things were 1) Very Strong Ad Rev; 2) Minor Capex Bump; 3) AI Opportunities

Very Strong Ad Rev: Meta is back in a big way. The long term benefits from AI content recommendation, ad targeting, business messaging and ads generation continues to perform extremely well. Q2 revenue growth of 22% stole the show in this print. Excellent stuff.

Minor Capex Bump: Meta is building their AI strategy in a very unique way. Although they are spending heavy Capex on building out AI infrastructure, they do not have a cloud service business to back this. However, I believe that owning more control of their destiny through this investment is going to continue to pay off in spades. Coming off a year of efficiency (graphic below), concerns were that costs were going to start to increase again. However, they only bumped Capex guide from 35-40B to 37-40B. Not bad considering all that growth.

AI Opportunities: Meta splits its AI work into two groups Core AI and Gen AI. Core AI encompasses the near-term financial opportunities refering to using AI to augment its existing products. Think higher engagement on their social platforms and optimized spending for advertising. Their longer-term AI capability surrounds their Gen AI from customer service chatbots for businesses, to character companions on the social side. Remember - Meta is building their Open AI model truly open source vs. the gated competitors. I always think of that movie, the Social Network, where first Zuck focuses on product, then monetization comes. He’s done this before, and I strongly believe he can do it again.

Key Graphic:

By the Numbers:

Amazon 👉 Trouble in Paradise

Overview: The three most important things were 1) North America Retail’s topline deceleration/lacklustre operating margin 2) AWS growth strong but lack of commitment to H2 acceleration 3) Capex Step-up in 2H

North America Retail: Amazon’s North American retail business continues to gain share, but was not immune from macro and competitive pressures. 9% growth slowed 2% from Q1, in part due to paid units and ticket slowing. 3P units did better, with lower fees on certain services driving marketplace gains. Amazon continues to call out macro pressure on discretionary spending driving a product mix to lower-ASP items.

AWS: – Q2 AWS Revenue solidly delivered on investor expectations, up 19% Y/Y, a 2% acceleration, the 3rd consecutive quarter of YoY growth acceleration and the 2nd consecutive quarter of AWS QoQ dollar-based increase ahead of Azure. That said, management fell short of committing to Q3 acceleration for AWS, and disclosed Q2 backlog with the first sequential dollar-based decline ever.

Capex Step-up: AMZN saw $16.4B in Capex spend in Q2, or $30B spend in H1 combined. Mgmt. expects H2 Capex to rise from H1 levels, the majority of which will be investment into growing AWS infrastructure ahead of strong demand from both Gen AI and non-Gen AI workload.

Key Graphic:

By the Numbers:

Apple 👉 Long and Strong

Overview: The three most important things were 1) Services Acceleration 2) Profits & FCF margins and 3) Apple Intelligence

Services Acceleration: Growth rates remain impressive (14%) despite tougher compares and Apple noted growth is a combination of install base, monetization and new services offerings. I think this could actually accelerate in CY25 and beyond given AI will unlock more offerings and higher monetization.

Profits & FCF margins: Apple continues to operate at fairly high levels of gross-margins (>46%), EBIT margins (30%) and FCF margins (31%) – this should enable stronger EPS/FCF as we go through the next iPhone cycle.

Apple Intelligence: Expectation is for a staggered launch of AI starting this fall and with ChatGPT integration likely by year-end. A fairly compressed launch time will help drive a sizable upgrade cycle through this holiday season. Apple CEO noted the level of value AI offers presents a compelling reason to upgrade. Could this spur an upgrade cycle??? I think so…

Key Graphic:

By the Numbers:

FOMC 👉 Cut Imminent

The Federal Reserve held interest rates steady at 5.25% - 5.50% on Wednesday but hinted that it is nearer to easing monetary policy as it cited "some further" progress on inflation and Fed Chair Jerome Powell told reporters a September cut "could be on the table."

If you watched the market, it was surprising calm in the intraday when the statement was released. This was the one day this week where stocks ripped higher. They climbed even further as Powell took the stage.

A lack of fireworks is good for the Fed, but we also got economic data out that indicated that a recession may be coming after all as more people questioned the possibility of the fabled soft landing.

Volatility is back into the market in a major way. It’s very important to check your notes and stick with stocks that have improving fundamentals despite gyrations.

Wow… what a week!

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Cheers,

The GRIT Alpha Team

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