For reference to terminology used, please look at technical analysis under our resources section here. Regarding the charts below, the vertical tan shades represent time factors. These are inflection points where we have high odds of something significant happening. More times than not, (3/4 of the time), they mark a turning point in the trend. So, what matters is the direction we are trending into these periods. Regarding the vertical lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.here. Regarding the charts below, the vertical tan shades represent time factors. These are inflection points where we have high odds of something significant happening. More times than not, (3/4 of the time), they mark a turning point in the trend. So, what matters is the direction we are trending into these periods. Regarding the vertical lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.

Elliott Wave count are meant to provide context. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play

Broad MarketBroad Market

I am updating the current counts to fit the most likely interpretation of the price action of the 2022 bear market. The blue count is the same, and I consider to be a low probability, while the red count is favored for several reasons. For those that have not seen my most recent webinar, I encourage you to listen, as I go into detail why the macro and technical information that we have supports this thesis. You can listen here for I/O Premium, and here for Seeking Alpha.

The NASDAQ-100 (NDX) offers the most pronounced version of this structure in red below. In fact, it was the only structure that accounts for the price data, while the blue count feels forced.

Red – The reason I’m moving away from the standard A,B,C structure is because the current 3 wave bounce would have to be the B wave. B waves tend to retrace the majority of the first leg down. This would mean that we make a run to new highs well above 4400 SPX. This is simply not true in this case. The B wave is making a lower high in price, while extending longer in time than prior attempts at a bounce.

The only structure that accounts for this type of behavior is a complex corrective pattern called a W,X,Y pattern. This is characterized by downward trending 3 wave patterns in all directions (sound familiar?), where the structure gets more extended towards the end. If true, we should drop in a 5 wave pattern into the 9000 NDX region to complete the bear market. This level would be around 3000 SPX.

Blue – this scenario has us bottoming in a rather exotic structure. The C wave plays out as a very extended diagonal pattern, while the A and B waves are rather short. It fits, but is more rare to see a correction unfold with such disproportionate waves than a W,X,Y pattern. To make this scenario more improbable, the fact that we only have a 3 wave bounce off the October low means that if this is a new bull market, it would have to unfold as a diagonal pattern. More times than not, 3 waves tends to be a correction than the start of a new trend.

Daily Chart SPX

Shifting back to SPX, which has the same W,X,Y pattern unfolding, if we analyze the 3 wave bounce off the October low, it appear to be incomplete. C waves are always 5 wave patterns, and this one only appears to have 4 waves in place. This would imply a run to new highs in the coming weeks, which will target 4225 – 4275.

15 Minute Chart15 Minute Chart

If we zoom in on the ongoing 4th wave of the larger C wave, it also appears to be incomplete. I suspect we will see early weakness into this week, which would be a buyable low for anyone trying to play the ~200 point bounce that the coming 5th wave implies.

The lower support region is 4025 SPX and must hold 3985. We will likely remove half of our hedge and go net long to play this move. The R/R levels are quite attractive – stop below 3985 with a target of 4225. However, please keep in mind, the odds favor that we will be picking up quarters in front of a steamroller, so being nimble is crucial. For this reason, if we break back below 3985 and sustain below this region, any hedge that we log a gain on, will be put back on.

MacroMacro

The blue count would imply a soft landing is more than possible, as the FED maintains a terminal rate of around 5%. The February FOMC meeting had a tone that implied this was possible, and that after a few more hikes, we would hold ~5% Fed Funds rate into 2024. Though cautious, the market seemed to agree that peak inflation was behind us and that the actions taken by the FED are working. The problem with this narrative is that equities bought it and bonds did not. In fact, the February FOMC meeting marked the high in bonds, as the downtrend continues into this week.

What the bond market is likely picking up on is that the economy is quite durable, and declaring victory over inflation is not a probable outcome at this point. The recent CPI and PPI readings confirmed that inflation is re-accelerating, proving that the battle against inflation is not over. Peak inflation is likely behind us, but the real battle will be getting it back to the 2% target. Considering the extraordinary actions taken to quell inflation, it is concerning that we are starting to see inflation re-accelerate, even slightly.

This is further shown in the recent PMIs. Regarding the PMI readings, anything above 50 indicates an expansion, while below 50 indicates a contraction.

For one, manufacturing is currently at lower levels than just before the February high in 2020. This is a notable reading, as prices are much higher than in the 2019 downturn. Manufacturing is in a recession, and due to its sensitivity to interest rates, it is always a leading indicator of a slowing economy. However, if you look at services PMIs, which accounts for about 86% of the GDP in the U.S., it has re-accelerated into expansion territory. 

This is ultimately what a soft landing looks like in the US, where manufacturing contracts while services stays resilient. We saw similar soft landings in the mid-80s, mid-90s and most recently in the 2014-2016 slowdown. So, it seems plausible that this could be playing out again, and all the recession talk is overblown.

The one common thread between all the prior soft landings was the liquidity cycle. The FED was either still in the expansion part of a liquidity cycle, or started up a new one, which diverted services from following manufacturing into a contraction. The current liquidity cycle is below in black and put up against the S&P 500 for reference.

There is a stark divergence between liquidity continuing to trend down and equities trying to recover. The bet that the bulls have to make, which would bolster the trend in equities (blue count), is that the FOMC is about to start a new liquidity cycle, or at the very least, stop QT and allow liquidity to stay flat to trending slightly up based on other metrics. So, the question one has to ask is – with the current new data in CPI and PPI, with pockets of strength in non-manufacturing and employment, is the FED more likely to start a new liquidity cycle, which would push asset prices higher, along with wealth and discretionary spending power? The bond market has answered with a resounding no. In fact, for the first time in this cycle, the bond market as well as institutional analysts are projecting a higher terminal rate than the FED, which is concerning.

Bail Out LevelsBail Out Levels

I have stated before, and will continue to state that my bearish outlook has an expiration. If TLT and the DOW can break back above their December highs, I will abandon our bearish thesis and flip back into the bull camp. I will also want to see DXY (the US Dollar) commence its downtrend. Short of this, I consider the current rally in equities to be running on fumes.

Hedge SignalHedge Signal

We will continue to lean into our hedge signal to tell us when to hedge/not hedge. Our cash raises are determined by our tech/macro outlook. As of now, the hedge signal is not close to flipping back into a risk-on mode. We are in bear market mode, which uses 3 data points to capture bear market bounces (compared to the normal signal that uses ~ 7 data points).

I/O Fund PositionsI/O Fund Positions

NVDA

NFLX

MSFT

MSFT is pennies away from closing the 3rd wave gap. Below $255.40 and it gets closed, as does the hopes of another 5th wave run higher. MSFT has clearly only given us 3 waves up off the low, and this wave, maybe, has one more high in it. As of now, NFLX, AMZN, GOOGL have likely topped. MSFT looks to be next.

TSLA

Here’s a big picture view of TSLA. Technically, it appears to have an incomplete correction. One more wave towards $92 would set up a phenomenal buying opportunity. However, if we get there, the fear surrounding that move would make one not want to buy. The coming pullback needs to hold $138 or this becomes the likely scenario. We will likely buy assuming both scenarios are playing out, and buy in layers.

AMD

My guess is that AMD has one more run to new highs in it. However, this drop needs to reverse soon. Below $75 and the odds start shifting towards the top being in.

TSM

Only 3 waves up, and right at the symmetrical price level (A=C). This type of pattern is usually bearish. The coming pullback needs to hold $70, or we could be in for new lows.

AEHR

MGNI

ENPH

I continue to signs of bottoming while NDX shows signs of topping. We’ll take a shot with some of our cash that the best ER of the year is holding its inverse correlation to NDX.

Crypto

Be open to this count. Bitcoin is completing 5 waves up off the low. How can it continue higher while risk assets push lower? Either the red count thesis is wrong above (we are very open to this), or Bitcoin is tracing a 4th wave. that would mean we are in a nasty, expanded flat correction with $13K on deck. Like with every position, the coming pullback will tell us everything.

Time AnalysisTime Analysis

We have many stocks and indexes showing a time factor coming up this week/next (Feb 20 – March 2). As always, depending on how we trend into it will be the most important piece of information. The NDX shows 2 cycles coming together in the chart below (20th-28th). If we see a sharp drop and reversal early in the week, it could signal the 4th wave low. If we see a move back towards 4200+ by next week, it will be a big warning. 

Tech growth is a certain style of investing; it’s a mix of grand slams but more strikeouts. Value investing is a mix of singles, doubles and even bunts, but with fewer strikeouts. Investing style and risk appetite runs a large spectrum from high risk/high reward to low risk/low reward.   

Similarly, there are different management styles. Datadog falls firmly in the candid, conservative style of management. They are the best-of-breed team that is least likely to overpromise and under-deliver, hence the perfect record on beating on the top line and bottom line.  

Both the CEO and CFO will tell investors exactly like it is, even it’s hard to hear. This is very different from other management teams that will take risks on guidance, with the hope of meeting the numbers somehow, and will smooth over anything negative so as not to raise alarm bells.  

Datadog’s guide does not necessarily foreshadow lower growth than other cloud companies that have reported, especially as we can assign a high level of probability the actual report will come in higher than the guide. Rather, it was the tone on the call that was very different. Ultimately, as we covered in our Q1 Earnings Prep Webinar, there is a lot of built-up anticipation for a H2 rebound. The rebound may or may not happen; I imagine next earnings season will be a real line in the sand given it takes place four to five months into the year.  

The rebound comes from analyst estimates, so of course, analysts are keen to make sure their estimates are correct with the bulk of questions aimed at what 2023 will look like. Datadog told analysts on the call they do not see evidence of a rebound yet, and with what they know today, their guide assumes optimization will continue throughout the year. They do believe eventually optimizations will slowdown, and that cloud migration will again become a tailwind. They are unwilling to provide guidance on when this will happen. 

Management specifically called out a bigger slowdown in December on usage than what they saw in October and November. So far, 2023 has more closely resembled December. They also specifically called out larger customers as the primary cohort optimizing and lowering usage and/or spend, while smaller customers are seeing little to no change. Large customers have more to gain from lowering costs, and face more uncertainty.  

Datadog’s financials are similar to what we posted on the forum, which is a slowdown from this time last year (to be fair, all cloud has slowed on a YoY basis from Q1 2022 to Q1 2023E). RPO was flat but Billings were down QoQ. Datadog still has a top position for bottom line strength in best-of-breed, although notably, the bottom line has softened. 

Financials:

Datadog beat estimates in the current revenue, yet guided below analyst consensus for Q1 and FY2023.

In the current quarter, revenue of $469.4 million represents growth of 44% year-over-year. This beat previous management guidance and analyst consensus of $449M, for a beat of +6% on the top line. This led to a beat on FY2022 revenue at 63% growth compared to 60.8% expected. 

Guidance for Q1 is for $460 to $470 million, for growth of 28%. Due to being conservative, as discussed in the intro, the fiscal year guidance is lower than Q1 at 23.8% for $2.08 billion. 

You can reasonably assume these estimates will be beaten with a 5% to 10% beat, if we rely on previous earnings surprises, but there’s no guarantees, of course. 

Adjusted EPS of $0.26 comfortably beat estimates of $0.19. GAAP EPS came in at ($0.09).  

Q1, Datadog management provided a guide in line at $0.22 to $0.24 compared to estimates of $0.24. For FY2023, there was a miss with guidance of $1.02 to $1.09 compared to analyst estimates of $1.13. 

Cash flow was up sequentially due to seasonality yet was down on a year-over-year basis. Despite Datadog decelerating, it still ranks high on FCF margins for cloud best-of-breed. Operating cash flow margin was at 24.3% and free cash flow margin of 20.50% equaling $96.4 million in cash flow.  

Let’s say we have a deeper recession than expected. Datadog is likely to survive this, but at what valuation is the question. There’s a solid chance cloud remains range bound at these valuations until there’s a return to growth, which means fluctuations up in price/down in price that ultimately provide little movement or gains. I don’t think Datadog is going to be the company that has an unpleasant surprise from an unexpected miss in their earnings report, which is my preference certainly for management style. Rather, they will take the hit up front, like we saw today. 

The company has cash and marketable securities of $1.9 billion on the balance sheet with fairly high stock based compensation of $112 million. 

Margins: 

·       Datadog has a high gross margin of 79.3%.

·       GAAP operating margin beat at (7%) actual compared to (10%) guide. This is a deceleration from 3% in the year ago quarter.

·       Adjusted operating margin was 18% compared to 22% in the year ago quarter.

·       GAAP net margin of (6%) compares to 2% net margin

Key Metrics: 

·       Datadog reported RPO of 30% YoY which was flat from the previous quarter. Notably, the Q4 to Q1 quarter tends to be flat for Datadog with more variability in Q2.

·       Billings softened to 31% growth YoY compared to 86% in the year ago quarter. This was a deceleration from Q3 with billings of 51%.

·       Customers with ARR of > $100K grew 38% compared to 64% last year

·       Customers with ARR > $1 million grew 46.7%. This is a newer metric for Datadog with no year-over-year comp available

·       DBNRR is above 130 but management stated on the call they expect this to dip below 130. 

Earnings Call:

In the opening remarks, the company stated the following about large customers in Q4: 

“Now moving on to this quarter's business drivers. Overall, we observed slower usage growth with existing customers while continuing to scale our new logo acquisition and new product cross-sells. Starting with usage. Usage growth of existing customers in Q4 was overall slightly lower than what we observed in Q2 and Q3, which we attribute first to a continuation of cloud cost optimization by our larger spending customers; and second, to a seasonal annual slowdown in the second half of December that was more pronounced than in previous years. 

As in Q2 and Q3, we continue to see more optimization from customers as a larger cloud footprint, while our smaller spending customers are exhibiting higher growth.” 

The CFO later provided more color in his opening remarks: 

“Next, similar to Q2 and Q3, we saw larger-spending customers grow slower than smaller spending customers. As with Q2 and Q3, we saw relatively more deceleration in the consumer discretionary vertical, particularly in e-commerce and food delivery. Geographically, we saw solid and relatively similar growth across all regions.” 

And the CFO also stated this: 

“We are incorporating an expectation for seasonally weaker growth in the first quarter due to the subdued growth in the month of December that creates a lower growth trajectory to start the first quarter. While our customers are continuing to expand with us, we are assuming in our guidance that cloud optimization continues to affect our expansion rate in 2023.” 

In regards to Datadog’s specific business, they essentially believe they are the next in line on optimization following cloud hyperscalers. In other words, companies are optimizing with the hyperscalers now and working their way through the stack with Datadog second in line, in terms of what order makes the most sense: 

“What we see, though, is that customers save money where it matters, which tends to be the very large line items, which for customers that are fairly far along into the cloud, is going to be, first, their cloud provider deals that are, again, one or two others are larger than their observability bills. 

And then we're going to be affected by that and maybe with some optimization more specific to observability as well. So that's what we see there.”

Also, management clarified with analysts the slowdown (for Datadog) is not related to headcount, given the many layoffs announced, rather it’s more usage based and related to reducing budgets. 

In regards to the larger trend of cloud migrations, Datadog said the following: 

“So that's where we're going. I think you're right, though, that the underlying wave that is — has been a tailwind throughout the of the company was cloud migration and digital transformation. I think that we might be a bit more of a headwind over the next few quarters. But we strongly believe that it will become a tailwind again in the future.” 

Conclusion: 

Datadog is a company we will watch closely and return to in the future. Knowing that I can’t control macro, it feels like 2023 should be used as an opportunity to build tech generals in the belly of a recession rather than guess on companies that are reporting tapering growth (although formally were very high growth). Please note, many companies are reporting tapering growth despite the market rewarding the companies with earnings pops. This is entirely based on expectations for future growth which may or may not materialize.  

It’s our preference to take advantage of the lower prices by focusing more on key tech generals for now while allowing time for smaller companies to prove their ability to withstand macro pressure. This strategy can be a win-win, because if we see a deeper recession than normal, the risk of picking the wrong company is much lower than if we bet on decelerating growth from less defensible companies. However, if we see a soft landing, then we are still positioned to participate in growth.   

We will continue to identify outliers, such as AEHR, with a heavy focus on this in March and early April. Look forward to new coverage and deep dives coming soon as we wrap up the last of our portfolio’s earnings season next week.

From the October 13th low, one of the best performing sectors has been semiconductors. This is a theme that we introduced in the I/O Fund Essentials video “Semiconductor Stocks Continue to Outperform Value” where we stated:

“With a rotation into value names underway, it would be easy to discard all of tech and move towards the sectors that are working. However, as we discussed last week, one specific tech sector is currently outperforming most value names – semiconductors.

This week, we provide a brief video taken from our weekly webinar where we offer a more macro context around why we like semiconductors going forward. Some markets appear to be closer to new highs than lows, and we believe that semiconductor stocks are signaling that they are ready to resume their leadership role going into 2023. 

Reference our analysis last week “The Next Bull Market’s Leaders are Being Decided Now” for more information in addition to the video below.”

Since releasing this for our Essentials Members at the end of December, semiconductors have continued to shine. The chart below shows semis are the number one performing sector in tech.

Once of the leading stocks within this sector is Nvidia, a stock that has been a top holding in our portfolio since 2018. Notably, focusing on building Nvidia and closely managing this allocation is as relevant as ever.

We covered this last week in our February stock tip when we stated: 

“Simply put, as Big Tech continues to build out hyperscale scale data centers and AI based technology, they will require specialized semiconductor chips – AI accelerator chips – to provide the necessary computing power required. At the moment, the AI chip market is a duopoly with Nvidia and AMD. However, Nvidia’s position is much larger than AMD and a “better” GPU. So as Big Tech continues these AI related investments, Nvidia is the first place Big Tech will go to buy them – namely Nvidia’s H100 GPU chip.”

Nvidia: Technical Analysis

Unlike most tech names, NVDA has a probable path to new highs. The long-term technical path from the 2018 low is listed below in blue, with my alternative path in red.

The market is stretched and setting up for a pullback. This is evident with NVDA’s momentum indicator below the chart. Every time internal momentum reached these heights, and pullback soon followed. As long as the coming pullback holds the $140-$138 region, then the blue path remains valid. This path has the 2022 bear market as a pullback in a larger uptrend, targeting $355+ in the coming months. If we do break below the $140-$138 region, then the odds of this path to new highs becomes diminished, and it opens the door to the $90 region.

The pressing question is how much farther can NVDA run in this bounce off the October lows? The $230 region is strong resistance. There is a confluence of key angles in this region.

If we do see a breakout above the $230 region, this is not a breakout we would buy. If we zoom in on the bounce off the October lows, it is quite clear that the structure of the uptrend is only 3 waves.

A three wave move (in either direction) tends to be symmetrical, and leads to large corrective moves. In terms of symmetrical, what I mean is that the length of the 2nd move higher tends to be the length of the first move higher.

So, if NVDA does see one more high into the $241 region, this would be the exact symmetrical move where most 3 wave bounces tend to end. When you factor in that each move higher is happening with less momentum, the risk is quite elevated above $241.

Conclusion:

We see the odds of NVDA retracing back to the $170-$150 region as a high probability. We will likely look to slowly layer in around these levels. However, NVDA holding the $140-$138 region will be crucial. If this region breaks, it will open the door to the $90 region. This would coincide with the macro environment beginning to drive equities once again. As long-term investors, our plan is to keep NVDA as a high allocation in our portfolio. Our goal is to further accumulate on the coming drawdown, and we will slowly layer into this stock at key levels.

We favor buying in small layers of 1% or 2% at key levels, which we described above. This mitigates our risk if we do reach the $90 region. For example, we bought at the Nvidia low in October at $108. No matter how high our conviction may be in a specific name, macro is the primary force on stocks right now, which is why adding in small layers is even more important in 2023 than in previous years, such as 2020-2021.

Knox Ridley holds a premium webinar every Thursday where he reviews key positions, including NVDA. We cover macro charts as well as various stocks to get a clear understanding of where the market may be going and how to position for it. Learn more about Advanced Market Signals here.Advanced Market Signals here.

Recently, we wrote about the 2023 outlook and trends for overall IT spending and Big Tech capex. In summary, both are expected to be flat to slightly down. Here is what we said on the premium site:

“Overall, Big Tech has forecasted capex to be flat to slightly down y/y. However, an important theme was a shift toward higher ROI capex such as technical infrastructure and reduction in lower ROI capex, such as office facilities. After embarking on an aggressive capex program in 2021 and 2022, Big Tech has taken a pause to reassess their cost base and to reprioritize capex in light of the current macro environment.  

Put another way, the size of the capex pie isn’t expected to grow in 2023 compared to 2022, but the slice spent on technical infrastructure (i.e. Cloud and AI), will grow at the expense of labor, office facilities etc. A change in capex mix that we believe is supportive in the medium-term of NVDA and AMD.”

There is a collective shift from higher return capex at the expense of lower return capex. From an investing perspective, the key takeaway is to identify markets where demand continues to be driven by secular demand and avoid those facing cyclical demand headwinds. For example, there is continued demand for Hyperscale Data Centers and AI related investments while the memory sector is grappling with weaker consumer related demand exacerbated by excess inventory.

The key theme from Big Tech Q422 commentary was the strategic importance and focus on AI investments to enhance their competitive positioning. Here at I/O Fund, we have continually looked for opportunities to invest in this secular theme and identify companies with strong market positions and competitive product offerings led by focused management teams with an identifiable investment catalyst.

With that in mind, we thought it would be worthwhile for our readers to revisit our positive investment thesis on Nvidia. It’s one of our largest core positions.  

Simply put, as Big Tech continues to build out hyperscale scale data centers and AI based technology, they will require specialized semiconductor chips – AI accelerator chips – to provide the necessary computing power required. At the moment, the AI chip market is a duopoly with Nvidia and AMD. However, Nvidia’s position is much larger than AMD and a “better” GPU. So as Big Tech continues these AI related investments, Nvidia is the first place Big Tech will go to buy them – namely Nvidia’s H100 GPU chip. (Note: Later in the year, AMD will release a GPU to rival Nvidia and we will cover this for you including correct timing as the I/O Fund has predicted every twist and turn AMD has taken in its enormous comeback against Intel – for now, Nvidia has a near monopoly on GPUs for AI acceleration.)

Given the market dynamics outlined above, here is how Nvidia’s CEO Jensen Huang described the AI market opportunity in response to a question by Vivek Arya around the overall capex outlook. Huang’s comments focused on Nvidia driving growth from AI acceleration, rather than general purpose computing. This implies that capex can be flat while Nvidia will be serving the most valuable piece in the stack. AI acceleration, according to the CEO, will not be flat or down. A similarly positive tone echoed by Big Tech.

“And then, Jensen, the question for you. A lot of concerns about large hyperscalers cutting their spending and pointing to a slowdown. So if, let’s say, U.S. cloud capex is flat or slightly down next year, do you think your business can still grow in the data center and why?”

“Vivek, our data center business is indexed to two fundamental dynamics. The first has to do with general purpose computing no longer scaling. And so, acceleration is necessary to achieve the necessary level of cost efficiency scale and energy efficiency scale, so that we can continue to increase workloads while saving money and saving power. Accelerated computing is recognized generally as the path forward as general purpose computing slows. The second dynamic is AI. And we’re seeing surging demand in some very important sectors of AIs and important breakthroughs in AI.”

“And so, you could see that our company is indexed to two things, both of which are more important than ever, which is power efficiency, cost efficiency and then, of course, productivity. And these things are more important than ever. And my expectation is that we’re seeing all the strong demand and surging demand for AI and for these reasons.”

In light of Big Tech’s focus on higher return capex, Jenson’s comment was very informative on how Nvidia stands to benefit from Big Tech’s change in capex mix. As Big Tech continues to invest in AI infrastructure, they will need chips that provide the highest computing power and productivity with the most efficiency. At the moment, Nvidia’s H100 is the best AI chip to fulfill these requirements.

How will Nvidia benefit?

The key investment catalyst for Nvidia is the adoption and implementation of the H100 GPU by its customers. 

So without getting too technical, here is an outline of the medium and long term investment thesis.

• Nvidia’s March 2022 introduction of the Hopper H100 GPU with 80bn transistors – 48% more than Nvidia’s A100 with 54 billion – is a game-changer. Simply put, more transistors means faster speeds and increased computing power
• H100 is 6x faster and its performance is 2-3x better than Nvidia’s prior A100 GPU. H100 has 50% more memory and interface bandwidths. Higher bandwidth will create more demand for their software in the future. The ability for the GPU to connect directly to the network will avoid CPU bottlenecks
• The A100 has led company gains since Q22020, now the H100 will lead the next leg of growth. In the most recent Q322 investor call, management indicated H100 will quickly overtake A100
• H100 will power AI based and high performance computing systems. There are four layers to Nvidia’s full stack accelerated computing: hardware (AI accelerators), system software, platform software and applications. Overtime, this position will enable Nvidia to monetize more of the software stack due to vendor lock-in effects. In the Q322 call, management indicated this is effectively starting “now” at the enterprise level
• Over the long term, Nvidia will combine its hardware offering with software component primarily targeting the auto industry  
• Nvidia is taking a play out of Apple’s playbook that helped it’S market cap grow to 2 trillion.  Nvidia’s goal is to leverage their dominate position in hardware to capture the lion’s share of the software. That’s exactly what Apple did with mobile devices and software related apps and services.
• Most importantly, and not covered at the level it deserves (or at all by the media), Nvidia is going to be an AI software leader. This marks a monumental shift for a company that is traditionally hardware-only. We have written about this long-term opportunity for our premium subscribers here.
• This transformation has not yet been appreciated by Wall Street nor reflected in the stock price. Nvidia’s 2022 Investors presentation identified a $300B Market opportunity.

To use a baseball analogy, Nvidia has just begun the first inning of this transformative process.

Upcoming catalysts

Nvidia is up about 52% ytd and is due to report earnings on 2/22/23. We will be looking for continued signs that gaming has bottomed, adoption trends of H100 and whether management expects a 2H23 bounce similar to what their peers guided for. We’ll touch upon these topics after the company report earnings.

It is important to note that Gaming is still an important business for Nvidia for its earnings contribution. Gaming’s exposure to consumer-related hardware products like PCs and gaming consoles has historically been the source of cyclical growth concerns and stock volatility around earnings releases. Future growth will not come from gaming, where Nvidia is already a mature, market leader. Nvidia’s 2022 Investor’s Presentation provided future estimates which detail how consumer exposure should become less of a concern to investors. Overtime, Nvidia will transform from a gaming to an AI software focused company.

There were signs that gaming weakness had bottomed in Q322 and the market may still be focused on that in Q422. Our main focus will be on H100. If the nascent signs of H100 adoption seen in Q3 continue to grow, this will increase our conviction on Nvidia and it will begin to get attention from Wall Street it deserves as 2023 unfolds.  

Why 2023 May be a Strong Year for Nvidia:

Big Tech is not immune to the weaker macroeconomy nor consumer. This has been evident in their earnings releases. For Big Tech’s next capex act, their commentary focused on shifting capex to higher ROI investments with a focus on cost efficiency. These comments have increased our conviction that investments in AI are a key strategic priority and will continue.

From an investing perspective, it supports our investment thesis in Nvidia and AMD. Nvidia’s new H100 GPU chip has positioned it to benefit from the buildout in AI related and hyperscale data center infrastructure. Critically, given their dominant market position in AI chips, this will enable Nvidia to then monetize and gain a greater share in the software stack. In addition, AMD plans to commercially release its MI300 GPU this year.

Per the most recent AMD earnings call:

“MI300 will be the industry's first data center chip that combines a CPU, GPU and memory into a single integrated design, delivering 8x more performance and 5x better efficiency for HPC and AI workloads, compared to our MI250 accelerator currently powering the world's fastest supercomputer. MI300 is on track to begin sampling to lead customers later this quarter and launch in the second half of 2023.”

In the most recent earnings report, Nvidia management commented that the H100 adoption rate and software monetization at the enterprise level is happening faster than expected.

This month, keep an eye out for technical analysis from Knox Ridley, where he will go over how he plans to manage the Nvidia position in the portfolio. On a side note, he nailed Nvidia’s bottom with an entry of $108.51 on October 13th with a real-time trade alert. You will get his very best technical analysis on a leading position in the portfolio that the analyst team believes will fundamentally stand apart this year. Stay tuned for this!

In addition, Essentials Members will receive an earnings update on Nvidia following the earnings report to  better gauge 2023 timing and entries.

We can’t urge you enough to take your time with each stock as too many research services pump out content for content’s sake. We are a real, live portfolio that is audited, and we show you the exact process we follow to make smart investing decisions. For the February stock pick, we want to drill down deep so our readers get top notch coverage of one of our highest conviction holdings. Don’t be surprised if you get more Nvidia coverage this month rather than moving on quickly to another name. Institutions take months to research a stock, and this level of depth is exactly what we bring to retail investors.

Have a wonderful weekend and we will see you next week!

In the past, we have written about the importance of Big Tech’s capex programs and its impact on demand for semiconductors. Particularly in 2021 and 2022, where there was a significant increase in data center and cloud computing related capex. It has been our position that Big Tech capex – which includes Google, Meta, Amazon and Microsoft – is a leading indicator for AI semiconductor companies and has been a secular tailwind for our holdings such as Nvidia and AMD.  Now that Big Tech have reported their fiscal 2022 earnings, we thought it’d be a good time to review the 2023 capital expenditure outlook for the IT market and Big Tech.

2023 IT Market Spending Forecasts

In January 2023, Gartner released their 2023 forecasts for overall IT spending. Gartner forecasts growth of $4.5 trillion, an increase of 2.2% from 2022. Looking at the breakdown, Software and IT services continue to see meaningful y/y growth. Meanwhile, after exhibiting healthy 12% growth in 2022, Data Centers is forecasted to be almost flat at 0.7% in 2023. Devices continues to be negatively impacted by inflationary pressures impacting consumer demand.

In contrast to Gartner’s 2023 forecast of flat growth in overall Data Center spending. The growth in Hyperscale Data Centers is forecasted to grow at levels that vastly outpaces Data Centers. Hyperscale Data Centers are large data centers operated by Amazon, Microsoft and Google.

According to Precedence Research, The global hyperscale data center market size was estimated at USD 62 billion in 2021 and is expected to hit around USD 593 billion by 2030, a forecasted growth rate (CAGR) of 28.52% during the forecast period 2022 to 2030.

 This growth is also reflected in forecasts for the Artificial Intelligence Chip market. In December 2022, Allied Market Research forecasts that the global artificial intelligence chip market will grow from $11.2 billion in 2021 to reach $263.6 billion by 2031, growing at a CAGR of 37.1% from 2022 to 2031. AI chips – supplied by Nvidia and AMD – will provide the computing power necessary to drive these hyperscale data centers.

Big Tech FY2023 Earnings Commentary

How did the recent Big Tech commentary on 2023 capex align with these market forecasts? Overall, Big Tech has forecasted capex to be flat to slightly down y/y. However, an important theme was a shift toward higher ROI capex such as technical infrastructure and reduction in lower ROI capex, such as office facilities. After embarking on an aggressive capex program in 2021 and 2022, Big Tech has taken a pause to reassess their cost base and to reprioritize capex in light of the current macro environment. 

Put another way, the size of the capex pie isn’t expected to grow in 2023 compared to 2022, but the slice spent on technical infrastructure (i.e. Cloud and AI), will grow at the expense of labor, office facilities etc. A change in capex mix that we believe is supportive in the medium-term of NVDA and AMD.

In 2016, Big Tech in total spent $30b in capex, in 2022 they spent $150b, a five-fold increase. Big Tech commentary indicates 2023 capex will be flat to slightly lower than 2022.

What did FAAMG say about 2023?

Alphabet:

Google spent $31.5b on capex in 2022 compared to $24.6b in 2021 and forecasted 2023 to be at a similar level to 2022. Although the forecasted growth rate in capex is lower than historical levels. Management commentary around  capex was very telling on where the priorities lay. On the Q422 call, management referenced AI a total of 56 times in relation to its importance to the future growth of the company. Here are a few snippets that stood out with an emphasis on AI being Google’s #1 priority. 

Sundar Pichai, CEO

• I'll focus on two major things today in a bit more detail, and then I'll give a shorter-than-usual quarterly snapshot from across our business. First, how we unlock the incredible opportunities AI enables for consumers, our partners and for our business; and second, how we focus our investments and make necessary decisions as a company to get there … the AI opportunity ahead. AI is the most profound technology we are working on today. Our talented researchers, infrastructure and technology make us extremely well positioned, as AI reaches an inflection point.
• Our AI is a powerful enabler for businesses and organizations of all sizes and we have much more to come here. There's a few flavors of this. Google Cloud is making our technological leadership in AI available to customers via our Cloud AI platform, including infrastructure and tools for developers and data scientists like Vertex AI.
• AI also continues to improve Google's other products dramatically
• On the AI side, it is a really exciting time. I think we've been investing for a while, and it's clear that the market is ready. Consumers are interested in trying out new experiences. I think I feel comfortable with all the investments we have made in making sure we can develop AI responsibly.

Philip Schindler, CMO

• Going forward, we are focused on growing revenues on top of this higher base through AI-driven innovation. Sundar highlighted the incredible opportunities underway with AI and the transformative impact it will have on businesses. Already, breakthroughs in everything from natural language understanding to generative AI are fueling our ability to deliver results that drive meaningful performance for advertisers and are useful to users.

Ruth Porat, CFO

• And as I indicated in opening comments, when we look at capex for 2023, we do expect it's going to be generally in line with 2022 with an important mix shift. We're increasing our investments in technical infrastructure. And that's not just for AI. That's to support investments across Alphabet, in particular in Cloud as well. And at the same time, we're meaningfully decreasing our capex for office facilities.
• With AI, this is obviously an Alphabet strategic priority, and we see huge opportunity ahead

Meta:

For Meta, capital expenditures, including principal payments on finance leases, was $32b billion for 2022 compared to $19.3b in 2021. 2022 capex was driven by investments in servers, data centers and network infrastructure. Meta forecasted 2023 capex to be between $30-33b down from their prior guidance of $34-37b. Similar to Google, management commentary around AI and capex was very telling on where the priorities lay.

Mark Zuckerberg, CEO

• Now before getting into our product priorities, I want to discuss my management theme for 2023, which is the Year of Efficiency. We closed last year with some difficult layoffs and restructuring some teams. And when we did this, I said clearly that this was the beginning of our focus on efficiency and not the end. And since then, we have taken some additional steps, like working with our infrastructure team on how to deliver our roadmap while spending less on capex
• And next, I want to give some updates on our priority areas. Our priorities haven’t changed since last year. The two major technological waves driving our roadmap are AI today and over the longer term, the metaverse.
• AI, it’s the foundation of our discovery engine and our ads business. And we also think that it’s going to enable many new products and additional transformations in our apps. Generative AI is an extremely exciting new area with so many different applications. And one of my goals for Meta is to build on our research to become a leader in generative AI in addition to our leading work in recommendation AI.
• Yes, I can start with generative AI. Yes, I think this is a really exciting area. And I mean, I’d say the two biggest themes that focused on for this year and one is efficiency and then the kind of the new product area is going to be the generative AI work.
• A lot of the trends that we are seeing here is, we are using larger models, which require more computation. We have shifted the models from being more CPU-based to being GPU-based

There is a positive readthrough on Zuckerberg’s comment on the shift from CPU to GPU models. This could potentially benefit Nvidia and their H100 GPU.

Susan Li, CFO

• Turning now to the capex outlook for 2023, we expect capital expenditures to be in the range of $30 billion to $33 billion, lowered from our prior estimate of $34 billion to $37 billion. The reduced outlook reflects our updated plans for lower data center construction spend in 2023 as we shift to a new data center architecture that is more cost efficient and can support both AI and non-AI workloads
• So we’re shifting our data centers to a new architecture that can more efficiently support both AI and non-AI workloads. And that’s going to give us more optionality as we better understand our demand for AI over time. Additionally, we’re expecting that the new design will be cheaper and faster to build than previous data center architecture. Along with the new data center architecture, we’re going to optimize our approach to building data centers. So we have a new phased approach that allows us to build base plans with less initial capacity and less initial capital outlay, but then flex up future capacity quickly if needed. We’re still planning to grow AI capacity significantly, and that connects
• The current surge in capex is really due to the building out of AI infrastructure, which we really began last year and are continuing into this year. We will be measuring the ROI of these AI investments, and their returns will continue to inform our future spend. Our intention is still to bring capex as a percent of revenue down, but capital intensity in the nearest term is really going to depend, in part, on the revenue outlook and our needs to further build AI capacity for future demand

Javier Olivan, COO

• I think if you look at the strategy on ads, we really have two parts, which is continue investing in AI and that’s where we are seeing a lot of the improvement in ads relevance.

Microsoft:

For Microsoft FY 2022 capex, including assets acquired under financial leases, was $29.2 and compared $24.2 to FY 2021. For FY 2023, Microsoft has stated “… we expect a sequential decrease on a dollar basis with normal quarterly spend variability in the timing of our cloud infrastructure buildout.”

Satya Nadella – Chairman and Chief Executive Officer

The age of AI is upon us and Microsoft is powering it. We are witnessing non-linear improvements in capability of foundation models, which we are making available as platforms. And as customers select their cloud providers and invest in new workloads, we are well positioned to capture that opportunity as a leader in AI. We have the most powerful AI supercomputing infrastructure in the cloud. It’s being used by customers and partners like OpenAI to train state-of-the-art models and services, including ChatGPT.

Amazon:

For Amazon, capex including equipment financial leases, was $58.3b in 2022 compared to $55b in 2021. These expenditures primarily reflect investments in technology infrastructure. In the past, management has indicated that about 50% of total capex has gone toward infrastructure. Management gave no guidance for 2023 other that these investments will continue.

Conclusions

Big Tech is not immune to the weaker macroeconomy nor consumer. This has been evident in their earnings releases. For Big Tech’s next capex act, their commentary focused on shifting capex to higher ROI investments with a focus on cost efficiency. These comments have increased our conviction that investments in AI are a key strategic priority and will continue.

From an investing perspective, it supports our investment thesis in Nvidia and AMD. Nvidia’s new H100 GPU chip has positioned it to benefit from the buildout in AI related and hyperscale data center infrastructure. Critically, given their dominant market position in AI chips, this will enable Nvidia to then monetize and gain a greater share in the software stack. In addition, AMD plans to commercially release its MI300 GPU this year.

Per the most recent AMD earnings call:

“MI300 will be the industry's first data center chip that combines a CPU, GPU and memory into a single integrated design, delivering 8x more performance and 5x better efficiency for HPC and AI workloads, compared to our MI250 accelerator currently powering the world's fastest supercomputer. MI300 is on track to begin sampling to lead customers later this quarter and launch in the second half of 2023.”

In the most recent earnings report, Nvidia management commented that the H100 adoption rate and software monetization at the enterprise level is happening faster than expected. We will further outline how Nvidia is well positioned to benefit from this spending in AI and what to look for in Nvidia’s upcoming earnings report. We’ve recently covered AMD here.

Keep a look out for future posts.

Please note: the Product Road Map and Earnings Call information was updated on Wednesday, Feb 8th with the transcript.

I recently wrote there would be very few perfect earnings reports this quarter when we covered Tesla. Fast forward two weeks, and Enphase gave us a perfect earnings report this evening. The company beat on the top line, the bottom line, and expanded its margins.

When analysts tried to poke holes into a potentially weaker Q2, management said they were “cautiously optimistic” about Q2 with quite a bit of time dedicated to reasons California NEM 3.0 may not weigh on the results as much as anticipated. The reasons 2023 may be stronger than anticipated include United States manufacturing that results in IRA credits, Europe and Latin America growth, and California’s NEM 3.0 pushing residential toward batteries, which is a strength for Enphase.

Financials

The earnings report provided by Enphase is rare in this macro environment. The company beat and raised with expanding margins. Not only was it a beat and raise, but revenue growth is accelerating on a YoY basis (at least for now).

Revenue came in at $724.6 million for growth of 75.5% compared to 70% growth expected. For next quarter, the company is guiding to $700 to $740 million, above the $680 million analysts were expecting. At the midpoint, this will be 63.1% growth, which is nearly 10% higher growth than consensus of 54% for Q1.

On a year-over-year basis, this marks an acceleration from 2021 Q4’s growth rate of 55.8% and 2022 Q1’s growth rate of 46%. It’s quite a feat in the current market to accomplish this while growing the bottom line.

Notably, FY2022 revenue growth came in at 68.8% compared to revenue growth of 35.3% expected for FY2023. I’m sure we will see the FY2023 consensus updated soon to reflect the Q1 raise.

EPS beat with $1.51 reported compared to $1.26 expected. Margins were strong this quarter and are looking strong next quarter, per management guidance.

What remains in question is Q2 and there were many questions about this on the earnings call, which I will detail below when the transcript comes out. I do want to say there’s plenty on the product road map to offset a potential slowdown in United States residential. Yet, it’s prudent to weigh both sides and to be prepared if Q2 is “less strong” than Enphase investors are accustomed to.

Margins:

On a year-over-year basis, the margins are expanding. In some cases, the margins nearly doubled year-over-year.

• GAAP Gross Margin of 42.9% compares to 39.5% in the year ago quarter. Adjusted gross margin also expanded by 350 basis points (bps).
• GAAP Operating Margin of 21.6% compares to 14% in the year ago quarter. The adjusted operating margin expanded by 700 bps.
• GAAP Net Margin of 21.2% compares to 12.7% in the year ago quarter. The adjusted net margin expanded by 440 bps.

Cash Flow:

Cash flow margins also increased both year-over-year and sequentially. Notably, Q4 is a stronger quarter seasonally than Q3.

• Operating cash flow of $253.7 million for a margin of 35% up from 23.5% in the year ago quarter. This is also 650 bps higher than Q3.
• Free cash flow of $237.3 million for a FCF margin of 32.7% up from 20.3% a year ago. This is also 450 bps higher than Q3.

The company has $1.61 billion in cash and $1.29 billion in debt. The company paid $77 million in stock based compensation.

Product Road Map:

·       The third-generation battery will be released in North America and Australia in the second quarter. This is the battery that management is saying will support a softer landing from NEM 3.0 when analysts about California-related concerns. The battery has 5KW modularity and 2X the power of the existing battery. Due to this, management has stated “we expect our battery business to perform well in the second half of the year”

·       EV chargers were discussed in the comments on the forum here. The IQ smart EV chargers will ship in the United States in Q2. There is also a new bidirectional charger on the product road map for early 2024. These bidirectional chargers can receive power from a residence or grid and also send power back to a residence or grid. Read more here. The battery storage also helps to keep vehicles powered in the event of an outage. The full roll-out for bi-directional is expected in January 2024.

·       The much-anticipated IQ9 will be released in 2024. This release incorporates gallium nitride (GaN) for better thermal properties (resulting in higher power) and also a higher frequency. 

·       However, the 480 watt IQ8P will be released for the United States market in H2 2023. This will be warm-up for the IQ9 with more emphasis on IQ9.

·       Manufacturing at Romania will start in Q1 2023 and will increase capacity to 6 million microinverters and then United States manufacturing will primarily increase the capacity to 10 million.  

·       Look for increased battery sales in Europe as the company is rolling this out now with limited battery availability in Europe prior to 2023 (mainly microinverters in Europe until now).

Earnings Call:

There were quite a few questions about the upcoming Q2 quarter, and any potential weakness from NEM 3.0 and also the United States residential solar market. We outlined what the initial concerns were in our last earnings write-up found here.

Also, please note, the CEO can be a bit long winded at times, and this leads to the longest earnings calls that I personally cover. I’ll try to take out the most pertinent excerpts. To read full responses, please reference the transcript here.

California is 20% of Revenue

The United States makes up 71% of Enphase's revenue. Certainly, it's important to pay attention to any U.S. slowdown. However, outside of California's potential Q2 pull forward, Enphase has been able to beat and raise in light of analyst notes predicting the slowdown would impact growth in Q1.

The information below is important if we do see a slowdown from NEM 3.0. The question that remains is if battery sales will pick up to help offset any impact, if Europe will pick up and/or carry the growth should there be any impact (this region is carrying the growth for Q1 to the point of a 10% raise on revenue), and when the market will begin to price in a better bottom line from IRA credits. NEM 3.0 seems to be the main obstacle in Enphase’s path so I want to start here.

“Ameet Thakkar

Great. Thanks for that. And then I think this time last year when we had this call, and certainly a battery kind of uptake in California will increase, and that might change things. But I think you guys said that like California was roughly 20% of total revenues post the initial NEM 3.0 proposal. I was just wondering if you could kind of give us kind of a refresh on where ‘22 ended up in terms of California as a percent of total revenues.

Badri Kothandaraman

Those numbers are right. Yes. California, the revenue is approximately 20% of our total revenue. That’s correct.

Ameet Thakkar

And it’s still 20% in ‘22?” 

Cautiously Optimistic About Q2 and Discussions on Why NEM 3.0 Will Encourage More Batteries:

This is what the CEO said about Q2 in the opening remarks:

“There are a couple of interesting observations I thought I will share with you. Even with the pronounced seasonality and sell-through in January, we would like to point out that our activations are holding up. The second point to also note is that in conversations with our installers and distributor partners, they have started to see originations pickup in January when compared to December. Although the data we have is limited, these two points make us cautiously optimistic about Q2. We have also seen some analyst reports about a possible shift from loans to PPA due to the high prevailing interest rates. We work with thousands of installers every quarter […]. Any shift from one type of financing to another only has a minor impact to our business, almost negligible.”

Here was one of the questions:

Brian Lee:

“Hey, guys. Good afternoon. Thanks for taking the questions. Kudos on the solid execution. First question I had was just around NEM 3.0. I think there is different implications of that policy uncertainty near term and medium term from what we’re hearing. So maybe just wanted to get your thoughts near-term, some views out there that maybe there is a pull forward on demand in California would be curious what you’re seeing with respect to that? And then kind of in the medium term, we’re hearing the industry is still maybe trying to figure out how to navigate this. 

So curious how you specifically are thinking about the second half of 2023 in the U.S. you kind of base case in California to be down significantly? And then how do you see yourself navigating that, if that’s the case? Are you driving more product to other states, focusing more in Europe? Just curious just how you’d be thinking about planning into that period of higher policy uncertainty in the back half? And then I had a follow-up.”

Badri Kothandaraman

Yes. On NEM 3.0, we aren’t really seeing any pull forward right now. But in talks with few installers in California, both big and small, like what I said, the originations are up strongly. They are all quite optimistic. And maybe we will see something soon that’s why I talked about an optimistic Q2. But so far, we haven’t seen any pull forward demand yet. 

Now on talking about NEM 3.0 in general. NEM 3.0 is going to be incredibly positive for us […] With NEM 3.0, it matters when you export these electrons. So you have 24 hours a day, 365 days a year. So basically, 8,760 data points, and there is an export rate for each of those data points. Each of those hours, there is an export rate. And – but what it works out to be is if you are interested in a pure solar system, your payback dropped understandably from, let’s say, 5 years, it increases actually to something like 7 or 7.5 years with the pure solar system. But the moment you add batteries, you can add batteries in steps of 5-kilowatt hour, 10-kilowatt hour, 15-kilowatt hour, the moment you add batteries, that payback comes right back in to that 5 to 6-year time, to that 5 to 6-year period. That is the stock difference with NEM 2.0. With NEM 2.0, the grid was the battery. Batteries didn’t have an ROI because batteries were primarily for resilience only. With NEM 3.0, batteries are going to be financially attractive. […] We got the right batteries for it with the third-generation battery. We got the modularity, which I think will start becoming popular. Grid tied may become popular, but we will be ready to do either grid tied or off grid, on grid with backup.”

The Comment About the United States Slowdown:

Here was the comment about the United States slowdown:

“Normally, we have 6-month order visibility and that has been – that is now somewhat reduced as they watch their spending. And then I also talked about the fact that our sell-through, which is what the distributors sell to the installers. Our sell-through was quite strong in December, while we saw a little bit more seasonality than normal in the month of January.”

Here is a longer discussion, which points toward Enphase not counting on the U.S driving the growth, rather it was stated and discussed a few times, growth will come from Europe and a bit from LatAm.

“Badri Kothandaraman

Yes. I mean, look, seasonality has always existed in the solar industry from Q4 to Q1. And historically, I would say that, that seasonality is a 15% number. That means, in general, the sell-through in Q1 is usually 15% down compared to the sell-through in Q4. Now right now, and I’m giving you a lot of data from January, and that’s the data we have. Our Q4 was very strong, including December. January, we start to experience a little more than 15%. That’s why I said more pronounced seasonality. And of course, we think it is due to the macroeconomic environment, but what we saw interestingly was the activations remain the same. I mean approximately and they were a little bit down they didn’t have that much of a seasonality. So that basically was somewhat good because the customer demand at least whatever we saw was – I mean, did not get that much affected. But having said that, I think the installers are quite cautious. Therefore, they basically are only buying what they need from their distributors, which is a stark difference from 2022, where they were focused on supply. They were focused on maximizing what they had in their warehouse. Now is that they are worried about their spending, they are worried about their OpEx, they are worried about their cash flow. Therefore, they are going to make sure they do exactly what is required. So that’s why I think – and I don’t have a crystal ball. I cannot be sure. That’s why I think we are seeing some customers who used to book 6, 9 months ahead, now will not book so much ahead. They will be a little more conservative.

And regarding your question on more – that the originations, whether they are improving or not, this is the data. We work with thousands of installers. We have a very strong sample set. We talked to a lot of distributors. Some of our distributors service hundreds of long tail installers. So we don’t see originations ourselves. We only – what I reported to you is anecdotal information. But we hear that originations and especially originations in California are back to being strong in January. That’s what we hear. And I think that is – that’s why I said that – plus the fact that we are not seeing that much of a link in activation points me to cautiously optimistic Q2 versus Q1.”

Europe is a Primary Growth Driver:

As discussed on the call, the United States is expected to decline between Q4 to Q1. 

“Let’s now cover the U.S. We expect our U.S. business to be slightly down in Q1 compared to Q4, primarily driven by seasonality and the macroeconomic environment. We are seeing that our distributor and installer partners are a little more cautious in booking orders. We normally have a 6-month order visibility and that has been somewhat reduced as our partners watch their spending closely. On the sell-through of our microinverters, while December was quite strong for us we saw a more pronounced seasonality in January than normal.”

For Europe, the company is expecting: “As for Q1, we expect healthy growth compared to Q4, consistent with the overall growth in the European market.” This will be driven by expanding to more countries for the IQ8 microinverters and increased battery sales.

Additional Quotes on the Europe’s Geo Strength:

“Well, as you said, we do not guide something annually, but European market is growing. At least our internal reports talk about served available solar market of about 13 gigawatts in 2023. The markets to really – the markets that are really driving are Netherlands, Germany, Spain, France, Italy, and even actually Austria, Poland, etcetera. They are all becoming quite significant markets. In addition, attach – battery attach is also growing. Like what I have stated in the prior question – answering the prior question, the attach rate on batteries in Germany is 80%. So, solar plus storage is growing healthily. And the geopolitical situation accelerated it last year, and that’s continuing what do – that’s what our position is […]”

Jeff Osborne

Hi. Good afternoon Badri. I have two quick ones. You touched a lot on Europe, but I was wondering if you can specifically drill down on the visibility you have there in terms of Q1 and Q2.

Badri Kothandaraman

Yes. Europe is actually the opposite. We do have good visibility. We do have these strong orders. Partners, our installer partners, distributor partners, they rely on us for supply. A few of them even come to our headquarters quite routinely, that’s something that we are starting to see. And we also visit them quite a bit. So, I think we do have decent visibility there.

Perhaps Most Importantly, Europe was hinted as the primary driver for reaching the 90% IQ8 Microinverter mix:

“Ameet Thakkar

Good afternoon Badri. Thanks for squeezing me in. Just I guess a follow-up on that last line of questioning. But I think you guys have targeted to get to 90% in terms of IQ8 mix by the end of the second quarter, I think you just said 60% is kind of what’s baked in for the first quarter. Are you guys running a little bit behind on that?

Badri Kothandaraman

We are running a little behind, I would say. I would – I am going to – or rather we are going to introduce IQ8 into several countries in Europe in the near-term. So, in Q2, we will probably be at maybe a little lower than 80%. And I think in Q3, we should probably catch up to that 90%.”

Manufacturing Capacity & IRA Credits:

In the opening remarks, this is what was stated about manufacturing in the United States:

“We plan to begin U.S. manufacturing of our microinverters in the second quarter of 2023 with a new contract manufacturing partner and in the second half of 2023 with our two existing contract manufacturing partners. We plan to open 6 manufacturing lines by the end of this year adding a quarterly capacity of 4.5 million microinverters, bringing our total quarterly capacity to more than 10 million microinverters as we exit 2023.We continue to await the details of IRA implementation from the U.S. Department of Treasury.” 

In regards to the benefit from IRA, the company is expecting the following:

“Badri Kothandaraman

Yes. I mean net-net, we expect a net benefit of between $20 and $30 a unit. I am giving you a wide range right now because we do have some puts and takes, and we will refine it as we go.”

Back of the napkin math puts this at a $500 million net benefit to Enphase once the credits roll-out. They do say it’ll take time, but that’ll help an already strong bottom line while other companies struggle to maintain profitable during a macro slowdown. 

Conclusion:

Articles like this one aren’t very meaningful considering Enphase raised Q1 guidance by 10% in light of a United States slowdown. This is being achieved through international sales, such as Europe and Latin America. 

My takeaway was that even with a “less than perfect” Q2, the manufacturing credits coming from IRA, as well as the product road map, will offset this by year end. The CEO did state “they are fully booked for Q1” and “bullish about 2023.” This leads me to believe a softer United States market is being accounted for in the Q1 guide – and I hope the same will happen come Q2 or soon after – which is that the U.S. market isn’t the thesis right now anyways except for the IRA credits. 

I believe the IRA credits shouldn’t be underestimated in terms of impact, and we are comfortable riding the wave of Q2 given the company’s ability to overcome many macro obstacles, thus far. We are looking for strong bottom lines and resiliency in a tough macro, and Enphase ticks those boxes. 

Additional Analyst Commentary: 

I’m starting with the bearish comments first, but per usual, it seems the bearish analysts were on a different earnings call than the bullish analysts as they are taking exact opposite positions on the same information. As you know, I’m in the bullish camp for three main reasons:

1.     The resiliency of this company in 2022 and going into Q1 2023 is rare, and I suspect they have what it takes to continue on this path. No major flags although there’s a question mark on 20% of revenue and how a decrease in microinverters will impact the company compared to an increase in storage. 

2.     The European segment is clearly carrying the company and seems poised to continue doing so per the sequential decline in the United States, yet raise on revenue growth (we have +10% at the midpoint, analyst below has +7% — analyst below likely referring to their estimate)

3.     Strong product road map, a few catalysts and any one of them can absorb a limited impact to 20% of revenue. Strong bottom line with clear information on this improving with or without a recession.

“Barclays analyst Christine Cho raised the firm's price target on Enphase Energy to $257 from $251 and keeps an Equal Weight rating on the shares following the "solid" quarter. While Enphase ended 2022 on a high note, microinverter shipments will slow as installers remain cautious in a tougher macro tape with inventory channels already at healthy levels, the analyst tells investors in a research note.”

“Susquehanna analyst Biju Perincheril lowered the firm's price target on Enphase Energy to $275 from $365 and keeps a Neutral rating on the shares. The analyst said they beat on the top and bottom line but demand within the US is becoming more uncertain as macroeconomic concerns are causing installers to purchase only what they need right now rather than to secure future supply.”

“Cowen analyst Jeffrey Osborne raised the firm's price target on Enphase Energy to $341 from $335 and keeps an Outperform rating on the shares. The analyst said its Q4 EPS upside was driven by gross margin strength attributed to IQ8 penetration. Q1 revenue guidance is 7% above consensus at the midpoint with the U.S. expected to decline QoQ on seasonality with management optimistic U.S. will rebound in 2Q23.”

“Oppenheimer analyst Colin Rusch raised the firm's price target on Enphase Energy to $328 from $323 and keeps an Outperform rating on the shares. With Enphase beating Q4 expectations and guiding ahead of the Street, the firm believes bearish investors will focus on slower battery sales in Q1 2023 and risk to the CA demand post NEM 3.0, but notes both set Enphase up for accelerating growth through 2023. Oppenheimer continues to see U.S. residential solar demand as more resilient than feared and believes Enphase is making sound changes to its battery and commercial rooftop products while being poised to enjoy 500-800bps-plus margin improvement from U.S. manufacturing credits.”

“Craig-Hallum analyst Eric Stine lowered the firm's price target on Enphase Energy to $315 from $323 and keeps a Buy rating on the shares. The firm notes Enphase reported a beat across the board in Q4 and guided Q1 2023 above the Street, with it fully booked and Europe a primary driver. While the Q1 guide does call for revenues down modestly quarter-over-quarter at the midpoint, Craig-Hallum thinks that Enphase's plan to more than double its capacity by the end of 2023 shows the true growth path and outlook, and with the majority of this expansion in the U.S., it also means substantial incremental EBITDA from the 45-times Advanced Manufacturing Tax Credit.”