2023Q1 Earnings Review Part VI: Communication Services, Technology, Healthcare

• Microsoft reported a better-than-feared quarter and substantial investment into artificial intelligence, but they face antitrust headwinds from the UK.
• Alphabet reported a solid quarter despite the media narrative that the company is behind OpenAI, making it one of the favorite large-cap technology picks in the market.
• Thermo Fisher Scientific beat on earnings as management made a strategic acquisition to diversify away from the diagnostics business.
• T Mobile US reported a mixed quarter coming from a record FY2022, and we like the company’s market share gain in 5G.
• Leidos Holdings reported a dismal quarter, and an activist investor will likely target the company.

Microsoft Corporation (MSFT)

Microsoft reported strong Q1 results, beating analysts’ expectations on both revenue and earnings. Revenue grew 2% year-over-year to $52.9 billion (beat Wall Street estimates by $1.85 billion), driven by strong demand for cloud services and devices. Earnings per share declined to $2.45 (beat Wall Street estimates by $0.22) due to a higher tax rate and lower other income. The technology giant’s earnings came in better than feared, as the company resisted in the face of a slowing economy. We estimated Microsoft would earn $2.26 per share on revenue of $51.5 billion as we anticipated the cloud revenue to slow as startups and hyper scalers reduced their demand.

Intelligence Cloud revenue increased 18% year-over-year to $22.1 billion, beating our fund estimate of $21.8 billion. Dynamics and Cloud Services revenue grew 13% year-over-year, outpacing the overall cloud market growth. Productivity and Business Processes revenue increased 7% year-over-year to $15.4 billion, boosted by Office 365, Dynamics 365, and LinkedIn growth. Personal Computing is still weak, with a revenue decline of 19% year-over-year and showing why the company needs the Activision Blizzard deal to close to help bolster this segment. Gross profit came in at 66.8%, down from our fund estimate of 68.2%. Microsoft generated $4.9 billion in free cash flow, down from $8.6 billion, reflecting the OpenAI investment.
Microsoft returned $12.2 billion to shareholders through dividends and share repurchases, up 18% year-over-year. The company ended the quarter with $104.8 billion in cash and cash equivalents. To close out the report, Microsoft provided a positive outlook for Q2, expecting revenue growth in all segments and operating margin expansion. Investors cheered the earnings news as the stock rocketed 9%, which is overdone regarding the hype about artificial intelligence. The company is still facing headwinds from a slowing cloud unit and a bottom of personal PCs, and things are not well on the regulatory front, with the UK blocking the company’s acquisition of Activision Blizzard. We like our stock position and want to add more to any pullback or market weakness.

Alphabet Inc (GOOGL)

Alphabet Inc. reported revenue of $69.8 billion (beat Wall Street estimates by $950 million) for the first quarter of 2023, a 2% increase year-over-year. The growth was driven by solid performance across all segments, with numbers coming in better than feared in Google Cloud, YouTube, and Search. Google Cloud revenue reached $7.45 billion, up 28% year-over-year, reflecting the continued demand for cloud services and solutions amid the digital transformation of businesses and organizations. This revenue number exceeded our fund estimate of $7.42 billion. YouTube revenue was $6.7 billion, down 3% year-over-year, reflecting the slowdown of online video content and advertising among users and advertisers. This is because of the slowing ad market due to harsh macroeconomic conditions.

Search only had 2% year-over-year growth, reflecting the global economy's slowing and decreased online activity of consumers and businesses. Operating margins contracted from 29.5% to 25%, while net margins contracted by 2.6% to 21.6%. Diluted earnings per share were $1.17, which beat Wall Street estimates by $0.10, and this reported number came in ahead of our fund estimate of $1.15/share. We like that Alphabet beat our revenue estimate of $69.6 billion, as we thought the company’s various segments would report slower growth than estimated. Alphabet’s free cash flow declined slightly from $17 billion to $15.3 billion, ending the quarter with close to $115 billion in cash on the balance sheet. Management announced a $70 billion buyback to make it $140 billion in share buybacks scheduled, which will support the stock. It is a sign that management feels their stock is undervalued, and we agree with that sentiment.

The company announced a re-organization of its Other Bets segment and combined its AI teams into Google Deepmind. We like the cautious approach Sundar Pichai takes regarding AI, and the media narrative the company is behind in AI is overblown. Alphabet is a core position in our portfolio and is significantly undervalued. The stock should be trading close to $125/share based on the number of properties it can weave in its AI technology. The company trades 19 times next year’s earnings and is the cheapest large-cap stock in the market.

Thermo Fisher Scientific Inc. (TMO)

TMO reported a strong financial performance for the first quarter of the fiscal year 2023, with revenue of $10.7 billion (beat WallStreet estimates by $40 million), a decline of 9.4% year-over-year due to the COVID-19 testing reducing as the virus has become more endemic with test requirements being rolled by governments. The company’s earnings per share (EPS) was $5.03, in line with Wall Street consensus estimates. We expected TMO to report $5.10 per share on revenue of $10.8 billion, so TMO's earnings and revenue were underwhelming. The Life Science and Lab Products segments are still the main revenue drivers for the company, and the Analytical Instruments segment reported numbers as well.

The company’s operating margin declined to 14.6% compared to 23.9% from the same period a year ago, while gross margins contracted by 7.5%, driven by lower volume and an unfavorable product mix. The company’s free cash flow was $271 million, down from $1.56 billion as management returned $3.1 billion to shareholders via share buybacks & dividends. The company’s cash balance also hit as TMO strategically moved to acquire The Binding Site Group for $2.6 billion to bolster its oncology product portfolio. The stock did not react well to the earnings report and acquisition, but we took advantage of that weakness to add to our stock position. We think TMO will help weather our portfolio in an economic downturn.

T-Mobile US, Inc. (TMUS)

T-Mobile US, Inc. (NASDAQ: TMUS) reported its Q1 2023 results on April 27, 2023, beating the consensus estimate of earnings per share (EPS) by $0.10. They reported an EPS of $1.75 (beating Wall Street estimates by $0.25). The company delivered industry-leading growth in customers and profitability, raising its 2023 guidance for both metrics. The company missed Wall Street estimates by 174 million as it reported $19.63 billion in revenue (a 2.4% decline compared to last year). The company delivered a solid EPS number, but the revenue fell short of our expectations. We estimated T Mobile would earn $1.64/share on revenue of $20.1 billion.
The company added 1.3 million postpaid net customers, more than AT&T and Verizon combined, and 523 thousand high-speed internet net customers, more than AT&T, Verizon, Comcast, and Charter combined, for the fourth consecutive quarter. The company’s net cash from operating activities grew 5% year-over-year to $4.1 billion, and its adjusted free cash flow grew 46% year-over-year to $2.4 billion. The company repurchased 33 million shares of common stock in Q1 2023 for $4.8 billion.
The company continued to lead the industry in overall network performance and 5G network coverage, speed, and reliability, according to Ookla and Umlaut. All the synergies from the acquisition of Sprint are starting to bear fruit for the company. The company launched its latest Un-carrier move, Phone Freedom, which allows customers to switch phones without paying extra fees or extending their contracts. The sell-off in the stock was warranted, given how the company missed on revenue, but we like that they raised their profitability guidance (higher pricing or cost cuts planned).

Leidos Holdings Inc. (LDOS)

Leidos Holdings, Inc. (LDOS) is a science and technology leader that provides solutions for defense, intelligence, civil and health markets. The company reported its first quarter fiscal year 2023 results on May 2, 2023, before the market opened. The company’s revenues increased by 6% year-over-year to $3.7 billion (beat Wall Street estimates by $40 million), driven by organic growth across all segments. The company’s net income was $164 million, or $1.17 per diluted share, compared to $151 million, or $1.03 per diluted share, in the same period last year. The company’s adjusted EBITDA was $346 million, or 9.4% of revenues, compared to $327 million, or 9.5% of revenues, in the first quarter of the fiscal year 2022.

The company’s non-GAAP diluted earnings per share were $1.47(missed Wall Street estimates by $0.12), up 14% year-over-year, reflecting higher revenues and operating income. Compared to our fund estimates, we expected Leidos Holdings to have a higher EPS number as management controlled costs, but the company’s interest expense rose 12.5% due to higher interest rates. The company’s net bookings were $3.0 billion in the first quarter of fiscal year 2023, resulting in a book-to-bill ratio 0.8. At the end of the first quarter of fiscal year 2023, the company's backlog was $33.6 billion, of which $8.4 billion was funded.
The company’s guidance for the fiscal year 2023 is as follows: revenues of $15.1 billion to $15.5 billion; non-GAAP diluted earnings per share of $6.15 to $6.45; cash flow from operations of at least $1.2 billion; and free cash flow of at least $950 million. The company has $379 million in cash on the balance sheet, and the company’s debt level is a bit concerning at $5 billion. Leidos has a good backlog comprising government contracts, so the revenue is very predictable, and we hope management comes up with a plan to reduce its debt levels. Investors did not like the earnings as the stock tanked over 15%. We added to our position because the company is a turnaround story ripe for an activist investor.

Disclosure: Cresco Investments is long Microsoft (MSFT), Alphabet Inc. (GOOGL), Thermo Fisher Scientific Inc. (TMO), T Mobile US Inc. (TMUS), and Leidos Holdings Inc. (LDOS).

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is intended for information, engagement & entertainment purposes only and is not to be construed as investment advice or direction. Investors are strongly encouraged to perform due diligence and consult with their financial advisor(s).