3 US shares with something to prove

Over the next few weeks, a trove of US names will release quarterly earnings reports. Despite a host of headwinds, from cost inflation to low consumer confidence, earnings are expected to grow on average.

It’s set up to be an important quarter, and not just for US investors. This earnings season will be a good barometer for how current conditions are impacting business performance.

Some companies are heading in with more momentum than others, and there’re some big names with something to prove. Here’s a closer look at three shares.

This article isn’t personal advice. If you’re unsure if an investment is right for you, seek advice. All investments can go down as well as up in value, and you could get back less than you invest.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Amazon

It’s not often Amazon delivers a quarter that can only be described as disappointing. But, that’s exactly what the first quarter was. Investors will be hoping the upcoming second quarter’s considerably more promising.

Net sales of $116.4bn were a smidge ahead of expectations, but eyes were firmly fixed on operating profit. It almost feels unnatural to say $3.7bn operating profit’s a disappointment. But that reflected a 58.6% decline and came in well under market expectations of $5.3bn.

Guidance didn’t fill markets with much confidence either, operating profit in the second quarter is expected between a loss of $1bn to a profit of $3bn. If the lower expectations are right, it would mark the first quarterly operating loss since 2014.

More concerning though, every ounce of profit came from the high-flying cloud computing business, Amazon Web Service (AWS).

Pressure’s now firmly on the retail arm to start contributing to profit, rather than eating into it. It’s arguably a victim of its own success, consumer sales grew so fast over the last couple of years that the fulfilment network needed to double in size to keep pace.

But, when costs rise to increase output, sales need to keep pace or profitability drops off. And the world looks very different now than it did even six months ago. Consumer confidence has tanked and soaring living costs mean spending’s under pressure. It now looks like the full-court press was a little overdone, and there’s work ahead to get costs back under control.

It’s certainly not all doom and gloom though. Aside from the fact Amazon’s retail arm’s a consumer staple we can’t live without, AWS is a golden goose.

Revenue for AWS has increased 37% year-over-year with the business becoming even more profitable over the period – operating profit increased 57% to $6.5bn.

As you’d expect with a behemoth like Amazon, the balance sheet’s in a strong position with net cash of $18.8bn. That’s a war chest that can be deployed to snap up additive businesses like the recent acquisition of MGM studios, which should help plump out Prime Video and Amazon Studios.

From here, AWS looks to be the main engine for growth. Though there’s only so long that can support a valuation that’s over 60 times forward earnings. The big challenge over the next few quarters is whether it can get the retail arm back on side. Expect disruption while that journey’s underway, especially given how uncertain the global consumer is right now.

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Meta

Meta’s been on a bit of a rollercoaster lately.

At the end of last year, markets received a shock announcement that Facebook was being rebranded as Meta. A move that signalled growing ambitions to push beyond a social media platform, into the virtual world of the metaverse.

That sounds snazzy and exciting. But back in reality, we’re waiting to hear real news about how it’s going to work. In the meantime, increased investment in research & development, along with higher staff numbers, mean costs have soared – up some 31% in the last quarter.

Higher costs aren’t necessarily a problem, especially when you’re trying to reinvent the wheel. Plus, there’re not many businesses that can boast a $44bn net cash war chest. But given revenue growth’s expected to be at its slowest pace in a decade, margins are starting to feel the pinch. Operating profit fell 25% over the last quarter to $8.5bn.

For now, traditional ad revenue is Meta’s bread and butter. And where that’s concerned, headwinds are a plenty.

Changes to Apple’s iOS, that mean users can opt out of allowing Facebook to track them across the web, mean advertisers are likely to spend less. More generally, ecommerce looks to be softening. Following a boom over the pandemic, demand for advertising has been impacted by increased competition, and the effects on businesses resulting from the Ukraine war.

In response, Meta’s looking to capitalise on a user that’s spending more time watching short-form videos. These include the likes of reels on Instagram, which already make up 20% of users’ time. For now, this shift is proving to be a drag on revenue as reels don’t service as many ads. But Meta’s no stranger to changing behaviours and has a proven track record of turning them into tailwinds.

2022 marks an important turning point for Meta, and markets haven’t been too impressed so far. The group’s valuation is significantly down year-to-date, which could make it look attractive. But, that’s based on earnings that are forecast to fall around 15% this year, and we wouldn’t be too surprised if there’s a bigger drop than expected.

The metaverse could be a treasure trove for whoever can build and monetise it first and we wouldn’t put it past Meta to do just that. But the risk of getting it wrong is high, which means there could be some more ups and downs.

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Twitter

Talking of rollercoasters, Twitter’s been on quite the ride since Elon Musk offered more than $40bn to buy the company back in April. Citing concerns over Twitter’s estimates that fewer than 5% of their accounts are fake ‘bots’, Musk officially notified Twitter he won’t be pursuing the deal.

It turns out pulling out of a multi-billion-dollar deal isn’t quite that simple, especially when the group’s valuation now trades significantly lower than the offer price. And so, Twitter now finds itself in a legal battle, to essentially force the deal through at the previously agreed price.

Whether or not Twitter will succeed remains to be seen, so we prefer to turn our attention to the underlying business. On which there’s now more pressure than ever, given the adverse reaction to the ups and downs of Musk’s potential takeover.

All told, Twitter is a giant advertising machine with a trove of user data that it also monetises. The more users, the more advertisers will pay. Last year was a record year for revenue, with a 37% rise to just north of $5bn. That was supported by 13% growth in monetisable daily active users (mDAU), a measure of authenticated logins, to 217m.

Twitter’s goals are bold, targeting $7.5bn in revenue and 315m mDAU by the end of 2023. But, there are some very real challenges to overcome.

As mentioned with Meta, Twitter’s felt the pinch of iOS changes too – though seems to be a little more upbeat about the impact. There’s also the wider concern that the weakening economic outlook could cause businesses to rein in marketing spend. We see the latter point as a very real challenge to that revenue target.

Then we come on to costs, which soared last year across the board as investment in growth ramps up. That’s not necessarily a bad thing, given growth is the number one aim, but it did contribute to last year’s operating loss of nearly $500m.

The good news is the balance sheet looks healthy enough to support the increased investment. Net cash sits in excess of $2bn and free cash flow’s expected to return to healthy positive territory next year, following an outflow of around $380m last year.

We do have a couple of bugbears. The first is the group’s hefty stock-based compensation. A $630m charge was associated with rewarding executives last year. That’s a 33% increase year-on-year, despite the business making a loss.

Second, and it’s hard to criticise a business returning cash to shareholders, is the renewed $4bn buyback scheme. Given all the requirements for cash, we can’t help but think this’d be better retained within the business for now.

The group trades on a forward price to earnings ratio of around 27. That’s a way below the longer-term average, but still requires strong growth from here on out to be justified. We expect volatility in the near term, as that valuation continues to be challenged.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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