Alphabet,
Q1 2019 - Results
April, 30 2019
1. Context
Alphabet’s first quarter results were out yesterday and the stock price is now down by 8%. Lance Cameron, one of the Facebook Group members was worried about this and posted his doubts regarding investors psychology.
This is a recurring theme for all kinds of investors out there and one which I am very interested about so I’ve decided to take a look at Alphabet before any other company.
First of all, I’ll read my first analysis.
Before I start, allow me to make a quick analysis on the stock price. Yes! – before even looking at the fundamentals…. bare with me.
This is the current stock price after the earnings came out.
And this is the long term stock price.
I think I can count at least a dozen times when the stock market was down by more than 10% so I’m not too worried about this one.
2. Results
3. POSITIVES
3.1. Revenue is up
As everything in this life, one can look at things as a half empty or a half full cup.
The Q1 revenue was up “just” by 17%. Mr. Market was expecting this to be higher so he is punishing the stock today.
The company attributes this lower growth to several things like the improvements they are doing to their products, a lower cost-per-click in the youtube ads and foreign currency.
3.2. Traffic acquisition costs are down
In my opinion, one of the most positive things about this quarter, and in the most part overlooked by Mr. Market, is the fact that the traffic acquisittion costs were down.
3.3. Operating margin
Excluding the $1,7B fine (we’ll get to that in a minute), the operating income was $8,3B representing a 23% operating margin. I consider this to be a very good surprise, given the fact that the operating margin has been going down for years.
3.4. Cash flow
As you might’ve noticed, I don’t even look at the net income, especially after these companies were forced to state unrealised gains or losses on equity securities (stocks) on the Income statement, an accounting rule that was subject to a harsh criticism by non other than Warren Buffett on his 2017 letter.
Instead I prefer to look at the cash flow and I’m even becoming a greater fan of looking at the cash from operations since all of these tech companies have different needs regarding CAPEX.
Anyways, the Cash from Operations was up by just 3% but the FCF was up by 72% due to lower capital expenditures.
During the conference call, the management has said that they expect this lower CAPEX to continue throughout the year.
3.5. Net cash
With a current ratio of 3,9 and net cash of $105B, Alphabet’s balance sheet is still pristine.
As of this writing, the net cash amounts to about 12,6% of the total market capitalisation.
3.6. Youtube and cloud
Unfortunately, the company still doesn’t breakdown its Cloud and Youtube’s numbers but at least the segment where they are packed into has grown by 25%. Although this is still a minor segment, I expect it to grow as a percentage of total revenue along the years.
4. NEGATIVES
4.1. Fine
As I’ve stated previously, the operating margin (and net margin) were hurt due to the $1,7B fine from the European antitrust regulators. Although one might argue that these big tech companies will face increasing scrutiny from the regulators, I prefer to see this as a one-time non-recurring expense.
5. OVERVIEW & CONCLUSION
5.1. OVERVIEW
Although we live in the digital era, Google is still an advertising company, more less like the billboard companies of the past (and present).
The difference is that these billboards are virtual, not physical. But what Mr. Market with his short term view forgets is that Google is a part of our lives and it’s really hard to live without it. Google Search, Google Maps (or Waze), Youtube, Google pay, docs, you name it.
Although I’m not scared at all by the results, I can’t stop to think that Google (and Facebook) is still mostly an advertising company and when a recession comes (it will come eventually) its revenue will get hurt. I’m becoming more and more concerned (in a good and healthy way) about what will happen to my companies should a recession or an economic slowdown come our way and that’s why lately I’m looking at more counter-cyclical companies.
Portfolio concerns aside, as you might’ve noticed by now, I’m starting my own business (AllinStocks.com) and I am obviously heavily dependent on digital advertising to scale my business.
In the city where I currently live in – Lisbon – I constantly hear people talking about digital marketing courses and startups (if there is a bubble on that sector, that’s a whole different story). How will most of these startups scale their businesses? Most of them will do it by advertising online. It’s a secular trend that doesn’t seem to be stopping. Just look at what happened to the newspapers revenues for the last 10 years. The online advertising still has lots of room to grow.
And a topic which I almost didn’t discuss is the cloud. Although AWS and Microsoft are way ahead of the game, I think there is more than enough space for the 3 companies and this can be a major source of growth for Alphabet.
Whether we’re talking about the cloud or the ad revenue, I always remember the ARPU slide on Facebook’s presentations. The US market, being the most mature market has the highest ARPU while the asia pacific region has the lowest. Of course we can’t expect the rest of the world to spend the same amount of dollars per capita as the US but whenever I travel to less developed economies, I feel that the world is rapidly leveling up and there are a lot of countries that will be spending more money on ad and cloud services going forward.
On my first analysis, I’ve drawn two scenarios for Alphabet. One of no growth – on which I’ve committed the error of applying a 25PE for a company with no growth – and a conservative 10% growth scenario.
Sticking to my 10% growth for ads, 25% for “other” and zero growth for bets, but this time applying a 20x multiple on the FCF instead of a 25x (being even more conservative), we could easily be looking at an 11% CAGR for the next 5 years.
To sum this all up, I’m not a bit worried with what Mr. Market thinks about Alphabet.
5.2. CONCLUSION
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