Google: Neutral View Before Earnings, Wait For The Long-Term Gain
Contributor since 2018 / 810 Followers
Summary:
- I have a neutral view on Google’s coming Q4 results.
- Google’s shares are traded at lower multiples in comparison with the shares of peer companies.
- There is also an upside to historical multiple valuation.
- Despite my neutral view on GOOGL’s Q4 results, I think that it is worth accumulating the company’s shares for the long-term period.
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Background
Problems in the global economy put pressure on the performance of many companies. Alphabet (NASDAQ:GOOGL) is no exception. The company’s business performance is under pressure from the weakness of the world advertising market, as well as the strengthening of the US dollar index. As part of the analysis of 3Q2022 results, I noted the undervaluation of GOOGL’s shares. Then, I noted GOOGL’s shares fall, following the publication, gave a good chance to start forming a position in the company’s shares. Google’s shares are up 7.7% since the last reporting (as of Jan. 30), while the S&P 500 is up 6.9% over the same period. Let’s take a look at what to expect from the upcoming Q4 results, which are scheduled for February 2 (after the market close). Looking ahead, I will note that I maintain my positive opinion about the company, however, my positive opinion is of a long-term nature. Regarding the coming reporting, I have a neutral opinion.
Q4 2022 consensus expectations
Let’s start with an analysis of the consensus expectations of GOOGL’s Q4 2022 results.
The Q4 consensus revenue forecast is $76.5 billion, implying 2% YoY and 11% QoQ growth. Revenue growth continues to be negatively affected by the strengthening of the US dollar YoY. Let me remind you that the regions outside the US account for 51% of GOOGL’s revenue.
The Google Search segment is expected to reach $43.2 billion in revenue, which is in line with last year’s results and up 9% from 3Q2022. YouTube’s ad revenue is expected by consensus to reach $8.2 billion (-4% YoY, +17% QoQ). Google Networks revenue is forecast at $8.9 billion (-4% YoY, +14% QoQ). Google Cloud sales are expected to be around $7.2 billion (+30% YoY, +5% QoQ). The Google Other segment is expected to bring in $8.1 billion in sales (flat YoY, +18% QoQ).
Operating profit is expected at $19 billion (-13% YoY, +11% QoQ, 25% margin). In the Google Services segment, operating income is projected at $22 billion (-15% YoY, +12% QoQ). Google Cloud segment operating income is expected to be at -$875 million, up 2% year-over-year but 25% worse than the previous quarter. The Other Bets segment is projected to have an operating loss of $1.5 billion, up from $1.45 billion a year earlier and $1.6 billion a quarter earlier. Diluted earnings per share are expected to be $1.21 (-21% YoY, +14% QoQ).
It is quite difficult to unequivocally expect positive results from Google’s approaching reporting. On the one hand, rather conservative results are expected for a number of segments, but on the other hand, these segments related to the advertising market may show results that are worse than expected. The state of the global advertising market in the 4th quarter causes concern. In addition to the actual results, the company’s forecast for the 1Q2023 will be important. Traditionally, this is an equally important part of reporting. Intel’s recent earnings are a clear indication of this.
1Q 2023 consensus forecast
Total Q1 revenue is expected at $70.7 billion (+4% YoY). In the Google Search segment, revenue is forecast at $40.1 billion (+1% YoY). YouTube ad revenue is expected to reach $6.9 billion (+1% YoY). Revenue from Google Networks is forecast at $8 billion (-1% YoY). Google Other sales are forecast at $7 billion (+4% YoY). The consensus forecast of Google Cloud revenue is at $7.4 billion (+29% YoY).
Operating profit is expected at $18.2 billion (-9% YoY, margin 26%). Google Services’s operating profit is expected at the level of $20.7 billion (-10% YoY). Operating income of the Google Cloud segment is projected at (-$787 million). A year earlier, there was a loss of $931 million. Diluted earnings per share are expected at $1.18. (-4% YoY).
As we can see from the above figures, the consensus 1Q forecast also does not assume any significant improvement in performance. Such forecast also create the possibility that the actual results will exceed it, but the likelihood of this is not so high taking in the account the current global macroeconomic conditions. Let’s analyze the current relative valuation of the company’s shares in order to understand whether there are risks of a significant fall of company’s shares in the event of weak quarterly results.
Comparative valuation of Alphabet
As peers, I used the rest of the FAANG group companies, adding Microsoft and Tesla to them.
Alphabet shares are trading at 10.7x on a forward EV/EBITDA multiple, the second-lowest multiple in the sector behind Meta. The average EV/EBITDA multiple for the rest of the companies in this sample is 19.5x. What is about fundamentals of these companies? Google’s revenue growth is expected next year at the level of 8% (consensus expectations). The average growth of other companies is projected at 9%, and excluding Tesla from this sample, it turns out that the average growth is expected at 6%. Alphabet’s ROTC (return on total capital) is 17.6%, while for the peer group’s average ROTC it is 17.1%. Google’s FCF margin is one of the best – 22%. Only Apple and Microsoft have better FCF margin, 28% and 29%, respectively. The sum of revenue growth and FCF margin for Alphabet is 30%, the average sum for other companies is 26%.
Using the peer EV/EBITDA multiple to revenue growth + FCF margin ratio, a fair multiple for Alphabet is 39% higher than the current one (EV/EBITDA 15x). I excluded Amazon and Tesla from the sample, as their presence in the sample affects the Alphabet target multiple too positively. However, it cannot be ruled out that the problem is not with Alphabet’s undervalued multiples, but with its peers’ overvalued multiples. For example, Netflix’s multiples are quite difficult to explain by its fundamentals, which I wrote about in the preview and review of NFLX’s Q4 financials.
Let’s consider if Alphabet was trading at a 15x multiple in previous years. The company’s average forward EV/EBITDA multiple for the past two years has been at 13.2x, representing a 23% upside to the current multiple. However, this multiple was in times of a more favorable macroeconomic environment for the company (interest rates were significantly lower than now) and the advertising market was in better condition. Thus, the return of GOOGL’s multiple to the average level looks more possible than the growth of multiple closer to the level of peers.
Are there drivers for the growth of multiples?
Alphabet’s share needs drivers to return to the average historical multiple level. There is not a lot of them.
Of the significant news over the past few weeks, I note two. First, the DOJ and a group of eight states announced an antitrust lawsuit against Alphabet. DOJ accuses Alphabet of violating antitrust laws in the advertising business. The plaintiffs point to a violation of the Sherman Act and demand the division of the company. Let me remind you that under the previous antitrust lawsuit, the Trump administration accused the company of abusing market power in the internet search business. At the moment, I consider the probability of Alphabet losing this litigation to be low. Nevertheless, this lawsuit will put pressure on the company’s share price.
The second piece of news is partly positive and should have a positive impact on the company’s margin in the face of a slowdown in revenue growth. Alphabet has announced that it will cut 12,000 employees, which represents about 6% of the company’s workforce. In the short term, this will certainly have a positive impact on the company’s profitability, but such cuts could theoretically have a negative impact on business growth in the future. Thus, the news background does not yet give grounds for significant optimism and the drivers for GOOGL’s share growth.
Final thoughts
The company’s upcoming report will determine the dynamics of GOOGL’s shares for the next quarter. I don’t expect significant positive from the upcoming reporting. At the same time, I do not expect significant negative from the Q4 2022 financials. However, the current valuation of the company compared to its closest peers gives us reason to believe that the shares are undervalued. Although it will be quite difficult to unleash Google’s shares growth potential in the short-term period, I think that it is worth accumulating the company’s shares for the long-term period growth. Separately, I note that Alphabet shares look more attractive, in my opinion, compared to other companies whose business is related to the advertising market (social media companies. By the way, Snap is reporting on Tuesday (after the market close). Its earnings could provide the first hints of what to expect from Alphabet’s earnings and digital advertising market dynamics in Q4 2022.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in GOOGL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is not investment advice. I am not an investment adviser. Before making any investment, please do your own research!