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Alphabet - revenue, profits beat and $25bn share buyback

George Salmon | 26 July 2019 | A A A
Alphabet - revenue, profits beat and $25bn share buyback

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Alphabet Inc NPV C

Sell: 1,464.96 | Buy: 1,466.00 | Change -9.48 (-0.64%)
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Alphabet's second quarter revenue and profits both came in ahead of expectations, with underlying revenue up 19% (or 22% at constant exchange rates) to $38.9bn, and adjusted earnings per share rising 20.9% to $14.21.

The group also announced a $25bn share buyback.

The shares rose 8.3% on the news in after-market trading.

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Our view

Alphabet is the parent company of Google. While its algorithms would give most maths professors a headache, it's as simple as ABC for investors.

It's all about volumes. The more people use Google, the better. Same goes for YouTube, Maps and the Play Store. As we spend more time online, advertising through these platforms becomes ever more attractive to advertisers.

The group has to incentivise others to offer its products as the go-to app on their devices, and some revenue is paid out to web partners. But in the great scheme of things not much cash is tied up in the operation. As a result, the core business is highly profitable.

That's given Alphabet the firepower to invest in side-projects like Waymo self-driving cars and Verily life sciences. These have the potential to bring significant profits, but are higher risk and unlikely to move the dial yet in any case.

A notable exception is Alphabet's investment in cloud networks, which use the internet to provide on demand computing power to others. This could meaningfully contribute to profits sooner rather than later. Significant investment here means capital expenditure is rising sharply. Fortunately the core business is more than able to meet those demands and still generate tens of billions in free cash flow every year.

Alphabet's cash on hand already stretches well past $100bn. It doesn't pay a dividend, and while the group has sanctioned a significant share buyback, it's still been able to step up spending on those Other Bets or pursue acquisitions.

The main worry is around regulation. The group already racked up billions in fines, and with the Department of Justice assessing the the big tech giants competitive practices, there's scope for the landscape to change.

Still, there's plenty of room for growth in the core business. Alphabet says nearly half of US ad budgets are still spent offline and only around 10% of shopping is digital. To us the group looks well placed to benefit as these balances change, which underpins our confidence it can grow profits in the years ahead, provided there aren't more faux pas in the pipeline.

That growth potential underpins a price to earnings ratio of a shade under 23.

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Second quarter results

The core advertising business saw revenue rise 16.1% to $32.6bn, with Google properties revenue (including Search, Maps and YouTube) growing by 17.5% to $27.3bn and Network Members revenues rising 9.1% to $5.3bn. That includes its partnerships with third parties through AdSense and AdManager. Other Google Revenues, including Cloud, Play Store in-app purchases and hardware, rose 39.7% to $6.2bn.

Paid clicks on Google properties rose 28% year on year, with impressions of ads on Google Network Members' sites up 11%. Traffic acquisition costs, which reflects what Google pays partners, either as their share of ad revenue or payments for being the default search provider, were of 22% of revenue, down from 23% last year.

As a result, net revenue at the advertising business was $25.4bn. After deducting other expenses, operating profit was $10.4bn, up 16%. The Other Bets division's operating loss widened to $989m.

The group's higher profits, translated to an operating cash inflow of $12.6bn. After accounting for capital expenditure of $6.1bn, the group delivered free cash flow of $6.5bn in the quarter. That took the net cash position to $117bn.

Find out more about Alphabet shares including how to invest

The author and their connected parties hold shares in Alphabet.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. 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.