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Alphabet - advertising revenues beat expectations

Nicholas Hyett, Equity Analyst | 3 February 2021 | A A A
Alphabet - advertising revenues beat expectations

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Alphabet Inc NPV C

Sell: 122.86 | Buy: 122.88 | Change 0.23 (0.19%)
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Alphabet reported full year revenues of $182.5bn, up 12.8% year-on-year and modestly ahead of market expectations. That reflects very strong revenue growth in the Cloud business, as well as good performances from Search and YouTube.

Operating profits rose 20.4% to $41.2bn, beating analyst forecasts by some margin. That was driven by growth in the core Google business and the non-recurrence of fines incurred in 2019.

Alphabet shares rose 5.3% in aftermarket trading.

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Our view

Google owner Alphabet is first and foremost an advertising business, the newspaper of the modern age. The general rule in advertising is that when times are good companies are eager to splash the cash and get products in front of customers, but when times are hard advertising budgets are a quick and easy cost saving.

That rule seemed to be playing out at Google in the second quarter, when advertising revenues slipped 8.1%. However, the US tech giant has subsequently torn up the rulebook, with advertising revenues up 21.8% in the final quarter.

Alphabet's scale and dominant market share make it an internet staple. And when the ad taps turn back on, Google will be there waiting. Nearly half of US ad budgets were spent offline pre-Covid, and only 10% of shopping was digital. There's likely to have been a lasting change in both over the last year - which can only be good news for Alphabet.

Over the years, core advertising profitability has given Alphabet the firepower to invest in various side-projects. Most notable is Google Cloud, where revenues are growing incredibly quickly, but which appears to have negative margins - actually losing money on every new sale. Other Bets that range from self-driving cars to life sciences barely generate any revenues let alone profit.

One of these moon-shoots could eventually be as world changing as Google itself, but that's some way off. For now they demand significant investment and are the main reason capital expenditure is running at over $20bn a year.

Fortunately cash on hand stretches well past $100bn, and despite the extra investment requirements, Alphabet still generates huge quantities of free cash. Capital expenditure is not under threat and the group should weather the current storm with some comfort.

Our main concern where Alphabet is concerned doesn't really have anything to do with the company itself. Alphabet has already racked up billions in fines, and its increasing dominance puts the group at the forefront of regulators minds. Regulators who have an increasing willingness to act.

The recently launched anti-trust lawsuit in the US focusses on anti-competitive practices in Search, and particularly Alphabet's deal to put its search engine on Apple devices. Google has described the lawsuit as "deeply flawed", but whatever the outcome, the reality is tech giants are going to face increasing scrutiny going forward.

Despite the regulatory threat we still think there's more positives than negatives in Google. The group's valuation is some way ahead of its long run average, but given the potential for rapid growth when the economic cycle turns that's no surprise.

Alphabet key facts

  • Price/Earnings ratio: 30.7
  • 10 year average Price/Earnings ratio: 20.9
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Full Year Results

Google Services - which includes the core advertising, search and YouTube businesses - saw revenues rise 11.1% in the year to $168.6bn. Advertising revenues across all platforms rose 21.8% in the final quarter of the year, driven by 46% growth in YouTube ad revenues. Full Year operating profits in the division rose 11.4% to $54.6bn.

Google Cloud revenues rose 46.4% to $13.1bn. However, operating losses increased to $5.6bn from $4.6bn a year ago. Revenues in the Other Bets business, which includes various moon-shot programmes, were flat at $657m, while operating losses fell 7.2% to $4.5bn.

Full year free cash flow of $42.8bn was well ahead of $31.0bn reported in 2019, reflecting the substantial increase in profits and a modest decline in capital expenditure.

Alphabet had $122.8bn of net cash on the balance sheet at the end of the year, up from $115.1bn a year ago.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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. 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 for more information.

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