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Alphabet - advertising boom drives revenue beat

Nicholas Hyett, Equity Analyst | 28 April 2021 | A A A
Alphabet - advertising boom drives revenue beat

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Alphabet Inc NPV C

Sell: 2,525.04 | Buy: 2,528.13 | Change -3.14 (-0.12%)
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Alphabet's first quarter revenues of $55.3bn rose 32% at constant exchange rates. That's some way above analyst expectations and reflects growth across all divisions. Total group operating profit more than doubled to $16.4bn, with operating margins climbing to 30% from 19%.

On 23 April the board authorised a $50.0bn share buyback programme.

Alphabet shares rose 4.7% in pre-market 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 of last year, when advertising revenues slipped 8.1%. However, ever since the US tech giant has been tearing up the rulebook, and advertising revenues are flying.

Alphabet's scale and dominant market share make it an internet staple. And now the ad taps are turning back on, Google is a natural beneficiary. 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, and with losses declining there's even an outside chance of profits in the not too distant future. Other Bets, that range from self-driving cars to life sciences barely generate any revenues let alone profit. One of these moon-shots 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. Some of that is now scheduled to make its way back to shareholders through a $50bn share buyback programme. But despite this and extra investment requirements, Alphabet still generates huge quantities of free cash. That's allowed it to weather the recent 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.

Anti-trust lawsuits in the US have focused on anti-competitive practices in Search, while Australian lawmakers have tried to make it pay for displaying news results. These kinds of cases are only likely to increase as time goes on.

Despite the regulatory threat we still think there are more positives than negatives in Google. There is potential for further growth if the economy continues to turn in its favour, which is probably why the group's valuation is some way ahead of its long run average.

Alphabet key facts

  • Price/Earnings ratio: 31.1
  • 10 year average Price/Earnings ratio: 21.3
  • 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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First Quarter Results

Ruth Porat, Google and Alphabet CEO put the quarter's performance down to "elevated consumer activity online".

The core Google Services business, which includes advertising revenue from Google Search and YouTube, saw revenue rise 34% to $51.2bn. The Cloud business saw revenue rise to $4.0bn, up from $2.8bn at the same time last year. Other Bets revenue rose 47% to $198m.

Google Services was the only profitable division, with operating income rising over 69% to $19.5bn. Losses reduced to -$974m from -$1.7bn in Google Cloud, and remained broadly unchanged at -$1.1bn in Other Bets. Corporate costs were 37.5% higher at $990m.

Results benefited from a change in the assessment of the useful lives of servers and network equipment, resulting in a $650m increase in net income.

Free cash flow reached $13.3bn, rising from $5.4bn, as capital expenditure remained broadly flat. Net cash of $121.2bn was down slightly compared to the end of December 2020.

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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.