Alphabet Inc (GOOG) NPV C
HL comment (28 July 2021)
Alphabet reported second quarter revenues of $61.9bn, up 62% year-on-year and far better than the market expected. That reflects increased online activity by consumers, underpinning an 83.7% rise in YouTube ad revenue, as well as broad based advertising demand in search and elsewhere.
A rise in operating costs of just 33.2%, including a 13% increase in headcount, meant operating profits more than tripled to $19.4bn.
Alphabet shares rose 3.2% in after-market trading.
Google owner Alphabet is first and foremost an advertising business, the newspaper, billboard and doorstep flyer 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.
However, the US tech giants have torn up the rulebook, with ad revenues continuing to grow throughout the pandemic. The increased importance of the internet when the globe was stuck at home allowed the likes of Alphabet and Facebook to seize a far greater share of the overall advertising pie.
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 going forward - which can only be good news for Alphabet. You can already see the benefits not that ad taps are turning back on.
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 although the division is still loss making. The 'Other Bets' division, which covers everything from from self-driving cars to life sciences, barely generates 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.
Recent anti-trust lawsuits in the US focussed on anti-competitive practices in Search, and particularly Alphabet's deal to put its search engine on Apple devices. Google described the lawsuit as ''deeply flawed'', but the reality is tech giants are going to face increasing scrutiny going forward.
Despite the regulatory threat we 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 that's no surprise. There are many worse businesses trading on 28.6 times earnings.
Alphabet key facts
- Price/Earnings ratio: 28.6
- 10 year average Price/Earnings ratio: 21.6
- 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.
Second Quarter Results
Alphabet's higher operating profits were driven by strong results in the core Google Services business, which includes; Android, Chrome, Maps, Play, Search and YouTube. Sales in that business rose 63.1% to $57.1bn, while operating profits rose 134.2% to $22.3bn. Traffic Acquisition Costs in the division rose 63.3% to $10.9bn.
All other divisions remained loss making. However, Google Cloud saw losses narrow from $1.4bn a year ago to $591m in the second quarter of this year. Other Bets revenue rose to $192m, with an operating loss of $993m.
Free cash flow in the quarter rose from $8.6bn last year to $16.4bn. Net cash at the end of the quarter stood at $121.5bn, compared to $122.8bn at the start of the year, as the group spent $24.2bn on share buybacks.
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 disclosure for more information.
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