Alphabet Inc (GOOG) NPV C
HL comment (31 July 2020)
Second quarter revenues were 2% lower than the same period last year at $38.3bn. That reflects a significant decline in advertising revenues partially offset by stronger results in cloud and other parts of the business.
Together with a modest increase in the cost base that meant the group reported a 30.5% fall in operating income to $6.4bn.
The shares were broadly flat in in pre-market trading.
Alphabet is first and foremost an advertising business, think of it as the newspaper of the modern age. 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.
Unfortunately a global pandemic, is far from the best of times and COVID-19 cost cutting measures are seeing companies take knives to advertising spending.
Google's ad revenues make up 82% of revenues so while an 8.1% fall in advertising spend is far better than many traditional media groups have reported, it's still a blow. Google's significant operating leverage means the knock on effect on profits has been even more substantial.
However, it's important to remember Google's scale and dominant market share make it something of an internet staple. And when the ad taps turn back on, Google will be there waiting. With nearly half of US ad budgets being spent offline prior to the current crisis, and only 10% of shopping done digitally, there's plenty of room for growth too.
Over the years, core advertising profitability has 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 provide on demand computing power and services to others. Rapid growth means the division is making around $12bn a year in revenue. However, growing the division requires significant investment, and capital expenditure has accelerated sharply.
Fortunately cash on hand stretches well past $100bn and Alphabet still generated a good amount of free cash this quarter. Capital expenditure is not under threat and the group should weather the current storm with some comfort. Nonetheless the last few months are a salient reminder that the global tech giants are not immune to the fortunes of the wider economy.
Our main concern where Alphabet is concerned doesn't really have anything to do with the company itself. It's increasing dominance puts the group at the forefront of regulators minds, and there is an increasing willingness to act. The group has racked up billions in fines, and with the Department of Justice assessing the big tech giants' competitive practices, there's scope for the landscape to change.
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 bear in mind that profits will be depressed this year - which will make the shares look pricier. In the long run we think there's plenty more room to grow.
Alphabet key facts
- Forward Price/Earnings ratio: 31.2
- 10 year average forward Price/Earnings ratio: 20.3
- Prospective yield: 0%
We've introduced this section in response to recent survey feedback.
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.
Half Year Results
Google advertising revenues fell 8.1% year-on-year, to £29.9bn. That reflects decline in both Google owned 'properties' like Google.com, Gmail, Maps and YouTube, and Network Members' properties where Alphabet provides adverts for third party websites' advertising space.
Google Cloud revenues rose 43.2% to $3.0bn while Google Other (which includes the Google Play store, hardware sales and YouTube subscriptions) saw revenues rise 25.6% to $5.1bn. Revenues from 'other bets' fell 8.6% to $148m.
The core Google business saw operating income fall 26.3% to $7.6bn, while losses from 'other bets' rose to $1.1bn.
Total costs in the quarter were 7.2% higher than last year at $31.9bn, reflecting a significant increase in General & Administration costs which were up 26.5%. Group operating margin fell from 24% last year to 17%.
Traffic Acquisition Costs (TAC), which reflects what Google pays partners to be able to place ads on their sites, or for making Google a default search provider, fell 7.5% in the quarter to $6.7bn. TAC as a proportion of total advertising revenue remained broadly flat year-on-year.
Free cash flow generated by the group rose to $8.6bn in the quarter, from $6.5bn this time last year. Net cash on the balance sheet hit $117.1bn.
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 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.
Previous Alphabet Inc updates
The London Stock Exchange does not disclose whether a trade is a buy or a sell so this data is estimated based on the trade price received and the LSE-quoted mid-price at the point the trade is placed. It should only be considered an indication and not a recommendation.
Trades priced above the mid-price at the time the trade is placed are labelled as a buy; those priced below the mid-price are sells; and those priced close to the mid-price or declared late are labelled 'N/A'.