Considering the fact that Alphabet GOOGL and Facebook FB, like everybody else, are in the middle of a global pandemic, their earnings reports were okay. The current quarter and the quarters thereafter will be more difficult for these companies as a battered global economy struggles to get back into equilibrium.
So what was there in the just-reported quarter (and overall) that can perhaps help us decide whether we might want to buy some shares?
Overall Results Weren’t Too Bad
Alphabet earnings $9.87 (Zacks Consensus $10.40, year-ago $11.90): miss, down 17.1%
Sales $33.707 billion (Zacks Consensus $32.587, year-ago $29.479): beat, up 14.3%
Facebook earnings $1.71 (Zacks Consensus $1.73, year-ago $0.85): miss, up 101.2%
Sales $17.737 billion (Zacks Consensus $17.286, year-ago $15.077): beat, up 17.6%
The primary concern as far as most investors are concerned is regarding the hit to ad revenue and the length of time this weakness may be expected to continue. Since both Alphabet and Facebook have a geographically widespread business that excludes China, they were both impacted by constricted ad budgets.
Ad Revenue Slowed In March
Alphabet’s total ad revenue grew 10% from 1Q 2019. YouTube ad revenues grew 33%, mainly because of very good growth in the first two months of the year that dropped off sharply in March, as brand advertisers cut back significantly, while direct response remained strong. APAC was the strongest region although U.S. and other Americas also grew.
Facebook also grew ad revenue 17% (or 19% on a currency-neutral basis), which is pretty good all things considered.
Asia/Pac was 5 points stronger that the rest. Usage (3 billion MAUs for the first time) and engagement (messaging, voice/video calling) both swelled, offsetting the drop in ad prices toward the end of the quarter.
The mobile newsfeed on Facebook was the biggest driver, due to prior product optimizations and increased engagement.
The company started seeing weakness in the second week of March, primarily from auto and travel operators, which is kind of not surprising. It did however see strength in gaming and what it called “relative stability” in technology and ecommerce (its largest served area). Weakness was more or less evenly spread between large and small players, and across the U.S., Canada, Europe and Rest of World.
Zuckerberg cautioned: “I don't expect that this exact spike in usage will sustain over a longer period of time.”
Both Companies Gained From Businesses Moving Online
In Alphabet’s case, this was reflected in its non-advertising revenue, including its Google Play Store that jumped 30% between February and March, Google Classroom that doubled to 100 million students and educators, an estimated 400% increase in Chromebook demand, its video conferencing software Meet now being used by companies like Twitter TWTR and Shopify SHOP.
And of course it was also reflected in the increased use of Google Cloud where revenues jumped 52%, with strength across companies in retail, public sector, healthcare, gaming, media and communications companies, and other sectors for things like network analytics, customer service, demand forecasting, and disease monitoring and control.
More users are looking for businesses on Facebook and Instagram platforms amid lockdowns and shelter-in-place orders. Facebook is making the most of this trend by quickly creating store fronts and facilitating transactions. This helped its small business revenue. The company expects its personalized ad targeting and measurability of ad performance to help it grow its small business roster. It has also sweetened things by offering funding to this group as well as news providers that now have to operate on reduced ad budgets.
The primary driver of both revenue and earnings for Facebook and Alphabet was again advertisements, as the first two months were very strong. When ad revenues dropped off, the other side of the business picked up.
Expenses with an Eye to the Future
In addition to higher traffic acquisition cost and content acquisition cost (mostly for YouTube ad-supported business), Alphabet reported additional depreciation related to infrastructure build and R&D and S&M team building to support the growing Google Cloud business. There was also a provision for expected credit deterioration related to COVID.
Increased depreciation related to its infrastructure build was a factor for Facebook as well, but the 40% increase in its R&D was attributed to AR/VR product development. Facebook’s marketing costs also increased. It also made a provision for expected credit deterioration related to COVID.
Facebook is obviously strengthening its ecommerce and online delivery businesses, while building Oculus, which had a very strong quarter, in an attempt to offset the weakness in ad revenues that is bound to continue. Alphabet is working to improve the Google Cloud business even as several non-ad segments are growing strongly.
Outlooks Show Increased Caution
Alphabet is concerned about the higher level of depreciation, the cost of operating its technical infrastructure, as well as things like customer support and content review in a market where revenues are dependent on economic recovery. So it will be scaling back capex slightly to below 2019 levels and reduce hiring beginning in the third quarter, except in strategic areas. The silver lining management pointed out is that search tends to snap back very quickly once economic activity resumes.
Facebook withdrew revenue guidance for 2020 and lowered total expense target from $54-59 billion to $52-56 billion (including $300 million allotted to date to help the broader community). Still, weaker revenue is expected to result in a negative impact on the 2020 operating margin.
Both companies generate the bulk of their revenue from advertising, which may be expected to remain very weak right through the year. Moreover, while they are both in different stages of diversification and Alphabet is somewhat ahead of Facebook, with the billions coming from cloud, hardware, Play, etc, it’s still unlikely to move the needle for the company if ad revenue falls too far.
While some of its initiatives under “Other Bets” also look encouraging, they’re unlikely to have any material benefit this year. Facebook’s other revenue is miniscule, so doesn’t warrant much of a conversation yet.
But Facebook has signed an exciting new ecommerce deal, wherein WhatsApp will collaborate with India’s Reliance Jio, which has incredible opportunities for the future (I’ll leave that for another day). The business might take off this year too, since Jio is already testing its ecommerce platform.
Also, these are solid companies with huge cash generating potential (and balance sheet cash) that will bounce back quickly when the market does. They won’t be set back too much the way many others will, i.e., they are very low-risk.
That said, my hunch is there’s more room to fall, with further deterioration in results looking forward and especially considering that they’re slightly overvalued now, on most key metrics. So while nobody knows for sure what a stock will do, I’d wait to add position here.
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