Alphabet Inc (NASDAQ:GOOG) reported 1Q19 gross revenue which were below consensus but GAAP EPS still beat Street estimates. Below are the comments from analysts on what they expect from the company.
Baird Equity Research
Alphabet reported 1Q19 gross revenue of $36.3B (+19% ex-FX vs. +23% in 4Q18), below consensus of $37.3B. Net revenue of $29.5B (excluding TAC) increased 18.5% Y/Y, a deceleration from 23.1% growth in 4Q18. GAAP operating income totaled $8.3B (23% margin on gross revenue ex-EC fine), above consensus of $7.95B driven by lower-than-anticipated expense growth, particularly within TAC, and consequently GAAP EPS of $11.90 was well above consensus of $10.49. Google paid click growth decelerated to +39% Y/Y (vs. +66% in Q4), while pricing (CPC) declined 19%, an improvement from 4Q18 (-29% Y/Y) – clicks and pricing growth are generally inversely correlated.
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Alphabet net revenues at $29.3bn missed Street at $31.3bn; however the $8.3bn (ex-EU fine) in operating income beat Street at $8.0bn. GAAP EPS of $11.92 (ex-EU fine) beat Street estimates at $10.17 aided by slightly better Google margins and other income benefit. Overall, despite EPS upside, a somewhat disappointing Q given Internet media comp strength, and Google’s confusing comments on the revenue impact from ad product changes.
Google reported revenue 3% below & EBIT 2% above consensus, and in standard form, didn’t offer much of an explanation on the deceleration. Despite management flagging this to some degree in February, the revenue miss is likely to leave a cloud over the story for a while, as GOOG had not printed a deceleration of this magnitude in 4 years. Some US & EMEA weakness is likely chalked up to pixel declining Y/Y, but sites growth of 19$ EX-FX missed by 300bps & against a very healthy 1q19digital ad backdrop, investor questions linger. Further, core segment EBIT margin decline of 120bps y/y improved a tad from 2018’s cadence but was not enough to offset the topline.
We have been neutral because we felt consensus did not properly reflect mix-shift to lower-margin businesses. But Alphabet had grown revenue 20%+ CC since 3Q15 and outperformed our expectations 10 out of the last 11 Qs. That run ended in 1Q19 as growth decelerated to 19.0%, vs. our 20.3% estimate and 22.6% in 4Q18. "Timing of product changes in ads" (a year ago) impacted growth, as foreshadowed last Q. But little color was added, adding risk to consensus EPS. We prefer AMZN for share gains in online advertising.
Overall, our EBITDA and FCF dollars remain essentially flat versus prior through 2020, and as such our price target remains $1400 and we maintain our Outperform rating as our thesis based on the following factors remains unchanged: 1) ongoing monetization improvements in Search through product updates, 2) larger-than-expected contribution from Google's larger non-Search businesses 3) optionality for value creation from new monetization initiatives such as Maps as well as the eventual commercialization of Google's Other Bets (Waymo, Life Sciences).
Alphabet’s 1Q19 revenue came in ~3% below our and consensus projections on tougher comps, FX, and what appears to be less impactful Search and YouTube product monetization changes in the quarter; we maintain our Market Outperform rating, but lower our price target to $1,300 from $1,375. Google’s 1Q19 earnings follow better-than-expected advertising results across Facebook (FB, MO, $220 PT), Twitter (TWTR, MP), Snapchat (SNAP, MP), and Amazon (AMZN, MO, $2,275 PT), and competition may have played a role here, although we believe the majority of the deceleration was self-imposed. Google typically makes 100+ product changes per quarter, and it was clear to us that some of these improvements were not as impactful and/or acted as a headwind in the quarter. We point to changes at YouTube’s recommendation engine as an example of the latter.
1Q results largely in line with expectations. Alphabet reported revenue below our and consensus expectations, growing net revenue 19% to $36.3B vs. our estimate of $37.1B and consensus of $37.3B. Ad revenue grew 15% and other revenue grew 25%. TAC was lower than expected and opex was moderately greater due to an EC fine. EBITDA (including SBC) was $13.6B excluding the fine, which was slightly above our estimate of $13.3B. EPS of $9.50 beat our estimate of $9.32, but missed consensus of $10.58.
Google reported weak ad revenue with core website decelerating 400 bps FXN, worse than our agency checks. Management attributed it to product changes related to user experience but didn’t specify where changes were made. We suspect that the tough comp came from YouTube’s positive algorithm change last year and recent negative changes to remove harmful content. We lower 2020 EBITDA by ~5% to reflect tough comps and introduce 2021 EBITDA at $79bn. Maintain Buy rating and PT of $1,350, representing 10.7x 2021 EBITDA versus estimated CAGR of 16%. We do not believe the YouTube algorithm change is a structural issue and the growth rate should rebound once the change is normalized and advertisers’ confidence returns.
What we liked most about 1Q19 included: a) FCF was $7.4B owing to only $4.6B of CapEx, well below our $6B estimate; b) solid expense discipline as costs and expenses (excluding the EC fine) grew by only 13% y/y, much slower than revenue, so reported OIBDA was in line and Non-GAAP EPS was above our estimates; c) TAC to Google Network members rose 3% y/y, well below revenue growth of 8% y/y; d) we like Wing’s FAA approval plus the Detroit Waymo news: e) Paid clicks rose 39% y/y, offset in part by 19% lower cost per click; f) direct response ad growth at YouTube intrigues us; g) key revenue drivers were mobile search, YouTube and Cloud (all high SOTP valuations in a spin-off); and h) we are most excited to see if Stadia (cloud-based video games) gains traction in 2020.
Ongoing changes to the ad business were cited as a reason for some quarter-to-quarter volatility (100+ enhancements introduced every quarter), though we were assured these changes are a result of management’s longterm view of the opportunity rather than managing to the sequential shifts. YouTube was highlighted as an area of strength (and we would note in a quarter with some negative headlines), and the Cloud opportunity remains a large area of focus (highest rate of headcount growth for Cloud). The hardware strategy was highlighted as an important piece of the non-ad business with announcements expected at Google I/O next week. This quarter will no doubt result in a reset to forward expectations, particularly for the ads business, as investors search for reasons for the fairly meaningful decel
Susquehanna Financial Group
The 1Q top-line miss and limited disclosures about the reasons why (other than product changes) are likely going to spark growth fears, as growth dipped below 20%, and pressure the stock in the near-term. We acknowledge that there aren’t necessarily any clear near-term identifiable catalysts, but we do think GOOGL still has ample search optimizations left to drive growth, such as the removal of average position rank, which is expected to go into effect in September. At the same time, the valuation has gotten to the point where downside is likely limited: the current share price implies that core-Google (ex Other Bets) is trading at less than 10x EBITDA, which we think is too bearish even if the near-to-intermediate term Sites revenue growth profile stays at 15%+.
Alphabet revenue growth dropped below 20% for the first time since 2Q:15, with gross revenue up +19% y/y FX-adj. and +17% on a reported basis. Operating margin (ex-FTC fine) beat Street estimates by ~180bps as the margin trend was helped by the accounting shift of investment performance fees into OI&E and the timing of some marketing spend which is expected to pick up in 2Q. At after-hour price levels, shares offer less than 10% upside to our PT, which remains unchanged following the 1Q report. The unexpected degree of revenue deceleration and lower visibility into the near-term reacceleration / deceleration potential lead us to believe the multiple on shares may be challenged to move meaningfully higher over the next twelve months. We move to a Hold rating as a result. At our $1,287 fair value, shares trade at ~24x our 2020E GAAP EPS.
1Q19 was a mixed quarter, the inverse of 4Q18's performance, this time a soft top line and higher EPS (excl. EC fine). While top line FXN was +19% (vs. cons. at +20% and +23% in 4Q18), US and EMEA showed a notable Y/Y decel, against tough comps fueled by unspecified product changes to YouTube made in 1Q18. While mgt failed to fully explain the decel, creating NT uncertainty, we believe GOOGL can sustain mid-teens growth with a focus on incremental profit $/FCFs, making it an attractive growth story at a compelling valuation. Regulatory risk still looms large in Europe and increasingly the US.
Revenue was $36.34 billion, compared with our estimate of $37.91 billion, consensus of $37.33 billion, and $31.15 billion last year. Results in Q1 were driven primarily by continued strength in mobile search, as well as by contributions from YouTube and Google Cloud. Foreign currency translation had a negative impact of roughly $1.0 billion in the quarter, reflecting in particular the weakening of the Euro, British Pound, Brazilian Real, and Mexican Peso. Non-GAAP operating income was $8.31 billion, compared with our estimate of $7.90 billion, consensus of $8.12 billion, and $7.63 billion last year. Non-GAAP operating income excludes the impact of a $1.7 billion fine from the European Commission associated with a violation of antitrust rules around Google’s AdSense for Search product.