Alphabet on Thursday delivered largely better-than expected earnings results that showed the search and cloud giant is finally on better footing in the fast-growing AI space.
- Total revenue in the three months ended June 30 rose 13.6% year over year to $84.74 billion, outpacing the $84.19 billion expected, according to estimates compiled by data provider LSEG.
- Earnings per share jumped 31% on an annual basis to $1.89, exceeding the $1.84 expected, LSEG data showed.
Why we own it: Alphabet’s Google Search is an invaluable tool for advertisers. Its YouTube platform continues to gain screen time with viewers and stands to grow even more as the company looks to acquire major league sports rights. Though it did get off to a bumpy start, we believe Alphabet to be a leader in artificial intelligence research and see progress aiding cloud-computing growth over time.
- Competitors: Amazon, Microsoft and Meta Platforms
- Weight in portfolio: 2.73%
- Most recent buy: March 4, 2022
- Initiated: July 22, 2014
Bottom line
Alphabet management demonstrated a strong dedication to keeping costs in check, evidenced by the lower-than-expected traffic acquisition costs. This led to a better-than-expected operating margin result and an earnings beat. We attribute the after-hours selling to nothing more than profit-taking. There isn’t much cause for concern with the company’s fundamentals.
Strong numbers in the company’s search and cloud businesses more than offset the slight misses in the YouTube and network units. Cloud recorded a couple of big firsts: exceeding $10 billion in revenue, along with $1 billion in operating income.
The big miss we see on the cash flow front is largely attributable to the timing of cash tax payments, so we’re not too concerned about that. The elevated capex result likely bodes well for fellow Club stock Nvidia, which is the biggest beneficiary of hyperscalers’ investments in servers and the data center. That’s where the bulk of Alphabet’s capex was targeted.
When asked about the aggressive investments, management offered up some thoughts on the upfront costs. In addition to simply working to define the category of generative AI, the team noted that they are looking to conduct investment in such a way that it both helps customers while also being able to further enhance company’s own offerings. That’s the best strategy because it means that these investments can offer up both an opportunity to grow sales as well as an opportunity to further cut costs.
In terms of the timing and need to spend up front before actually seeing the financial benefits or getting a true sense of how large it can be, the team said that the risk of underinvesting is dramatically greater than the risk of overinvesting. Even cases that turn out to be overly invested can be used across other parts of the business and learned from. “Having said that, we obsess around every dollar that we put in,” said CEO Sundar Pichai. “Our teams work super hard and I’m proud of the efficiency of work, be it optimization of hardware, software, mobile deployment across our fleet. All of that is something we spend a lot of time on, and that’s how we think about it.”
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Alphabet shares were tough to own for a while, but Tuesday’s results show that after stumbling out the gate, the team is finally on proper footing with AI. Customers are benefiting from its AI offerings and the company’s own suite of products appears to be realizing the benefits of the new technology. Add in solid progress by management to “durably reengineer” the cost basis and we come away from the quarter with the view that the stock still has plenty of room to the upside.
Therefore, we reiterate our 2 rating on Alphabet shares, with a $210 price target.
Quarterly results
Better-than-expected search and other revenues of $48.51 billion demonstrate the benefits of generative AI (gen-AI) integration. Whereas investors were — and many still are — concerned about what generative AI might mean for Alphabet’s search revenue, the opposite appears to be the case, at least for now.
Pichai, on the post-earnings conference call with investors, said AI is helping the company deliver better responses on more types of search queries and introducing new ways to search. “People who are looking for help with complex topics are engaging more and keep coming back for AI overviews,” Pichai said, noting high engagement from younger users aged 18 to 24 when they use search with AI overviews. Pichai said users will soon be able to ask questions by taking a video with Lens.
YouTube advertising revenue came up a bit short versus expectations but was still up 13% from a year ago, driven by brand and direct response advertising. Chief Business Officer Philipp Schindler said the company’s long-term investment in CTV continues to deliver: Views are up more than 130% in the last three years. According to Nielsen, YouTube is the most watched streaming platform on TV screens in the U.S. for the 17th consecutive month. Schindler said its Shorts (short-form video) monetization is improving, particularly in the U.S. Google subscriptions revenue also benefited from strong subscription growth in YouTube TV and YouTube Music Premium.
Google Cloud revenue grew roughly 28% to more than $10 billion for the first time. Also a first: Operating income nearly tripled to exceed $1 billion. On the call, Pichai said the company’s AI infrastructure and generative AI solutions are already generating billions in revenues for its Cloud customers and is now used by more than 2 million developers. This is great news for investors because the biggest question for Alphabet and other hyperscalers has been whether these big investments in AI are yielding positive returns. In the case of Alphabet, that appears to be the case.
Ruth Porat, who is stepping down as Alphabet‘s chief financial officer to take a new role as president and chief investment officer, added that growth was driven by the Google Cloud Platform, which grew faster than the broader Cloud segment, and Google Workspace results, which reported an increase in the average revenue per seat.
Former Eli Lilly CFO Anat Ashkenazi will become the company’s new CFO effective July 31.
Capital returns
Alphabet returned nearly $15.7 billion to shareholders through buybacks, partially offset by $5.9 billion in stock-based compensation. It exited the quarter with a little over $100 billion in cash, cash equivalents and marketable securities on its balance sheet.
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