Google: Surpassing Expectations Against the Trend? Mixed Emotions in Joy

Hello everyone, I'm Changqiao Dolphin!

This morning, on April 26th Beijing time (April 25th after the US stock market closed), Google released its first quarter performance report for 2023.

After the market's expectations were constantly lowered due to short-term macro pressure, Google finally achieved a slightly better-than-expected report card:

The search revenue was resilient, the cloud revenue was stable, and the advertising business profit increased in the book value after depreciation adjustment, and the cloud business turned losses into gains.

However, Dolphin believes that due to the market's conservative expectations, the first-quarter performance can only be said to be average, and there are also hidden risks and pressures on the income side in the short term. After excluding the disturbance of exchange rates, the growth rate is not a rebound but a decline.

This trend reflects that the macro environment is still unclear, but the good news is that the base has already decreased starting from the second quarter, which can to some extent alleviate the growth pressure.

The new $70 billion repurchase plan announced in addition to performance may be the core reason for Google's (GOOGL) after-hours rise.

As for whether it can continue to resist the macro headwinds in the next quarter and for the whole year, and how much impact the strategic adjustment of Google's AI layout due to the unexpected market changes and increased investment will have on the subsequent profit repair pace, these questions need to be answered through the conference call given the current complex macro trend.

Later, Dolphin will release the conference call on the Changqiao app and user group for the first time. Interested users can go to the small assistant public account "dolphinR123" to get it.

The key points of this financial report include:

1. Announce a repurchase plan of $70 billion: Before discussing the performance, let's first talk about the main benefit of this financial report-the addition of a $70 billion repurchase plan. The previous repurchase plan was launched in April last year, and it was also a $70 billion quota, with a monthly repurchase of about $5 billion. According to this repurchase rhythm, it is expected to be repurchased in about a year.

2. Advertising slightly exceeds the market's conservative expectations: The advertising business, which contributes 80% of revenue, is holding Google's overall operating performance. Due to the inflation rate that has fallen from exceeding expectations over the past two months, the market has become more conservative about its expectations of economic growth pressure, and therefore also more cautious about the advertising market.

Google's actual performance still shows its ability to resist risks, with first-quarter advertising revenue of 54.5 billion US dollars, which is flat compared to the same period last year, while the market is expected to decline by 1-2%. But the resilience of the search far exceeds YouTube's competitive impact.

From the survey of advertisers, the budgets of businesses are still relatively tight. Google's financial report also shows signs of economic weakness, especially in the United States, which accounts for nearly half of its revenue. The overall revenue F/X growth rate in the US region in the previous quarter was still 11%, but it dropped to 4% this quarter.

3. Cloud business grows steadily and achieves turnaround for the first time: The growth rate of cloud business in the first quarter was 28%, and the growth rate naturally slowed down due to the high base and macroeconomic pressures, which was basically in line with market expectations. It is worth mentioning that the operating profit margin of cloud business began to turn positive in the first quarter, which also significantly exceeded market expectations.

3. There is still room for profit improvement: In the first quarter, the profit side was slightly better than the revenue side expected by the market, realizing an operating profit of 17.4 billion and the profit margin also recovered from 27% in the previous quarter to 31.6%. The core reason for the improvement in profitability is that the depreciation period of servers was changed from 4 years to 6 years starting from the first quarter, which saved a "book" cost of 988 million yuan in a single quarter and helped the gross profit margin increase by 1.5 percentage points.

The profit margin of the original business in the second quarter can theoretically continue to improve, but attention also needs to be paid to some related cost increases brought about by the landing of AI business. Although layoffs were carried out in the first quarter, the current expenses include nearly 2 billion yuan in severance pay and 600 million yuan in office building disposal costs, which reduced the current profit margin by 3.7 percentage points. After these one-time costs are reduced in the second quarter, theoretically, they will bring about continued improvement in profitability.

The number of employees disclosed in the first quarter included employees who were dismissed in the quarter, so there was no significant decline in the number of employees for the time being. However, from the net increase of 477 people compared to the previous quarter (compared with a net increase of 3,455 people in the fourth quarter of 2022), it can be seen that the pace of recruitment has further slowed down.

4. More outlooks and guidance for next year need to be paid attention to during the conference call: Under the condition of exchange rate neutrality, Google's growth rate has slowed down, especially in the large-sized US region. As Google is the first advertising giant to release financial reports, whether this is the impact of macroeconomic weakness or new changes in the competitive landscape still needs to be heard from management.

5. Comparison of Key Indicators with Expectations

Longqiao Dolphin's view

With the strengthening of the expectation of economic weakness or even recession in the data disclosed recently, the pressure on the performance of advertising companies that are deeply bound to the macroeconomy has become more obvious. This is also the reason why Google can fall to only 10,000 market capitalization under the impact of macro and ChatGPT competition.

In terms of this financial report, it can only be said to be "better than expected" on the basis of the conservative market expectations. The reason for the improvement in revenue growth rate is the weakening of the impact of the high exchange rate of the US dollar.

However, if the exchange rate fluctuations are not considered, the overall real revenue growth rate compared to the previous quarter has slowed significantly (6% YoY in 1Q23 vs 12% YoY in 4Q22).We believe that the reason behind this is more closely related to the macroeconomy. According to the survey information of advertising agents, although the absolute value of economic indicators in the first quarter is still strong, advertisers' expectations have reflected greater caution. But the good news is that starting from the second quarter, Google's base has already been lowered to a certain extent, which can alleviate the pressure on growth.

As for whether the migration of part of the advertising budget by some markets to ChatGPT after it went public on New Bing may affect it, Dolphin tends to maintain the view that "After TikTok, will ChatGPT usher in a new 'revolution' in the US stock market advertising?" According to the views in the "Long Bridge Weekly" article, although New Bing's user search volume is increasing, advertisers' budgets will not shift quickly until new users reach a certain scale. However, this does not mean that Google does not need to take any action or that its response is still slow. Therefore, if there are any signs of Google's procrastination, it will still be reflected in the short-term stock price.

As for the improvement of profit margin through cost reduction such as depreciation adjustment and layoffs, layoffs are still the most effective measure in the short term. Depreciation period adjustment can indeed bring cost optimization, but from the perspective of cash flow, it has not brought any benefits, unless the company really reduces its new investment in servers because of this.

In the first quarter, due to the extra expenses of severance pay, the improvement of profits from layoffs has not yet been reflected, and it will be reflected to a certain extent in the second quarter.

In terms of valuation, Google's EV/EBITDA of 9.6x is close to the level of 10.2x before the big liquidity injection in 2020. Therefore, the short-term valuation is in a reasonable range, but there is no obvious safety net.

As the downward trend in the macro economy still exists, it is necessary to closely monitor the possibility of unexpected weakening/recession. The Long Bridge Dolphin will focus on analyzing the actual changes in the macro economy and market expectations in its weekly strategy report on Mondays. Interested users can follow it.

On the other hand, in addition to the unexpected soft landing of the macro economy, more measures to reduce costs and increase efficiency announced by Google can also boost stock prices.

Dolphin will share the minutes of the phone meeting with Dolphin's user group through the Longbridge App. Interested users are welcome to add WeChat account "dolphinR123" to join the Long Bridge Dolphin investment research group and obtain the minutes of the phone meeting in a timely manner.

The following is a detailed interpretation of the financial report.

I. Basic Introduction of Google

Alphabet, the parent company of Google, has a variety of businesses, and the structure of its financial report has also changed several times. If you are not familiar with Alphabet, you can first take a look at its business structure.

To briefly explain the long-term logic of Google's fundamentals (there is a difference with the current short-term logic):

Advertising business, as the main source of revenue, contributes most of the company's profits. Search ads are facing a crisis of being eroded by information flow ads in the medium and long term, and high-growth streaming media YouTube is used to make up for the decline.
Cloud business is the company's second growth curve. It has turned losses into profits and has shown a strong momentum of signing contracts in the past year. As advertising will continue to be dragged down by weak consumption, the development of the cloud business is becoming more and more important in supporting the company's performance and valuation imagination space. Section 2: Resilience in Search, Stability in Cloud

1. Revenue exceeds conservative market expectations, but macro pressures still need attention

Google's overall revenue for the first quarter was 69.8 billion yuan, a year-on-year increase of 2.6%, slightly higher than the market's expected 69 billion yuan. The reason for the gap between actual and expected revenue was mainly due to advertising. Considering macroeconomic weakness and advertisers' continued cautious expectations since the second half of last year, the market is still cautious about predicting growth in the advertising business.

Cloud revenue grew by 28% year-on-year, and the growth rate slowed down month-on-month, which is consistent with expectations (the market has recently lowered its expectations).

Looking at regional revenue performance, the United States performed worse than other regions, with revenue share dropping from 49% to 47%. Under currency neutrality, the year-on-year growth rate in the United States was 11% in the previous quarter, but only 4% this quarter.

2. Advertisers' wallets are still tight

Google's advertising revenue in the first quarter was 54.5 billion yuan, flat year-on-year. Although the growth rate improved compared to the previous quarter, the base period of last year's first quarter had already lowered, and currency pressures were far less than in the previous quarter. Excluding these factors, a trend of weakening compared to the previous quarter is evident.

This is in line with the survey of advertising agents, except for possible competition for YouTube. In fact, the macro factors play a greater role.

Considering this, market expectations have been kept conservative and low, so Google's actual performance is "better than expected", but it is still worth paying attention to and maintaining caution.

3. Cloud services slow down as expected

In the review of last quarter's financial report, "Dolphin" Jun reminded us that the acceleration of the cloud business growth in the fourth quarter was closely related to its contract expiration and not necessarily because demand in the industry had increased. At that time, the market was quite optimistic about the growth of Google's cloud business, but in reality there is still a high possibility that the industry will cut capex. Therefore, the original market expectation of a 30%+ growth rate needs to be adjusted.

Since then, as the market has lowered its growth expectations to 28%, it basically agrees with Google's financial report this time. Although the growth rate has indeed slowed down compared to the previous quarter, it has already been priced into the stock price. In fact, Google Cloud's growth rate is still better than "Dolphin" Jun's expectations. Follow-up can be paid attention to the index data of contractual performance in the complete financial report.

In addition, the most "surprising" part of the cloud business in the first quarter was undoubtedly the first-time achievement of turning losses into profits. Although there was an on-paper optimization of server depreciation adjustment, the estimation of the difference from the expectation also played a role in improving the profitability of the business itself.

III. There is still room for profit improvement

In the first quarter, the cost began to reflect the spending optimization brought by the extension of the server depreciation period. For expenses, the compensation for dismissals of 2 billion and the expenses of disposing of office space of 600 million were taken into account. The real efficiency improvement can only be reflected in the next quarter.

Therefore, the 2 percentage points increase in operating profit rate is mainly from gross profit rate, of which 1.5 percentage points come from the extension of the depreciation period, and 1 percentage point from the cost optimization of the original business.

However, considering that Google's Bard is expected to be added to the original search engine as soon as possible, the related R & D costs and operating costs need to be confirmed. Will it affect the pace of short-term profit margin repair? Previously, the Dolphin discussed in "US stock advertisement: After TikTok, will ChatGPT start a new 'revolution'?" about the possible impact of AI Q & A on Google's profit margin. With the increase in the number of questions and answers, the short-term erosion of profit margin cannot be ignored, unless such services are charged separately.

Changqiao Dolphin Investment Research "Google" Historical Collection:

Financial Report Season

February 3, 2022 Financial Report Review "Compared with simply cutting fingers, pay more attention to revenue growth (Google 4Q22 conference call minutes)" 2022 Financial report review on February 3, "Short-term pressure is not small, Google needs to learn Meta."

October 26, 2022, Telephone Conference, "Short-term optimization resources, opportunities still depend on search and YouTube (Google 3Q22 telephone conference summary)"

October 26, 2022, Financial report review, "Google: Decline is approaching, and the first in advertising has fallen."

July 27, 2022, Telephone Conference, "Google: Economic uncertainty in the second half of the year, centralized investment in better long-term prospects (telephone conference summary)."

July 27, 2022, Financial report review, "Google: Defeat expected, hard submission under tough situation."

April 27, 2022, Telephone Conference, "Management avoids talking about TikTok, but the competition still intensifies behind the importance of Shorts (Google Telephone Conference Summary)."

April 27, 2022, Financial report review, "Google: With the headwind, the eldest brother is also struggling."

February 2, 2022, Telephone Conference, "Google actively seeks expansion by increasing investment and accelerating recruitment (telephone conference summary)."

February 2, 2022, Financial report review, "Performance brilliance, rare stock split, Google is going to take off again."

Deepen

February 21, 2023, "After TikTok, will ChatGPT start a new 'revolution' in American stock advertising?"

July 1, 2022, "TikTok will teach 'elder brothers' to do things, and Google and Meta will change." 2022-02-17: "Internet Advertising Overview-Google: Watching the Wind Rise" (https://longbridgeapp.com/topics/1925017)

2021-02-22: "Dolphin Investment Research: Analyzing Google-Has the Recovery of the Advertising Leader Ended?" (https://longbridgeapp.com/news/29665685)

2021-11-23: "Google: Performance and Stock Price Soar, Strong Recovery is the Theme of the Year" (https://longbridgeapp.com/topics/1360634?invite-code=032064)

Risk Disclosure and Statement for this Article: [Dolphin Investment Research Disclaimer and General Disclosures] (https://support.longbridge.global/topics/misc/dolphin-disclaimer)