1Q20 results: Alphabet posted solid 1Q20 results, all things considered. Advertising results sounded strong in January and February but saw an abrupt drop off in March.
- Search increased 9% for 1Q but ended March down at a mid-teens rate. While search activity increased, the searches were focused on less commercial topics. And advertisers reduced spending.
- YouTube ad revenues grew 33% but declines accelerated to a high-single digit rate by the end of March. Brand advertising accelerated in the first two months of the quarter but saw headwinds beginning in mid-March, while direct response advertising was strong across the quarter.
- Google Network ads grew 4% in the quarter. Growth was solid during the first two months but ended March with a low-double digit decline.
Non-ad related revenue remained strong throughout driven by Google Cloud.
Overall, the ad declines were not as bad as we expected. Google, especially Search, is highly exposed to small and medium sized business (SMB) spending, which has been hit particularly hard. And, the company has high exposure to restaurants, retail and travel, all of which saw outsized impacts from the COVID pandemic.
Changes to estimates: In our model, we assume advertising growth rates remain at the March levels in 2Q (-15% ad revenue) before an improving decline in 3Q (-10% ad revenue) and modest growth in 4Q (+5% ad revenue). Looking out to 2021, we expect a strong bounce back, with 26% growth in advertising revenue. This implies a two-year CAGR of 11%, which is below the high teens rate we had expected pre-COVID.
We expect Search to lead the way, as it is easy to turn on and off. YouTube direct response ads should remain strong given their position at the bottom of the funnel. We expect brand advertising to resume more in-line with the overall economy.
Near-term catalysts: Digital media has seen its share of ad spending equal its share of ad spending in recent years. This suggests that strong digital ad growth will moderate and will track more in-line with its share of time spent. However, coming out of the COVID-19 pandemic, we believe that Google has opportunities to see continued strong top-line growth.
- On the consumer side, the COVID-19 pandemic is driving greater adoption and usage of Google products including Search, Android phones, apps, Google Play and YouTube. We expect that Google will maintain this increased usage coming out of the pandemic.
- On the business side, COVID 19 going will likely accelerate the pace of digital transformation as businesses plan for a comparable shutdown, working from home becomes more widespread, etc. This should benefit demand for Google’s Enterprise products, especially its Cloud offering.
- While Search is maturing, we see opportunities for Google to squeeze additional revenue out of the ecosystem like it is doing with Travel and Job postings.
- YouTube should benefit from the continued shift to digital video, both by consumers and advertisers.
Furthermore, we believe the increased consumer reliance on Google’s products during the COVID-19 crisis could result in COVID could moderate regulatory risk
Google a Core Holding: We think Google remain a core holding. We think it is a great way to play some of the big trends impacting the broader economy including digital transformation, augmented reality/virtual reality (AR/VR), cloud computing, ambient computing and shifts to online video, among others.
Google’s dominant position is going to be hard to overcome. While there are always unexpected developments to be on the lookout for, we expect it should continue until there is some sort of paradigm shift that it is slow to adapt to. This would be something like when Microsoft was slow to adapt to the internet. So far, we believe Google has been pretty good at anticipating these shifts, with the YouTube acquisition, building out a programmatic platform, the Android acquisition, etc. The company now appears to be well positioned in shift to ambient computing, especially with the acquisition of FitBit, and AI/ML.
$1,475 target price: We assign the stock a $1,675 target price, 25% upside. We determine this by averaging our P/E, EV/EBITDA and P/S-derived valuations.
- We assign a 27.5x multiple to our $61.22 2021 EPS estimate. Our target multiple is a 7% premium to the three year 25.5x average. We’re 11% ahead of consensus on EPS. This implies a $1,684 target price.
- We assign a 14x multiple to our $73.7bn 2021 EBITDA estimate. Our target multiple is a 13% premium to the three-year 12.2x average and our EBITDA estimate is 4% ahead of consensus. This implies a $1,706 target price.
- We assign a 5.4x multiple to our $208bn 2021 sales estimate. Our target multiple is roughly in-line with the three-year average and our sales estimate is 2% ahead of consensus. This implies a $1,630 target price.
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