Since June 8, when a renewed surge of coronavirus infections prompted investors to move into growth tech stocks and out of cyclical value shares, Google is up almost 5%. It was up more than that, before a slight pullback in the past few weeks. Google is closer to a growth stock now than it was in 2019, as its cloud business has begun to flourish and its longer-term monetization opportunities on some of its platforms support strong revenue growth.
Expectations for the second quarter feature a revenue and earnings decline. Advertising spending is questionable as brands pull back on marketing in the face of lowered revenues of their own. Google’s operating margin is also expected to contract significantly. But the stock has largely powered through that headwind as investors look to a rebound in 2021 and Google’s cloud business -- up against thick competition from Amazon (AMZN) - Get Report and Microsoft (MSFT) - Get Report -- has begun to emerge of late.
Here are the expectations, according to FactSet consensus estimates:
- Revenue: $37.3B (-4% year-over-year)
- Search and YouTube Ads: $24.9B (-8%)
- Operating Margin: 16% (23% last year)
- GAAP Earnings Per Share: $7.95 (-44%)
Analysts estimate Google cloud revenue is somewhere around $10 billion per quarter, give-or-take, and growing at somewhere around 40% to 50%.
There are two key fundamental risks.
Whatever the actual ad revenue results are, the ongoing recovery in ad spending is a question mark. "Read through from Twitter and Snap is ambiguous to slightly cautious with neither company providing strong evidence of a V-Shaped recovery in Online advertising but both provided evidence that Direct Response advertising was performing better than Brand,” wrote RBC Capital Markets analyst Mark Mahaney in a recent note. Google has both branded and direct-response ads.
Snap (SNAP) - Get Report said on its earnings report, which was strong, that it cannot give guidance because of ad revenue uncertainty, although some analysts note its strength in direct-response may see it through for the year. Direct-response ads are automated and designed to translate into immediate sales or new customers for the marketer. Many analysts are looking for roughly 10% year-over-year growth in industry ad revenue in the second half of the year, which would not represent a full recovery to pre-virus levels. But Mahaney says recent survey works suggests the second half could show about 13% growth in the second half, which would represent an almost full recovery. Investors will be listening to any guidance, or at least language that hints at a robust recovery in the second half.
On Google Cloud, "Read through from Microsoft suggests cloud revenue is likely to decelerate,” Mahaney said. Analyst noted after Microsoft’s earnings that the company missed Azure estimates from the buy-side, with growth coming in at about 50%, down from above 60%. Mahaney, for now, thinks Google can post cloud revenue growth of about 49%, down from 52% last quarter.
As is often the case when substantial risks to the economy and financial market loom, investors give much more weighting to guidance and forward-looking indicators than they do to the reported quarter. The cloud result may provide a clue for future cloud growth and language around ad spend may provide the same for the ad business.
Put this against a stock trading at a rich valuation, and there is some discernible level of risk. The stock is trading at 34 times EPS for the net 12 month, against a 5-year historical high of 32 times, although it is important to note the new growth divers Google is starting to tap into. Like many other stocks, Google is trading at a normal multiple on 2021 EPS, at 27 times. So while the valuation isn’t sky-high, it’s not cheap.
Earnings on deck.