Alphabet Profits Remain Hidden Behind the Cloud, but Ad Spending Front and Center

Ad revenue remains front and center for Alphabet heading into earnings next week, but the as-yet unprofitable cloud business could be where the future lies.

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5 min read
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Key Takeaways

  • Pay attention to the surge in online ad spending as Alphabet aims to ride its re-emergence
  • Cloud remains an unprofitable yet “aggressive” investment with growth forecasted in the quarters to come
  • YouTube poised to capture viewers abandoning the cable TV market

Without much doubt, Alphabet (GOOGL) shares have come a long way. They’re up 4,371% since the first public offering in 2004, so it’s easy to think that GOOGL shows every sign of being a “mature” company.

But GOOGL’s also shown an ability to reinvent itself over the years, and that’s kept investors interested. Two of its biggest stories this quarter and last—namely, advertising and cloud technology—support this idea that the company still has traction, even in the online ad space where it remains under congressional scrutiny for allegedly holding a near monopoly.

We’ll get the results of our latest search into the company’s developments when GOOGL reports next Tuesday after the close.

Ad Revenue Bounces Back to Front and Center

Back in Q2 last year, GOOGL saw its advertising revenue sink as companies held back ad spending amid the Covid lockdown. In Q3 and Q4, as economies began opening up and vaccines started rolling out, the company benefited from the ensuing ad spending bounceback—a big deal when you consider it made up around 81% of GOOGL’s total revenue last quarter.

After the Google search platform, YouTube is the most-visited online site in the world with 34.6 billion global visits a month. It’s also the second most popular “search engine” next to Google. Its ad revenue grew 46% from 2019 to 2020, raking in $6.89 billion in Q4, topping analyst expectations.

As GOOGL claws for more market share in the streaming industry, that industry is rapidly snuffing out the television space. Analysts expect 46.6 million consumers to cut the cord with cable TV by 2024, paving the way for streaming services like YouTube to jump in. If it’s successful in grabbing this disintegrating market, that’s a lot of prime consumer data (not counting what GOOGL already has through its search segment). For advertisers to reach those customers, GOOGL becomes the gatekeeper, more or less.

Overall, the company’s total ad revenue of $46.2 billion last quarter is a fraction of the estimated $389 billion in digital ad spending for 2021, according to research firm FactSet. There’s arguably still plenty of “land” to grab.

Cloud Segment Still in Third Place

By the end of last year, global cloud infrastructure grew to nearly $40 billion. Of that market share, Amazon’s (AMZN) AWS had the most, around 32%, and Microsoft’s (MSFT) Azure had the second largest at 20%. Both had more than double Google Cloud’s 7% share.

Yet Google Cloud’s revenue grew by a stunning 47% year over year in 2020, slightly over $13 billion for the entire year and just around 7% of the company’s total revenue for the year. This may sound like a lot of growth, and arguably, it is, but doesn’t mean that it’s a profitable venture, because it isn’t...yet.

It’s still in the “investment” stage, or as GOOGL Chief Financial Officer Ruth Porat explained on GOOGL’s Q4 earnings call earlier this year. “...Cloud’s operating loss reflects that we have meaningfully built out our organization ahead of revenues. Operating loss and operating margin will benefit from increased scale over time.”

Although investors are paying close attention to Google Cloud’s momentum when it reports Q1 earnings, you might want to give this rapidly growing segment more than just a few quarters to develop.

Communication Sector Rising Amid Digital Shift and Ad Spend

Year to date, the S&P 500 Index (SPX) market performance is up more than 10%. The Communication Services sector—which GOOGL is part of—is floating slightly above it at 13%. And GOOGL is soaring above both, nearly 32% since January (see chart below).

FIGURE 1: REVVING THE (SEARCH) ENGINE. Shares of Alphabet (GOOGL—candlestick ) have handily outpaced the S&P 500 Index (SPX—blue line) and the Communication Services sector (($IXC—purple line) since the start of 2021. Data sources: S&P Dow Jones Indices, Nasdaq.  Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

CFRA analysts expect to see the media and entertainment side of Communications improve as ad spending revs up. Overall, CFRA said, the sector is expected to grow 12.9% in Q1 year over year, trailing the same-period S&P 500 growth forecast of 19.7%.

According to CFRA’s latest Sector Watch report, GOOG, Facebook (FB), and other social media companies may be best positioned to ride this surge. However, analysts noted, both GOOGL and FB still face the specter of “regulatory risk,” news of which may affect the companies in the quarters to come

Looking Back and Looking Forward

Last time out, GOOGL topped Q4 expectations with earnings of $22.30 per share versus $15.90 consensus, according to Refinitiv. Revenue grew 23% on an annualized basis that quarter, as the company raked in $56.9 billion versus $53.13 billion expected by analysts.

Cloud revenue came in at $3.83 billion, still better than the anticipated $3.81 billion. And YouTube ads generated $6.89 billion, topping analyst expectations and making a solid part of the company’s overall ad revenue of $46.20 billion, up 22% year over year.

Looking to Q1, Porat sees an “increase in consumer online activity and the return of advertiser spend as reflected in our Q4 results,” according to the last quarter’s earnings call. She also forecasts stronger performance in the following quarter, noting that Google Cloud remains in aggressive investment mode, and that similar to last year, its operating loss in Q1 is expected to remain higher, with improvements surfacing in the quarters to come.

Good Trading,
JJ
@TDAJJKinahan

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Key Takeaways

  • Pay attention to the surge in online ad spending as Alphabet aims to ride its re-emergence
  • Cloud remains an unprofitable yet “aggressive” investment with growth forecasted in the quarters to come
  • YouTube poised to capture viewers abandoning the cable TV market

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