Alphabet (GOOGL) reported better-than-anticipated first-quarter results after the closing bell Tuesday, getting a bump higher in after-hours trading. We’re not surprised that the stock reaction is muted. Total revenue of $69.79 billion represented a year-over-year increase of about 3%, or 6% in constant currency, and outpaced analysts’ estimates of $68.01 billion, according to Refinitiv. (Constant currencies help strip out fluctuations in foreign currency to provide a clearer financial picture.) Adjusted earnings-per-share (EPS) fell nearly 5% from a year ago, to $1.17 but managed to exceed the Wall Street consensus estimate of $1.07. Bottom line Alphabet needed a strong report and that’s exactly what we got as the headline beats were accompanied by a better-than-expected operating margin, strong cash flows and lower-than-expected traffic acquisition costs. A newly announced $70 billion share repurchase authorization didn’t hurt either. On the other hand, management said they expect full-year capital expenditures to be “modestly higher” versus 2022, which did serve to cap the stock move. The Street was looking for roughly flat capex versus a year ago. That said, the expenditures are geared to technical infrastructure investments and will be partially offset by a decline in office facilities costs. Given the introduction of generative AI tools such as ChatGPT from Microsoft-backed OpenAI and Alphabet’s own Bard, Wall Street may give management some leeway here as long as the spending growth remains below the rate of sales growth, and management delivers on their promise to rationalize costs elsewhere. We are not ready to take a victory lap just as yet as we believe further cost rationalization must take place before investor sentiment can truly improve. For this reason, we were happy to hear management reiterate their commitment to operating in a more cost-effective manner. They said on the call that there are “significant multiyear efforts underway to create savings.” These efforts include leveraging artificial intelligence to increase automation and enhanced productivity, better-managing costs with suppliers and vendors, and continuing to optimize where and how employees work. However, as we heard last quarter, the real benefits of these initiatives should be felt more in 2024 and beyond. While we’re not off to the races following this release, the numbers were strong enough to put a bottom in the stock and for sentiment to improve. We think investors may be willing to look past the near-term headwinds of an economic slowdown to the leaner more efficient company Alphabet intends to become as we work our way through the rest of the year. Don’t expect the stock to zoom higher right away; near-term upside is capped. As solid as this quarter was, a number of questions marks remain, including the costs and the economic backdrop. Additionally, the risk to Search market share posed by Microsoft’s revamped ChatGPT enhanced Bing search engine remains, and the Justice Department’s antitrust lawsuit are also points of uncertainty. As a result, we are maintaining our 2 rating and trimming our price target on GOOGL to $125 per share, from $130, on the view that there’s no need to rush into shares despite the solid results. These headwinds mentioned above still need to play out one way or another. We will, of course, look for updates on all these fronts as we do believe that longer-term Alphabet has many opportunities for growth as uncertainty surrounding these issues abates. Before digging deeper, we must note that due to an update in how management allocates business costs, to a more simplified methodology, we do not have accurate estimates for segment operating income results as reflected near the bottom of the earning table above. At a high level, this change appears to have moved some costs into the Services segment and out of Cloud and Other Bets. Operating income As a result, Google Cloud booked its first-ever operating profit, $191 million in Q1, something analysts weren’t expecting to see until maybe sometime in 2024, at the earliest. However, given the change in cost allocations, this profit should be taken with a grain of salt at least in terms of how much weight investors are going to be willing to put on it. Segment sales Digging into quarterly sales, Search saw a better-than-expected Q1 of $40.36 billion, which rose about 2% from a year ago. Advertising strength was driven by growth in the travel and retail verticals, partially offset by declines in finance, media and entertainment. Despite coming up slightly short of expectations, Google Cloud Platform (GCP) sales of $7.45 billion, continues to demonstrate solid momentum, increasing 28% in Q1 from year-ago levels. On the call, management said GCP’s annual deal volume has increased nearly 500% over the past three years, with deals worth over $250 million increasing over 300% in that time. As we have heard from other cloud providers, GCP customer consumption growth did slow as a result of customers seeking to better optimize costs against the uncertain macro backdrop. YouTube, though down to $6.7 billion, reported a smaller year-over-year decrease of 2.6%, than we saw in the prior quarter. That’s supportive of the view that Q1 was the low point, especially with management calling out “signs of stabilization.” YouTube’s quarterly sales were also better than expected. We are also seeing strong subscription revenue growth. YouTube Shorts, Alphabet’s answer to TikTok is “seeing strong watch time growth” and just as important, management noted that the monetization of Shorts is “progressing nicely.” YouTube is also seeing strong momentum on connected TVs, and management highlighted shopping on YouTube as an initiative in its “super early days,” in which they see a lot of future potential noting that over 100,000 creators, artists, and brands have already linked their stores to their YouTube channels as a means of increasing sales. Capital returns Alphabet returned $14.56 billion to investors via share repurchases in the first quarter, partially offset by $5.28 billion of stock-based compensation. It exited the quarter with $115 billion in cash, cash equivalents, and marketable securities on the balance sheet. (Jim Cramer’s Charitable Trust is long GOOGL, MSFT. See here for a full list of the stocks.) 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Alphabet (GOOGL) reported better-than-anticipated first-quarter results after the closing bell Tuesday, getting a bump higher in after-hours trading. We’re not surprised that the stock reaction is muted.
