Alphabet (GOOGL) Q2 Earnings Preview

by Dan July 28, 2016 12:05 pm • Trade Ideas
Event: Alphabet (GOOGL) reports Q2 results tonight after the close. The options market is implying about a 5% one day move, which is cheap to the 4 qtr average of about 7%, and shy of the 10 year average one day post earnings move of about 5.8%.  

Sentiment: Wall Street analysts are overwhelmingly positive with 45 Buy ratings, 5 Holds and NO Sells with an avg 12 month price target of $912, or 20% higher than current levels. Short interest is only 1% of the float.

Technicals / Price Action: GOOGL is down 2% on the year, and down about 6% from its 52 week and all time highs made in early February.  The stock is up about 13% in a straight line since late last month, following the post Brexit mini-panic, yet still below the level from its Q1 earnings gap in late April.  The April high, just below $800 could serve as meaningful near term technical resistance, while $700ish should serve as decent support:

[caption id="attachment_65357" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

Valuation, expected growth: GOOGL trades nearly 23x expected 2016 adjusted eps $33.37 growing at 13%, but on a GAAP basis it trades at 28.7x. Sales are expected to grow in 2016 to $71 billion, yoy growth of 17%.  We we have here is growth at a reasonable price.

Expectations: Let’s first go back and see what stalled the stock back in April when revenues disappointed, sending the shares down 5.4% the next day, from RBC analyst Mark Mahaney on April 21st in a note to clients:

(1) Robust & Consistent Revenue Growth – 23% Y/Y Organic Rev growth and 22% Y/Y Ad growth (ex-FX) were only 1pt lower than Q4’s 3 year highs; GOOG performed particularly well abroad with a somewhat muted U.S. top-line.

(2) Expanding Op Margin – Non-GAAP Op Margin of 41.5% was up 90bps Y/Y and above Street ests; Core Google Op Margins of 46.5% were up 140bps Y/Y and above our 45.1% est. We view Core profitability as the key positive. We believe Core Margins will continue to expand.

(3) Paid Clicks Slightly Decel – 29% Y/Y Paid Click growth across Google and 38% on Google Sites; 9% Y/Y CPC decline was an improvement, however.

(4) Higher TAC – 8.5% of Google Sites and 69.6% of Network were new highs, largely due to an increasing mix of Mobile and Programmatic. That was the key negative.

While the street lowered sales estimates for 2016 by about $1 billion vs the prior expectation of $71 billion, there were no rating changes and most discounted the near term headwinds. In a note to clients on Monday previewing the Q2 Mahaney highlighted the follow issues to focus on:

1) Revenue and Operating Margin Trends for CoreGoogle – We are looking for Core Google gross revenue of $20.4B (20%Y/Y growth, ex-FX) and net revenue of $16.6B (16% Y/Y reported), driven by increasing strength in Mobile Search, Programmatic, and YouTube. We are also looking for $7.9B in Core Google non-GAAP operating profit (a 48% margin on net revenue, up 130bps Y/Y), as we believe the company’s improved cost focus could drive margin expansion in the near to medium term.

2) Revenue and Operating Loss Trends for Other Bets – We are looking for $174MM in Other Bets revenue and a non-GAAP operating loss of $754MM, which would be an increase from the $574MM loss level of Q2:15, although we do not have much conviction in the direction of these
loss levels.

3) Paid Clicks, CPCs, And TAC – In Q1:16, we saw Paid Click growth of 29% Y/Y, decelerating 2pts from Q4. On a 5pt tougher comp, we believe this decelerates further in Q2 to 22% Y/Y. We are modeling cost-per-click (“CPC”) declines of (4%) Y/Y in Q2, a 5pt improvement from Q1 on a 4pt easier comp. In terms of TAC, we anticipate that TAC will increase 10bps Q/Q for both Network Sites and Google Sites, going to 69.7% and 8.6%, respectively.

4) Share Buybacks – In Q1, Google bought back 3.2MM Class C (GOOG) shares for a total purchase of $2.3B, leaving $1.4B remaining

My view into the print: If TAC increases for the second straight quarter and operating margins decline due to increase spending than the likelihood of a new high in the stock is hard to ponder prior to their Q3 results due in Oct.  On the flip-side, a beat end raise and the stock is up in line with the implied move up near $800.

As we did with Apple & Facebook earlier in the week, we will follow up with some options trade ideas for those with existing positions, or a directional inclination into the print.