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GOOG

I'd expect the market to have a mixed reaction to the GOOG 1Q22 earnings report, as it showed two trajectories: better than expected Search results and weaker than expected YouTube revenues.

Actuals vs. Estimates: GOOG reported Q1 gross revenues of $68.01bn (vs.Consensus $68.06bn), or +23% YoY. Q1 GAAP Operating Income was $20.09bn (Consensus $19.74bn) for a 29.5% GAAP Operating Income margin.

Based on multiple channel checks intra-quarter, the direct response advertising environment (especially search) had remained robust as the tailwinds of post-pandemic recovery and new categories penetration increased, such as autos.

Concerning YouTube, I need more time to understand engagement trends, the mix of short-form vs. long-form video, and the overall brand advertising environment to better establish the drivers of the reported results.

About the Cloud biz, GOOG reported revenue growth ~ in line with the market (+44% YoY growth) and sustained high op. losses vs. 21' – questions on the mix of sustained growth, backlog, and path to eventual operating profits are likely to dominate the debates about Cloud.

For equity returns, I see GOOGL’s $13.3bn of Q1 share repurchases and an increased $70bn repurchase authorization as another step to sustain a multi-year trend of improved shareholder returns.

Overall, the $GOOG long-term trend seems intact, though I'd expect more negative prices on share prices due to video dynamics and Covid-related headwinds on search.

Nevertheless, we’d highlight its valuation, which looks depressed. After considering the 1Q22 earnings, our model still suggests an FCF Yield of 5% for 2022, a substantial premium to long-term Treasury Yields.

Source: Giro Lino, Koyfin.

If GOOG’s market multiple is fair, the stock appreciation should be represented by its earnings growth, buyback, and dividends.

Considering only the earnings growth, the market expects a 20% EPS CAGR for the following five years, meaning that GOOG’s stock prices should yield this return. This is a considerable internal rate of return.

Source: Source: Giro Lino, Koyfin.

However, for a realistic scenario, we should be considering the average earnings surprise versus the consensus estimate and discounting it.

Looking at the all-time data, our sample captures 33 earnings releases, in which 33% of them presented an average of 4.3% negative earnings surprises.

Source: Source: Giro Lino, Koyfin.

Assuming a 50% negative earnings surprise and in-line for the other half, our bear case for GOOG would be a 17.5% internal rate of return, assuming no multiple re-rate, no buybacks, and no dividends.

We recently posted on Twitter, but we’ll stick to our simplicity thesis for buying exceptional businesses at a reasonable valuation. This is what GOOG looks like.

MSFT

Unlike $GOOG, $MSFT showed a strong performance in its earnings, pretty much in every biz. $MSFT is indicated flat AH after reporting 1Q22 results that were relatively in line, with a slight beat in revenue of ~70 bps.

We acknowledge that the magnitude of the company's non-GAAP EPS of $2.22 (vs. Street expectations of $2.19) was weaker than in historical prints.

Looking deeper, we were encouraged by MSFT's performance across the following key metrics that are critical in identifying the overall health of the company:

  1. Commercial cloud bookings grew +35% YoY, vs. 37% in 2Q22, despite a 26pp more challenging comp.
  2. Re-acceleration in Azure's growth rate to 49% (vs. 46% in 2Q22), with an ARR of ~$45bn. This compares to Google Cloud's reported growth of ~44% YoY on a base of ~$23bn.
  3. Sustained mid-single-digit growth in Server products. As one of Microsoft's most economically-sensitive business offerings, ongoing spending is a strong indicator of the wider IT environment.

We also note the strength in the commercial PC market and the close of its Nuance acquisition on Mar 4 as drivers of revenue growth.

Overall, $MSFT reported strong figures, especially under more challenging comps. Moreover, we see the third company's third consecutive quarter of +20% y/y growth rate as considerably solid given Microsoft's +$200bn ARR business.

A decade from now, Satya Nadella will be recognized as one of the best CEOs ever. Even though MSFT has a look of criticism for its “buy and kill” strategy, it delivered a tremendous value to shareholders.

More importantly, Satya created an unparalleled earnings recurring machine. One of the most underestimated characteristics in most businesses is cash flow durability.

Source: Giro Lino, Koyfin.

Disclosure

All posts on Giro’s Newsletter are for informational purposes only. This post is NOT a recommendation to buy or sell securities discussed. So please, do your work before investing your money. Giro’s Newsletter makes no representation, warranty, or undertaking, express or implied, as to the accuracy, reliability, completeness, or reasonableness of the information contained in the piece. Any assumptions, opinions, and estimates expressed in the article constitute the author’s judgments as of the date hereof and are subject to change without notice. Any projections contained in the information are based on several assumptions about market conditions, and there can be no guarantee that any projected outcomes will be achieved. Giro’s Newsletter does not accept any liability for any direct, consequential, or other loss arising from reliance on the contents of this presentation. Giro’s Newsletter is not acting as your financial, legal, accounting, tax, or other adviser or in any fiduciary capacity.

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