Google's Latest Quarter

Here’s a full breakdown of Alphabet’s earnings and why these numbers sent Mr. Market into a full-scale panic attack

July 25, 2024

Silver banana goes to…

In this issue of the peel:

  • U.S. manufacturing earned a gold medal in July, just days before the Olympic gains begin across the pond.

  • Our latest addition to the WSO Alpha portfolio led the market yesterday. Big Tech stocks got absolutely massacred, driven by non-perfect earnings reports weighing on brittle valuations

  • Here’s a full breakdown of Alphabet’s earnings and why these numbers sent Mr. Market into a full-scale panic attack

Market Snapshot

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Macro Monkey Says

American Showoff

Remember that kid in school who invariably got straight As but worried aloud that they did terribly when test results came out?

Yeah, we all hated that kid.

But that’s essentially how Europe views the U.S. anytime we worry about economic slowdowns or contractions.

This discrepancy came into crystal-clear view with the release of the latest S&P Global Manufacturing reports. Let’s get into it.

What Happened?

Despite some imperfections, the U.S. has put on a masterclass of economic recovery in the post-pandemic period.

Carried by services, the U.S.’s latest Purchasing Manager’s Index (PMI) from S&P Global came in strong at 55.0, an increase from June’s 54.8.

As a reminder, any reading above 50 indicates expansion, while below 50 indicates contraction. So, July’s reading suggests an even more rapid expansion than the prior month.

With that said, manufacturing alone fell into contraction territory, declining to 49.5 in July from 51.6 in June.

New orders, inventories, and production all declined, contributing to July’s precipitous fall. Employment still grew, but at a much slower rate, all contributing to a spike in concern on the outlook for U.S. manufacturing.

Despite July’s contraction in manufacturing, the composite reading of 55.0 clocked in as the highest since April 2022.

Services PMI led the way at 56.0, the highest since March 2022. Input prices, still largely driven by employment cost increases, contributed the most to July’s increase.

Compared with data from across the pond, however, countries like Germany would kill for the contraction registered by the U.S.

Germany is like the California or Texas of the Eurozone—the region’s manufacturing powerhouse. Last month, German output declined for the first time in four months, contributing most heavily to the region’s slowdown.

Like a water-fearing dog attempting to swim, the Eurozone’s total PMI clocked in at 50.1 this month from 50.9 in June, barely staying above water.

Data from France, the region’s second-largest manufacturer, didn’t help much either but did move in the right direction.

Declines in factory production contributed most to the declines. In fact, looking at the Eurozone’s output PMI alone, we find that this reading contracted for the 16th month in a row, doing so at the fastest pace since December 2023.

The Takeaway?

Although magnitudes vary, both sides of the Atlantic are largely experiencing similar trends.

The services sector remains relatively robust, primarily elevated by prices. While that’s not ideal, it does suggest that service demand remains elevated, reflecting positively on macro conditions.

Declines in manufacturing, meanwhile, certainly signal cause for concern. A rebalancing of spending away from durable goods and discretionary items like clothing is likely the primary driver, suggesting that consumers are nervous about a slowdown on the horizon.

With the Olympic games set to begin in Paris tomorrow, France and the Eurozone region will get a boost from increased spending around the games.

But the U.S. has already won gold in macro performance. And, according to all the drunkenly-placed bets I made on the games last night, there’s plenty more gold to come over the next few weeks.

What's Ripe

Enphase Energy (ENPH) 12.8%

  • Shoutout to this stock for giving the WSO Alpha analysts a reason to live amid yesterday’s market massacre. Enphase surged on charged-up earnings.

  • The maker of solar energy products returned to quarterly revenue growth in Q2, reporting a 15.4% increase to $303.5mn. Margins set multiyear highs as well.

  • The solar industry declined faster than Biden’s cognitive abilities in the aftermath of rate hikes. But it seems that demand is getting energized once again.

AT&T (T) 5.2%

  • A surprise from AT&T usually refers to a service outage or exorbitantly high bill for reasons including “f*ck you.” But yesterday’s surprise was a good one.

  • Not for customers, obviously, but certainly for shareholders, as the telecom giant’s 419k wireless additions beat estimates by a massive 47%. Meanwhile, Verizon was spotted crying in the corner.

  • The postpaid churn of 0.7% outperformed expectations, too, leading to 9% annual free cash flow growth and beats on the top and bottom lines.

What's Rotten

Big Tech (MAGS) 6.1%

  • Tesla and Alphabet join the ranks of Shoeless Joe and other Black Sox players that threw the 1919 World Series after the big tech firms sh*t the bed in Q2.

  • As we talked about yesterday, Tesla’s report wasn’t that bad. Alphabet’s wasn’t terrible either, but missing expectations on YouTube revenue hurts.

  • The problem highlighted yesterday is how brittle these valuations have become. Price for perfection is an understatement for Big Tech firms, so any slip-ups carry industry-wide downbad vibes.

  • Every stock in the Miserable 7 was down at least 2.8% yesterday.

Lamb Weston (LW) 28.2%

  • A serious bear market of enjoyable meals is ravaging the U.S. economy. The country’s largest french fry maker is on the ropes after earnings.

  • Lamb Weston, who supplies the slices of joy we call McDonald’s fries, reported an EPS of $0.78/sh on $1.61bn in sales vs estimates for $1.26 on $1.7bn.

  • Facing price and volume pressures from disinflationary trends and slowdowns in U.S. restaurant traffic, the company expects the rest of FY’24 to be “challenging.”

Thought Banana

Earnings Spotlight: Alphabet Inc (GOOGL, 5.04%)

In his poignantly luminous 1999 literary masterpiece “Still Don’t Give a F*ck,” artist Eminem famously stated, “I can’t rap anymore, I just murdered the Alphabet.”

Yesterday, the market joined him as an accomplice in that murder.

Together with Tesla, the firms have mired Big Tech’s Q2 earnings in losses early on this earnings szn. Let’s see how bad it was.

The Numbers

Google’s parent company delivered earnings of $1.89/sh on total revenue of $84.74bn against estimates for $1.84/sh on $84.19bn.

The tech giant beat on all key operating metrics… except for one.

Google Cloud revenue beat by 1.5%, and Traffic Acquisitions Costs did similarly, beating by 1.1%. However, YouTube ad revenue of $8.66bn vs estimates for $8.93bn was the primary contributor to Wednesday’s selloff.

Total revenue growth was solid, along with most key segments, particularly Google Cloud revenues. However, the miss in YouTube and declines in Google Network are causing concern among analysts that marketing budgets are getting slashed.

When entering slowdowns, marketing spend is one of the easiest to cut. So, if a recession is commonly viewed as on the horizon, CMOs will pull ad dollars.

It seems like this could be driving the weaker-than-expected performance and declines in some business units.

However, the surge in Other Bets growth driven by healthcare and internet services through Verily and Google Fiber is promising for long-term revenue diversification and, ideally, growth.

Speaking of Other Bets, Google’s effective in-house venture unit, the company plans to pour another $5bn into Waymo this year in hopes of catching up with Tesla’s FSD.

The Takeaway?

If Google’s ad business is falling victim to a potential economic slowdown, I can’t imagine what’s happening at smaller ad-driven businesses.

Snapchat, Pinterest, Trade Desk, and others all report in the coming weeks. We’ll find out then if this is a Google problem, an industry problem, or (probably) an economy-wide problem.

Stay tuned.

The Big Question: Is Google’s ad business suffering under a pending recession? When will any “Other Bets” investments meaningfully contribute to total revenue?

Banana Brain Teaser

Previous

If a two-digit positive integer has its digits reversed, the resulting integer differs from the original by 27. By how much do the two digits differ?

Answer: 3

Today

Xavier, Yvonne, and Zelda each try independently to solve a problem. If their individual probabilities for success are 1/4, 1/2, and 5/8, respectively, what is the probability that Xavier and Yvonne, but not Zelda, will solve the problem?

Send your guesses to [email protected]

❝

Having been trained as a computer scientist in the '90s, everybody knew that AI didn't work. People tried it. They tried neural nets, and none of it worked.

Sergey Brin

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Happy Investing,
David, Vyom, Jasper & Patrick