In a period where tech and cloud companies have taken an absolute beating, Alphabet (GOOGL) has managed to beat our expectations, and as a result, Morningstar analysts are upgrading our fair value estimate.
The Google parent company issued its Q4 results on Tuesday, where it also revealed that the board has approved a 20-for-1 stock split. The decision, which follows the footsteps of both Apple (AAPL) and Tesla (TSLA), sent the share price soaring in after-market trading. Read our explainer to find out what the stock split, which will happen on July 15 this year, means for investors.
The quarterly report also revealed that total revenue for the quarter was up 32% from a year ago, driven by a 31% and 45% increase in Google services and Google cloud revenue, respectively. This equals $75.3 billion, driven by continuing growth in search advertising, YouTube monetization and cloud services.
As a result, Morningstar analysts have increased the fair value estimate from $3,470 to $3,600. The wide-moat stock is currently trading in 4-star territory, meaning it is undervalued and trading at a 21% discount.
Ali Mogharabi, Morningstar senior equity analyst, explains: “While we expect slower revenue growth this year, we project double-digit growth in YouTube and cloud to continue. We have modeled lower margins in 2022 given Alphabet’s continuing aggressive investment in its cloud offerings.
“We foresee a return of margin expansion in 2023 due to the steady increase in Google’s cloud recurring revenue,” he adds.
“On the services front, continuing increases in brand advertising and marketing spending by retailers, with further improvement in travel and hospitality ad spending pushed search revenue up 36%. Total advertising revenue (including YouTube, up more than 25%) grew nearly 33% from last year.
“Additionally, Google’s other revenue which includes hardware such as the Pixel, along with Google Play and YouTube’s subscription revenue, increased 22%. Cloud segment revenue increased 45% from last year and the backlog increased 70% to $51 billion.
“Fourth quarter total operating income of $21.9 billion represented a 29% operating margin, a 150 basis point improvement from last year, mainly due to Google services margin expansion which was driven by strong search and YouTube top line growth.”
Mogharabi continues: “In our view, Google has successfully become a full-funnel and omnichannel advertising platform as both search and YouTube are attracting more retail marketing and consumers, in addition to small and medium-size businesses looking to generate foot-traffic, while demand from brands remains strong. As more advertisers and different campaign types continue to jump on board, we think Google’s network effect remains intact.”
YouTube and Cloud
“On the YouTube front, while billions of viewers remain loyal to the platform, we think the increase in creators and their monetization opportunities will further strengthen YouTube’s network effect. In addition, we think YouTube’s advertising revenue will also benefit from the fast-growing connected television advertising market, which we estimate will grow around 31% annually to nearly a $15 billion market by 2025 in the US.
“The firm stated that connected TV was the fastest growing part of YouTube in the fourth quarter. We believe this will continue and expect advertising revenue from YouTube connected TV to represent nearly 30% of YouTube’s total advertising revenue by 2025, from what we estimate was below 15% in 2021.
“Regarding Google’s cloud segment, we think it can grow at nearly a 30% annual rate through 2026 driven not just by overall business digitization but also increasing adoption to Google’s offerings as indicated by the significant growth in the segment’s backlog.
“As more businesses of all sizes begin to use Google cloud, the likelihood of transitioning mission critical systems onto Google also increases, which could be an early indicator of the emergence of the switching cost moat source, in our view. For the year, Google cloud’s operating losses declined further, and we think the segment is well on its way to breakeven by 2024.”