There are three parts to the bull case for Alphabet Inc.’s stock, according to Bernstein analyst Mark Shmulik. But the Google parent company’s latest earnings report may have crushed two of them — at least for a while.
Those hoping that artificial intelligence would offer a jolt to Google’s cloud-computing business likely will have to keep waiting, after the company underwhelmed with 22% growth in this part of the business during the third quarter. Shmulik had heard a “whisper number” suggesting some expectations were for 28% growth.
Read: Google Cloud miss overshadows upbeat earnings for Alphabet, sending stock lower
Management’s commentary about “optimization efforts” — basically a signal that customers are more conscious about their spending — is spooking Wall Street, and Alphabet’s stock
GOOG,
GOOGL,
is off 8% in morning trading Wednesday despite healthy trends in the company’s digital-advertising business.
Shmulik noted that “optimization” issues at Amazon.com Inc.’s AWS cloud-computing business “have dragged on for 12+ months and weighed heavily on investors.” In his view, it’s “unclear just how widespread GCP optimization efforts are and how far along customers are in the journey,” but the challenges could continue for a few more quarters at least.
Plus, Shmulik is less encouraged about the prospects for meaningful operating-margin expansion next year.
“Ramping AI spend ([capital-expenditure] and headcount-related), as well an annual $2 billion Sunday Ticket expense means Google needs to structurally re-engineer their cost base just to try to stay in the same place with operating margins in the high 20s,” he wrote. That backdrop offers “little room” for earnings and free-cash-flow expansion, he added.
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The bull case that remains is an admittedly big one: Google’s advertising business is substantially larger than the cloud business, and it topped expectations in the latest quarter. Even Shmulik, who rates Alphabet’s stock at market perform and has “longer-term questions” about the future of search in an AI era, said that the ad business “appears well positioned to benefit from a slightly longer and promotional-heavy holiday season.”
Piper Sandler’s Thomas Champion said he was “slightly disappointed” by the latest commentary.
“Search results were above expectations although we suspect buyside was looking for a stronger beat,” he wrote. “Cloud growth was soft. We would have liked to see better operating leverage as net employees increased [sequentially].”
Nonetheless, he kept an overweight rating on the stock and upped his price target to $150 from $147.
The spending picture is a “well-founded” worry for Alphabet investors given the cost to compete in the battle for AI supremacy, according to MoffettNathanson analyst Michael Nathanson.
“While [capital expenditures] and employee costs have been restrained this year, the uncertain outlook will weigh on the stock until more is disclosed,” he wrote, while keeping a buy rating and a $155 target price on the stock.
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Brad Erickson of RBC Capital Markets weighed in similarly.
“Search continues proving resilient in the face of a choppy macro but a cloud miss, rising capex intensity attributable to [generative AI] and a lack of margin flow-through are leaving investors with relatively less upside to play for looking into ’24 versus the other mega-caps in our coverage,” he wrote. “Ongoing execution on search while layering on GenAI along with YouTube acceleration is a compelling thesis into next year and keeps us at Outperform but we believe this could take another few [quarters] before investor fears prove out as overdone.”
He has a $155 target price on shares.
Wedbush’s Scott Devitt offered a more upbeat perspective.
“Owning Alphabet for its Cloud business is like rooting for Michael Jordan to play baseball,” he wrote. “We think the reaction in shares after-market is overdone and believe investors are placing too much relative value on the company’s Cloud segment which accounts for just ~11% of revenue.”
Devitt cheered an acceleration in core advertising growth as he maintained an outperform rating and a $160 target price on the stock.
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