Alphabet Inc. (GOOG, Financial) (GOOGL, Financial), the parent company of Google, reported strong earnings for the second quarter of 2023 on Tuesday, which were driven by growth in the cloud.
As a result, shares jumped about 7% in after-hours trading.
Super financials
Alphabet reported strong financial results for the three months ended June 30. Revenue grew 7% year over year to $74.6 billion, beating analyst forecasts by $1.85 billion.
The company's Google Services segment contributed to the vast majority ($66.3 billion) as sales increased 5% year over year, boosted by its core Google Search and other advertising revenue. This may not seem like super growth, but given the macro pullback in advertising spending, these are positive results.
YouTube advertising revenue continued to grow, recording a 4% increase. The total YouTube revenue for the trailing 12 months (ending in March) was a staggering $40 billion. A key growth driver was YouTube Shorts as the number of monthly logged-in users watching rose from 1.5 billion in 2022 to 2 billion this year.
Connected TV is also a key growth area as YouTube reached 150 million via connected TV screens.
YouTube has become more vertically integrated with its subscription services. The company reported 80 million YouTube Music and Premium subscribers. In addition, the introduction of an NFL Sunday Ticket helped to drive greater signups. These initiatives helped to boost YouTube’s non-advertising revenue, which sits under “Other revenues” and rose 24% year over year to $8.1 billion.
This was also boosted by hardware sales, which included the launch of the new Pixel 7a.
Moving onto Google Cloud, the business' revenue rose by a blistering 28% year over year to $8 billion, driven by growth across countries, industries and product types. However, the company did report “moderating” in consumption during the earnings call, which was expected due to macro headwinds.
Google Workspace has also continued to grow, driven by a greater number of seats and higher average revenue per seat.
Artificial intelligence tailwinds
Microsoft's (MSFT, Financial) Azure is often considered the number one artificial intelligence infrastructure provider due to its close relationship with Open AI (the creator of ChatGPT). However, Alphabet reported that “more than 70% of generative AI unicorns are Google Cloud customers.” These include Cohoere, Jasper, Typeface and many others.
Google also offers its own tensor processing units, as well as Nvidia's (NVDA, Financial) advanced GPUs, such as the H100.
With regard to AI and the advertising and search business, Alphabet is in a tough position. It is thought that the cost to service an AI query is greater than the cost to service a standard search query. Therefore, the more the company moves into AI searches, the more it cannibalizes its own business model. However, Google has highlighted that many of the AI queries have a huge commercial opportunity for advertisers and thus, this does fit with its core business model.
In its Cloud and Workspace businesses, Alphabet has launched Duet AI to help people create code, write and dive into data easier. Currently, 750,000 workplace users have access to this feature.
Its cloud business has also reported strong demand for other 80 of its AI models, which include many open-source versions. Total customers using these services rose by 15 times during the quarter, according to the earnings call.
Alphabets “Other bets,” also referred to as “Moonshots,” reported revenue of just $285 million and an eye-watering loss of $813 million. However, many of the products in this segment are beginning to gain traction, such as Waymo, the self-driving vehicle provider.
Waymo is currently being rolled out in San Francisco and recently scored a partnership with Uber (UBER, Financial), which is a major deal as it is expected to accelerate the adoption of the autonomous vehicle. For Uber, this also secures its business against major disruption.
Alphabet is also working on a quantum computer that could change the face of computing as we know it. However, this truly is in the “moonshot” phase.
Profitability improvements
Returning to financials, Alphabet reported a total cost of revenue of $31.9 billion, which rose by 6% year over year. This was driven mostly by content acquisition costs related to YouTube subscriptions, as well as higher hardware costs for the Pixel smartphone.
Its operating expenses increased 4% year over year to $20.9 billion. However, operating income grew at a faster 12% rate to $21.8 billion, a solid 29% margin.
The company's earnings per share of $1.44 topped forecasts by 10 cents.
Free cash flow was $21.8 billion for the quarter and $71 billion for the trailing 12 months.
Alphabet has a fortress-like balance sheet with $118 billion in cash and marketable securities and total debt of around $29 billion, of which the majority is long term.
Valuation
Alphabet trades with a price-sales ratio of 5.53, which is lower than its five-year average. The company also trades with a forward price-earnings ratio of 22, which is also lower than its average over the same period.
The GF Value indicates a fair value of $148 currently based on its historical ratios, past financial performance and analysts' future earnings projections. As such, the stock is modestly undervalued.
Final thoughts
Alphabet is a tremendous company that benefits from advertising. There were fears that the company would be disrupted by Open AI and the resurgence of Bing, but so far these concerns have not played out. The company is now in a delicate position as it continues to push AI, while also reinventing its traditional search model.
