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Alphabet Inc. (NASDAQ: GOOG, NASDAQ: GOOGLE) filed its third-quarter earnings sheet yesterday after the market closed, and the tech company missed estimates on both the top and bottom lines. The earnings sheet Google shares were also down 6.7% outside of regular trading.

Unfortunately, Google also reported yet another quarter of decelerating growth, as advertisers became more cautious about ad spending in the third quarter. YouTube ad revenue actually fell for the first time ever, a sign that the global economic downturn may be more severe than feared. Still, Google generated a huge amount of free cash flow in the third quarter, which will help the tech company complete its ambitious stock buyback and support the stock price. I believe Google stock is still a good deal for long term investors!

Google Loses On The Top And Bottom Line

Google generated third quarter revenue of $69.1B which was $1.6B below the consensus estimate. EPS was also lower than expected: the consensus was for EPS of $1.26, while Google reported earnings of $1.06 per share.

Seeking Alpha: Google Q3'22 Results

Seeking Alpha: Google Q3’22 Results

Unfortunately, a global slowdown in ad spending further decelerated Google’s revenue growth in the third quarter: the company’s Q3’22 revenue growth fell to just 6% year-over-year. In the previous quarter, Google’s top-line growth also slowed year-over-year but was about twice as high as top-line growth in Q3’22, about 13%. Google’s ad revenue increased just 2.5% year over year to $54.5B, largely due to slowing ad revenue growth on the YouTube platform. YouTube-related ad revenue actually fell 2% year-over-year to $7.1B, marking the first decline ever, and the consensus estimate called for a 3% increase.

The Google Cloud business, however, did well, and a little better than expected. The Cloud segment posted revenue of $6.9B, showing top-line growth of 38% year-over-year and a slight acceleration over the segment’s second-quarter growth rate of 36%. The estimate for Google Cloud revenue was $6.7B, so the segment slightly outperformed the consensus call. Cloud is a key growth engine for Google and should be expected to do well in the future, in part because Google Cloud is a top three Cloud Service provider, with a market share of approx. by 10%, and that more IT workloads are moving to cloud platforms.

Google Segment Results C3'22

Google Segment Results C3’22

Free cash flow, margins and stock buybacks

Google generated $16.1B in free cash flow in the third quarter on revenue of $69.1B, which calculates to a free cash flow margin of 23.3%. Despite the downturn in the advertising market, Google generated 3.5B more in free cash flow than in the second quarter. Google’s free cash flow margin improved to 5.2 PP quarter over quarter.

$ millions

Q3’21

Q4’21

R1’22

R2’22

Q3’22

Income

$65,118

$75,325

$68,011

$69,685

$69,092

Net cash provided by operating activities

$25,539

$24,934

$25,106

$19,422

$23,353

Less: purchase of property and equipment

($6,819)

($6,383)

($9,786)

($6,828)

($7,276)

Free cash flow,

$18,720

$18,551

$15,320

$12,594

$16,077

Free cash flow,

28.7%

24.6%

22.5%

18.1%

23.3%

(Source: Author)

Even though the ad market is slowing down, Google has no issues generating tons of free cash flow for the benefit of shareholders. In the third quarter, Google repurchased $15.4B of its common stock, and more stock buybacks are sure to follow, I believe. Google currently has a $70B stock repurchase authorization in place, which I expect to be exhausted next year. I also expect Google to announce a $100B stock buyback plan in FY 2023.

Google is a market

Say what you will about Google’s third quarter, the firm did reasonably well given the results in the advertising business. Google is expected to have revenues of $321.3B in 2023 and, assuming a free cash flow (“FCF”) margin of around 23%, could generate $74B in free cash flow next year. With a market cap of $1.37T, the current valuation implies a P-FCF ratio of 18.5 X. Based on earnings, Google is also cheap, trading at 17.9 X earnings and below the average 1-year P/E ratio of 20.0 X.

Chart
Data at YCharts

Risks with Google

Pressure on Google’s advertising top line is set to increase as advertisers react to high inflation and interest rates that are posing risks to economic growth. Google’s advertising growth has unfortunately slowed to single digits in Q3’22 and is likely to continue to put pressure on Google’s revenue and investor estimates. As analysts rush to update their estimates for FY 2022 and beyond, I believe investors may see a lower valuation factor in the near term.

Final thoughts

The earnings report wasn’t as big as I thought it would be, and shares of Google plunged after the earnings report. However, a slowdown in advertising revenue was expected, at least to some extent, and the Google Cloud business performed better than expected. Google generated tons of free cash flow from its businesses, especially advertising, and the company has considerable firepower to buy back more shares in the future. I believe the market outperformed Google’s results assuming the firm’s free cash flow margins improved quarter over quarter!



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