Research Notes: Big Earnings Reports
A detour over to the mega-cap universe
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This week’s Research Notes takes a look at a few earnings reports, with more of a mega-cap focus than I usually have. Blame a nervous market which leaves us all looking for any kind of signal we can find:
Alphabet (GOOG) (GOOGL)
The market’s negative response to Alphabet earnings, at least based on my Twitter feed, seems to be greeted with a battle between “this is dumb, the market is just dumping any stock no matter what earnings look like” and “anyone saying ‘this is dumb’ is dumb”.
I’d probably lean toward the more skeptical explanation at this point. Yes, GOOG is a wonderful business. GOOG is probably a decent buy here.
That said, I’d still think there are better buys out there from a “buy the dip” mentality. At the least there’s more going on here than just market panic.
Over the past four quarters, the core Google Services business has done ~$95B in operating income. After-tax, that’s ~$75B; Google at the current price has an enterprise value of ~$1,500B.
So, yes, the core business is at ~20x EPS; and investors could see that as a reasonable (or cheap) multiple, and in that model ostensibly get the rest of the business for ‘free’.
I mean…OK? 20x EPS is probably a bit too cheap, but there were real tailwinds during the pandemic and some cyclical risks looking ahead. Alphabet itself is saying that the business is going to decelerate going forward:
In terms of outlook by segment for Google Services, the revenue growth rates we delivered in 2021 in our advertising businesses benefited from lapping the COVID-related weakness in 2020. Obviously, we will not have that tailwind for the rest of this year. As discussed in prior calls, the largest impact from COVID on our results was in the second quarter of 2020, which means that in the second quarter of 2022, we will face a particularly tough comp as we lap the recovery we had in the second quarter of 2021. Additionally, the second quarter results will continue to reflect that we suspended the vast majority of our commercial activities in Russia.
The other problem is getting the rest of the business for free. Against a $1.5T enterprise value, how much is that moving the needle? Google Cloud has done $21B in TTM revenue, and can’t come close to turning a profit. Is that worth $100 billion? The ‘Other Bets’ businesses are Waymo and stuff that doesn’t seem to have really hit. Is that worth $100 billion?
Relative to the Twitter debate, the truth seems to be somewhere in the middle. The market certainly hasn’t “lost its damn mind.” The stock seems like it ran too far in getting to $3,000, and there’s nothing in Q1 to really change that perception. 20x Services EPS plus the rest of the business is fine as far as it goes, but it’s not an absurd valuation or a sign of a panicked market.
There’s some logic to the trading here. Meanwhile, Microsoft (MSFT) is rallying nicely (adding ~$140 billion in market cap as I write this midday).
So the idea that GOOGL earnings show a terrified market doesn’t seem to hold up. Indeed, our next company shows investors will still pay up for strength. And in my own universe, I’m not seeing unjustified sell-offs left and right (though, admittedly, most small- to mid-caps haven’t reported yet).
We’re seeing more caution, even skepticism, certainly. The bar for a post-earnings rally might be higher. But, at least in the early going, Alphabet earnings seem part of a trend in which investors overall are being reasonably rational.
Last decade, there were two large-cap stocks I simply didn’t understand at all: Coca-Cola and Procter & Gamble (PG). Neither company was performing well. Coca-Cola’s total adjusted pre-tax earnings actually declined about 9% from 2013 to 2018. P&G’s adjusted net income went nowhere for much of the post-crisis period.
Both companies had supposed opportunities from massive, multi-year turnarounds. Coke had its refranchising efforts. P&G started with a $10 billion cost-cutting program and continued shrinking through divestitures and layoffs. But, at the same time, neither company’s brands seemed all that strong. Coke was fighting a worldwide obesity trend and competition from sparkling water; P&G was dealing with private label competition and a weakening of its American middle-class ‘halo’ overseas.
Yet both companies pulled it off. PG stock has better than doubled; it’s near an all-time high. KO stock too is just off record levels, and the company just posted a massive quarterly beat that almost doesn’t seem like it should be possible for a large-cap consumer company in a ‘Big Data’ age.
That said…is this not the perfect environment for both stocks to trade? Investors want to be invested in stocks, but maybe not most of the stocks. Bond yields aren’t yet high enough to provide real competition to the PG/KO dividends, and duration risk in that market remains a major problem.
If the market really turns south (like 2000-01 or 2008-09 south), KO and PG aren’t emerging unscathed. If it snaps back, those stocks almost certainly underperform.
At these levels, owning names like PG & KO feel like a rationalized, half-in decision, with the bull case based at least in part on the desire not to own other stuff. They seem dangerous — but I’ve been wrong before.
Procter & Gamble (PG)
In fact, there’s a reasonable case to short PG here, or at least look to sell out-of-the-money call spreads.
I discussed the stock elsewhere in a less forceful manner, but PG trades at its highest valuation ever, and there are real challenges coming. Inflation is one. The likely stronger dollar is another — FX crushed P&G’s earnings last decade. The chart is ugly; PG simply cannot hold $165, and couldn’t even in a more optimistic environment.
When PG reports Q4 earnings in July, the focus probably turns to FY23 numbers. But PG still is at 25.6x next year’s consensus; it seems like a big guidance beat is priced in. It’s hard to see how that arrives in this environment; P&G has performed exceptionally well this year only to be dinged by external factors (commodities and FX mostly).
Do we hate the idea of an October 160/165 spread, which as I write this is basically a 1:1 bet that the stock declines over the next six months? More conservatively, a step up the ladder to the 165/170 offers a ~60% return in betting that PG can’t return to, and hold, all-time highs over the next six months. Maybe this is just too good a company to bet against right now, but investors in recent months would have made an awful lot of money betting against good companies priced for perfection.
I doubt that in my lifetime we’ll ever see a stock as controversial as Tesla is. No stock in my 20-years plus in and around the market has generated a quarter of the intense attachment from bulls as TSLA. Meanwhile, for much of Tesla’s time as a public company, there has been an equally intense distrust, and often disdain, of chief executive officer Elon Musk and his management style. Add in the environmental impacts (both positive and negative) of EVs and the toxicity of the bull/bear debate — well before the Twitter (TWTR) drama — is not particularly surprising.
So far, the bulls obviously have won that debate. Just as obviously, many bears aren’t conceding defeat. (The $TSLAQ cashtag lives!) But for those of us on the outside (I have no position at the moment1), I do wonder whether the controversy around the company, and the nature of the online discussion, has obscured a pretty amazing story.
One of the long-running problems with analyzing TSLA stock is that, particularly online, the quality of the discussion has been heavily, heavily weighted toward the bears. Whether on Twitter or sites like Seeking Alpha, bullish analysis has often seemed thin, with theses like “have you driven the car?” or “Musk is great and everyone is going to drive EVs, so TSLA is a long.”
Meanwhile, bears were doing deep dives into SEC filings and highlighting apparent anomalies in accounts payable, or detailing multiple incidents of design and/or technology failures. Those analyses stuck out in contrast to even professional bulls like Ron Baron or Cathie Wood, who seemed/seem to offer their thin analysis (trillions of dollars in added fair value based on robotaxis!), or the Wall Street analysts whose price targets followed the stock rather than led it.
But, simply put, the bears were wrong — even ignoring the rise in TSLA stock. In 2018 and 2019, multiple TSLA bears repeatedly argued that Tesla was going bankrupt, citing mounting evidence that some as-yet unknown legal reason was preventing the company from raising capital. Even investors (myself included) who didn’t quite buy that theory saw a company that looked dramatically overvalued, and whose ceiling was probably being a niche auto manufacturer — which is not the greatest business model out there.
But over the past four quarters, Tesla has generated $8.4 billion in net income and nearly $8 billion in free cash flow. It did $3B in profit in Q1 — not an easy quarter in which to manufacture cars profitably. (Some bears still will argue that those numbers are somehow fraudulent; that’s an argument that I believe is absolutely preposterous2.)
Three years after legitimate investors were making a coherent case for TSLA being a zero (and when the company, according to Musk himself, was “about a month” away from bankruptcy), Tesla is an impressively profitable enterprise.
That’s not to say that I agree with everything Musk has done; I absolutely do not. It’s certainly not to say that TSLA is a buy at a market cap still above $900 billion.
But there’s been so much debate, and so much acrimony, surrounding Musk and Tesla that the actual business story perhaps is getting overlooked. It’s incredible what the company and its employees have done — full stop.
I imagine the company and its employees would get more credit were their CEO not quite so controversial — but I also imagine Tesla’s results wouldn’t be quite as impressive without that controversy and the consistent ‘buzz’ it creates.
(And, no, I wouldn’t buy this stock at $900 with someone else’s money.)
As of this writing, Vince Martin has no positions in any securities mentioned.
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I actually have shorted TSLA twice in the past — and made money both times. I pretty much bottom-ticked the stock when I covered last, in late May 2019. Yes, that’s a little bit of a brag. Yes, that’s a little bit of dumb luck. Either way, I should get a T-shirt or a pair of long shorts or something.
Back in 2019, I detailed the common-sense argument against Tesla’s numbers being fraudulent. First, we have zero evidence Musk has the knowledge or attention to detail to execute that kind of scheme. This is a CEO who demonized short sellers and then sold convertible debt (which traditionally is hedged by…shorting the company’s stock). When he was supposedly taking Tesla private, he said he would allow public shareholders to stay private owners, which is not how it works. He said the same this month about his potential bid for Twitter . There’s no evidence — zero — that Musk has the understanding of capital markets or accounting to execute a massive, ~decade-long fraud.
Perhaps, then, someone else did the dirty work with Musk’s backing. The problem with that thesis is that Tesla’s former CFO departed — for the second time — in early 2019. CFOs running massive frauds don’t leave in the middle of those frauds (unless they’re off to a beach in Venezuela), and CEOs who are in on the frauds don’t let them leave.
Looking back on that piece I wrote three years ago, my description of the TSLAQ community then sounds like a less crazy version of the AMC community now, both dominated by groupthink, sneering condescension, and a taste for conspiracy theories. Three years later, I sincerely think that description was spot-on.