Google Shares Jump Post Stellar Earnings

  • Google beat revenue and EPS estimates comfortably.
  • Google's ad business hasn't accelerated, but YouTube and Google Play will drive revenue.
  • Google shares have upside potential post Q2 earnings.

Google (NASDAQ: GOOG), (NASDAQ: GOOGL) bulls have perhaps scored their most significant victory yet this year after the search giant delivered second quarter fiscal 2015 results that topped both top line and bottom line projections. Google reported revenue including Traffic Acquisition Costs, or TAC, of $17.727 billion, up 11% Y/Y and non-GAAP EPS of $6.99, up 13.5% Y/Y.  Google's ex-TAC revenue and EPS came in well ahead of consensus analysts’ projection of $14.27 billion and $6.70 for revenue and non-GAAP EPS, respectively. Google reported a GAAP EPS of $6.43, up 31.76% Y/Y.

Google stock price has surged on the back of the results. Google's stock rallied 11.36% over the past 5-days and is up 10.46% YTD after languishing in the red zone for much of the year. Investors have been concerned that Google has been using its massive cash hoard in unprofitable projects by investing in moonshot projects with little to show for it.

Google Stock 5-Day Share Returns

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Source: CNN Money

Cost Discipline & Lower Traffic Acquisition Costs

What stood out most in Google’s latest earnings report was the company’s success in trimming its costs including TAC. Costs and expenses grew just 10.3% Y/Y compared to 13.3% growth during the first quarter. Operating expenses excluding cost of sales grew 13% compared to 21% during the first quarter. Lower expenses allowed Google’s operating margin to improve 200 basis points to 34% compared to the prior year period, and 100 basis points Q/Q.

Meanwhile, Google’s TAC, one of the company’s biggest line items, clocked in at $3.377 billion, which works out to 21.1% of revenue compared to 22.7% of revenue recorded during last year’s comparable quarter. Google’s TAC had reached a high of 24.7% of revenue during the third quarter of fiscal 2013. Traffic Acquisition Costs refers to the money Google pays to companies such as Apple (NASDAQ: AAPL) to become their search engines. Google pays Apple about $1.5 billion each year to become the search engine on Safari browser. Lower TAC by Google is probably being driven by the growing popularity of Chrome browser. The more people use Chrome browser during their Internet searches, the less TAC Google has to pay other companies.

Slowing Top Line

But, Google’s slowing top line, a pet peeve by Google bears, continued its journey south. Google’s top line growth of 11% was 100 basis points worse than the 12% growth by the company during the previous quarter. This is being orchestrated by falling CPC rates. Aggregate paid clicks were up 18% Y/Y but CPC rates were down 11%. Falling CPC rates is probably the reason why Google is having trouble with its partner network. While Google Sites reported a healthy 30% growth in volume of paid clicks, the same metric for Google partner sites was down 9%. So this is becoming a vicious cycle where falling CPC rates are making advertisers to pull out of Google’s networks which leads to slowing top line by the company.

The problem of falling CPC rates is being caused by shift to mobile ads and also due to the fact that Google is relying more on international markets to drive growth. During the last quarter, international markets contributed 55% of Google’s revenue. This trend is therefore likely to continue in the foreseeable future.

But Google can compensate for weaknesses in its search business.

Google Non-Search Assets to Play Bigger Role for Google

Google’s growth woes might not last for long. Credit Suisse has been able to work through the company’s reporting and determined that YouTube and Google Play are contributing significantly to Google’s top line. The analysts expect YouTube to bring in $6 billion for Google in the current year up from 4 billion in 2014, while Google Play is expected to bring in revenue of 5.1 billion. The two platforms combined are expected to bring in about 15% of Google revenue in the current year. The two segments, however, are projected to grow considerably faster than the rest of the company and will reach 24% of Google’s revenue by 2020.

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YouTube in particular looks promising for Google. Though the platform has never made a profit, this could soon change. Google plans to start using data from its own sites when targeting YouTube audiences with ads, which will deliver a better ROI for marketers and help Google to claim better CPM rates for YouTube ads. This will allow the platform to finally become profitable.

Over the long-term, Google shares have good upside potential. Near-term gains, however, are likely to be dictated more by things like the company’s results.

Article cover image licensed from - Copyright: mikewaters / 123RF Stock Photo

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