Facebook Inc warns again about a slowdown in ad revenue. But FB stock still remains a buy given its strong fundamentals.
Menlo Park, California-based social networking giant Facebook Inc (NASDAQ:FB) recently reported stellar earnings, beating both top and bottom line expectations, (as expected) though the company again raised growth concerns during the conference call. The management has been warning about an impending slowdown in revenue growth since last year, however, it has still not reflected in the company's revenue growth. Facebook stock did receive a downgrade from Pivotal Research due to risk and growth concerns. But most analysts (38 of the forty according to FactSet) are still bullish on the company. As we have discussed earlier, the company's other platforms including Instagram and Messenger and growing focus on video ads could be big revenue growth drivers. Given the strong growth and profitability, we rate Facebook stock 4.2 on a scale of 5.
The company's top line grew by 45% YoY, driven by strong growth in the mobile advertising segment. Mobile advertising revenue represented 87% of total profits, up from 84% in the second quarter last year. Revenue from the United States grew by over 41% to $4.04 billion while international revenues registered even faster growth of over 47% to $5.27 billion. Europe was a strong growth driver with revenues increasing by over 71% YoY in the continent.
Facebook Inc sees margin expansion.
While revenue growth was good, growth in profits was even more impressive. EPS grew by around 70% YoY from $0.78 last year to $1.32 this year. The higher EPS growth was driven by slower growth in costs, as well a declining effective tax rate. The cost of revenues grew by 34% from $917 million to $1.24 billion. Marketing and sales expenses grew at an even slower rate of 24.7%. Overall operating expenses grew by 33%, resulting in operating profits expanding from 42.47% in the second quarter last year to 47.2%. The company also saw its effective tax rate decline from over 17% to just around 13%, due to more of the company's income being earned in jurisdictions with a tax rate lower than that of the U.S. Lower effective tax rate coupled with cost control saw its net income jump from $2.28 billion to $3.9 billion.
Facebook's valuation multiples are coming down.
This strong revenue growth and expanding margin is driving Facebook stock higher. FB stock is up almost 48% year-to-day and almost 37% in the last one year. As you noticed, Facebook's stock price grew at a slower pace than its revenue and earnings growth, leading to a compression in Facebook's valuation multiples. Company's PE (ttm) ratio has declined from 59.6x a year ago to 38.69x in yesterday's trade while PS (ttm) ratio is down from 16.02x a year back to 14.85x now. While these valuation multiples don't look cheap when compared to the industry or other related companies, one must keep Facebook's growth and strong profit margins in mind. While Facebook's growth will decelerate in the coming quarters, it will still remain strong.
Facebook Inc warns again about a slowdown in growth.
The growth in Facebook's revenue has remained impressive. Facebook's revenue has grown at a compounded annual growth rate (CAGR) of around 50% in the last five years, slightly higher than the 45% YoY revenue growth posted by the company in the current quarter. The company further repeated its warnings that revenue growth is likely to slowdown due to saturation in ad load. During the conference call, David M. Wehner, Facebook's CFO warned that:
As we have discussed before, we continue to expect that Facebook ad load will play a less significant factor driving advertising revenue growth going forward, and that desktop ad revenue growth rates will slow in the second half of 2017 when we begin to lap efforts to limit the impact of ad blockers.
Ads in the news feed are the biggest source of revenue for Facebook, so a saturation in ad load in the news feed does have the potential to slow down Facebook's revenue growth. Analysts at Pivotal Research also warned that digital advertising market is also getting saturated. "With every passing year, digital advertising is closer to a point where the market is saturated." Brian Wieser analyst at Pivotal Research wrote in a recent note. He also gave a sell rating on Facebook stock with a price target of $140, translating to a 20% downside from the current stock price.
Facebook stock is part of our top stock picks.
However, Mr. Wiser is in the minority. In spite of the warning from the company about revenue slowdown, most analysts expect Facebook stock to go even higher. Goldman Sachs’s Heath Terry raised his price target on Facebook stock from $180 to $205 while FBN Securities’s Shebly Seyrafi raised his price target to $210 from $175. The average analysts' price target on Facebook stock currently is at $188, representing more than 10% upside from the current price. Analysts have also upped their revenue projections for 2017 and 2018, quite contrary to Facebook's warning of a slow down. Facebook stock has been part of our top stock picks from the tech sector which have outperformed the Nasdaq Composite by around 150%.
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