S&P Global and Google: Contrasting Q2 Earnings Reports

S&P Global Hits A Grand Slam, But Valuation Matters (SPGI)

I have to say I'm writing this article with mixed feelings. On the one hand, being bullish on S&P Global (NYSE:SPGI) was the right call when I wrote my most recent article on May 1, titled "From Ratings To Riches: Why S&P Global Deserves A Spot In Your Portfolio." On the other hand, I'm not in it, as the stock has returned 19%(!!) since then, with me watching on the sidelines. This has pushed the ten-year return to more than 570%, three times the S&P 500's return with an additional 11%. In this article, I'll update my thesis on the company, as it just reported, its financial numbers. These numbers not only show us how well the company is growing revenues and margins but also tell us what the bigger economic picture looks like, as S&P Global is the world's largest rating agency and a provider of data to countless corporations. So, as we have a lot to discuss, let's get right to it! The second quarter was fantastic, as the company reported a 16% increase in total revenue, excluding the divestiture of Engineering Solutions. According to the company, growth was mainly driven by a significant surge in transaction revenue from its Ratings division, which grew by more than 60%. Additionally, revenue from subscription products increased by 8% on a year-over-year basis. The only thing better than elevated revenue growth is higher margins. The company boosted its margins by 450 basis points, allowing earnings per share to soar by 30%. Moreover, the realization of almost $200 million in annualized run-rate revenue synergies from the integration of S&P Global and IHS Markit data sets puts the company ahead of its target to achieve $150 million in revenue synergies by 2026. In addition to these benefits, the company is implementing new technologies, as I have discussed in prior articles as well. This includes generative AI technologies. Essentially, GenAI is artificial intelligence that can perform out-of-the-box tasks, including creating its own content like text, pictures, and whatnot. S&P Global used these technologies in the launch of Chat AI on Platts Connect. Essentially, this platform combines data from Platts Dimensions Pro and IHS Connect, which allows users to get better access to data, research, and insights. If there's one thing AI is great for, it's handling data. Luckily, S&P Global has a lot of data, which makes AI a perfect tool to enhance and expand its existing product portfolio. Speaking of data, in May, S&P Global announced the acquisition of Visible Alpha, a company that was founded less than ten years ago with the right tools for S&P Global's platform. Founded in 2015, Visible Alpha provides consensus forecast estimates, key performance indicators, and analytics from in-depth sell-side analyst models and distributes the data through a variety of distribution channels including a web-based platform, APIs and Feeds. Visible Alpha is backed by a group of investment banks that are key contributors of research and data to the platform. Their continued contributions will further enhance the depth and breadth of the overall Visible Alpha and S&P Capital IQ Pro offering. - S&P Global (emphasis added) According to S&P Global, the integration of Visible Alpha has already shown promising results, with a 5% increase in contributing brokers and the generation of over 150 sales leads. In general, SPGI is doing a terrific job adding new services and exploiting market trends, including in its Sustainability & Energy Transition division, which saw a 23% revenue growth rate, pushing revenue to $87 million. This was driven by strong demand for advisory services and subscription offerings related to energy transition. Meanwhile, the Private Market Solutions segment saw a 26% increase in revenue. This was boosted by elevated demand for ratings for debt bank loans and CLOs (see below). With regard to growth in its rating business, the company saw massive tailwinds from favorable market conditions, including tight credit spreads and strong refinancing activity. Adding to that, the S&P Dow Jones Indices division continued to thrive, with a 12% revenue increase, which was driven by higher asset-linked fees and strong ETF market inflows. Even better, the division's operating margin expanded by 210 basis points to 70.7%, which shows the power of a strong asset/capital-light business model. In general, on a TTM-adjusted basis, we see the company has an operating margin of 48%, led by Ratings and Indices, who both have operating margins of more than 60%. This is truly a fantastic profitability profile, especially in light of sticky inflation. The good news is that growth is expected to be higher than previously anticipated. What's better than strong results? A guidance hike. Looking ahead, the company raised its financial guidance for the full year, expecting revenue growth in the range of 8% to 10%, with adjusted operating margin expansion of 125 to 175 basis points. Note that 8.0% revenue growth was the upper bound of the prior range. Adjusted diluted EPS is expected to be between $14.35 and $14.60, which marks a $0.50 increase from the company's prior guidance. Digging a bit deeper, the revenue guidance hike in ratings really stood out, as it almost doubled the guidance midpoint to a new range of 14.0% to 16.0%. After its recent surge, SPGI shares trade at a blended P/E ratio of 36.0x, roughly ten points above the 10-year average of 26.2x. Using the FactSet data in the chart below, analysts expect 13-14% annual EPS growth through 2026. When adding its 0.7% dividend yield, it could return 14%-15% per year. Since January 2004, it has returned 14% annually. However, that scenario would be based on its current valuation. I do not see that happening, as a 36x multiple is simply too rich. Although there's a good chance the company will trade above its 10-year average for a while, a lot of good news has been priced in, which implies a fair stock price of roughly $490 (based on its 10-year average multiple). The current consensus price target is $516, 5% above the current price. As such, I believe a Hold rating is appropriate here, with corrections of 15% or more being good buying opportunities. Historically speaking, these corrections tend to happen on a regular basis, as SPGI is still a cyclical business. S&P Global has been on a tear, with a 19% gain since my last article. The company's recent earnings report highlights impressive growth, driven by a surge in its Rating division and the successful integration of IHS Markit, to name two examples. Moreover, revenue growth is strong, margins are expanding, and the outlook is even brighter with a guidance hike. While the stock's valuation is currently lofty, the long-term opportunities remain strong. Hence, for now, I'll keep a close eye on SPGI and continue to appreciate the company's stellar performance from the sidelines, betting on a correction opportunity in the not-too-distant future.

Google: Massive Spending Spooks Wall Street (NASDAQ:GOOG)

The recent dip can be a good entry point for long-term investors, as the long-term EPS growth estimates are strong, and the valuation is relatively cheap. Google (NASDAQ:GOOG) was able to deliver excellent earnings in the recent quarter by beating estimates in terms of EPS and revenue. However, Wall Street has punished the stock, likely because of faster capex growth projections made by the management. It is very important to put the AI hype in context when it comes to Google and other Big Tech stocks. During the calendar year 2023, we saw rapid price growth in Google, Meta (META), and other tech stocks. A large part of this bull run was due to the cost optimization initiatives of these companies. Google was able to massively reduce its headcount, which helped improve the EPS growth trajectory. The rapid growth in self-driving service provides another runway for growth, as mentioned in the previous article. The AI hype likely did not play a big part in the bull run, as the valuation multiple of Google peaked at only 28 in 2023. In the recent quarter, capital expenditure came at $13.19 billion, compared to $12.01 billion in the first quarter of 2024 and a bottom of $6.3 billion in the first quarter of 2023. The forward guidance by the management mentioned that the company will maintain the current rate of $12-$13 billion in capex every quarter, which is close to $50 billion annually. This rate of capex is the highest investment level by Google, which has spooked Wall Street, as we could expect to see a negative impact on EPS trajectory over the next few quarters. Google has a number of growth drivers like cloud, autonomous vehicles, subscriptions, and more. However, it will need to maintain discipline in spending if the management wants to show a good EPS growth trend. The monetization of many AI initiatives is still not clear. We could see some short-term headwinds due to higher capex, but the long-term growth momentum for the company is still quite strong. The forward PE ratio of Google is only 22 compared to 33 for Apple (AAPL) which has a significantly lower revenue growth trajectory. Google stock remains a Buy despite some short-term corrections. We have seen a strong bull run in most of the big tech stocks over the last few quarters. While AI hype has helped a few stocks, most of the other companies have seen bullish sentiment because of their cost optimization efforts. Google, Meta, and other tech companies announced massive layoffs in 2023 which helped in improving their EPS trajectory. This inevitably improved the sentiment towards the stocks and helped deliver one of the best bull runs for tech stocks in recent history for the last few quarters. The forward PE multiple did not expand significantly during this time despite the AI hype as shown in the following chart. The forward PE ratio of Google and Meta peaked at less than 25 in the recent bull run, and most of the stock price growth was due to strong EPS growth. The reduction in headcount helped Google improve the profit margins over the last few quarters. Despite the recent 14% revenue growth, the headcount in the recent quarter came at close to 179,000 employees compared to over 181,000 in the year-ago quarter. The headcount reduction has certainly helped expand the profit margin and EPS growth. However, the management has announced that it will again start increasing the headcount. Higher capex and employee count will inevitably hurt the EPS growth in the next few quarters. Hence, it is important to closely watch the future spending programs of Google in order to gauge the returns potential in the stock. Google reported $10.3 billion in quarterly revenue for the Cloud segment, which is an increase of 25% from the $8 billion revenue reported in the year-ago quarter. The bigger news in this segment has been the strong margin expansion. The operating income in Cloud segment increased from $395 million to $1.17 billion. This increases the operating margin to 11% in the Cloud segment. There is a big gap between the operating margin of Google Cloud and the market leader Amazon's (AMZN) AWS. Over the last few quarters, AWS has reported ttm operating margin in the range of 25%-30%. It is highly likely that Google Cloud would be able to close the gap in operating margin with AWS over the next few quarters as it gains better economies of scale. Combined with strong revenue growth in the Cloud business, we could see a rapid improvement in operating income, which will boost the overall margins for the company. If Google Cloud is able to show an average revenue CAGR of 25%, it could reach $150 billion annualized revenue rate by 2030. At 25% operating margin, this segment alone will add $40 billion to Google's operating income by 2030. The recent ttm operating income of Google is $97 billion. If Google Cloud shows the above-mentioned revenue growth and margin trend, it could deliver a CAGR 6.5% growth in operating margin for the company on a standalone basis till the end of the decade. Google could invest this profit in other growth options and increase the buyback pace, which should help the EPS trajectory. Another major growth segment in the self-driving business of Waymo. Google announced another $5 billion "multiyear" investment in this segment. The autonomous driving segment has required massive investment and lots of time. This would make a high barrier to entry for other businesses. We have already seen the poor performance of GM's (GM) Cruise. Even Apple with its deep pocket has cancelled the self-driving Project Titan. I believe we will eventually see only three big players in this space: Google's Waymo, Tesla (TSLA), and Amazon's Zoox. The robotaxis are just the tip of the iceberg in terms of the addressable market. They are also likely to be one of the most complex problems as it includes transporting people, which comes with its own regulatory headaches. It is inevitable that we will see this segment expand to robotrucks. According to the Bureau of Labor Statistics, there are many more times the number of truck drivers as there are taxi drivers. We could also see an expansion of this segment into package delivery. Waymo has successfully completed 2 million paid trips and is rapidly expanding in new cities and increasing its customer base. Waymo has completed these trips in less than 10 months of operation. We could see a strong inflection point as it expands the service in other cities. A successful growth trajectory in Waymo should improve the bullish case for Google and also help improve the valuation multiple for the stock. The subscription business is becoming a key anchor service for Google, on which other services can be monetized. The management does not work in a vacuum, and it is likely that they will take the recent stock correction as a strong signal by Wall Street to rein in huge spending. The forward EPS estimates for Google are very good, and we could see an upward revision in them if the company is able to deliver good growth in Cloud, autonomy, and other segments. Figure: EPS estimates for Google over the next few years. Source: Seeking Alpha The stock is trading at less than 20 times EPS estimate for the fiscal year ending 2025 and close to 17 times the EPS estimate for the fiscal year ending 2026. The PEG of Google stock is very good compared to many other big tech stocks. Google is trading at a forward PE ratio of only 22 compared to 33 for Apple. On the other hand, the revenue growth of Google is significantly better than Apple. The long-term growth drivers for Google are also better than Apple due to Cloud and other high growth businesses. If Google's management is able to keep spending in check and deliver good EPS growth, we could see an improvement in valuation multiple by the end of 2024. Google stock saw a correction as Wall Street is worried about the high levels of capex for building AI capacity. The monetization of these initiatives is still not clear. Google will have to rein in spending if it wants to improve the EPS trajectory. The strong revenue growth and increase in margin in Cloud segment is a good tailwind for Google stock. There is still a big gap between the margins of Google Cloud and AWS. This should allow greater margin expansion in this segment over the next few quarters. Alphabet's Waymo has also been successful in commercialization of its self-driving service. We should see strong growth as the service is expanded in other cities, increasing the addressable market. Google stock has a forward PE ratio of only 22 compared to 33 for Apple. This shows that the stock is quite cheap, and long-term investors could use the recent correction to add to their position. I maintain a Buy rating for the stock.