Three Key Questions About Alphabet Inc. (NASDAQ: GOOGL) Earnings in July 2023

Alphabet Inc. (NASDAQ: GOOGL) reported better-than-expected earnings for Q2 2023 after the market close on Tuesday, July 25, 2023. What happened during the release and earnings call, and what are the new questions to focus on?

1. What happened with Google Cloud?

This business was profitable again this quarter and surprised the market again. In addition to strong revenue growth, the Cloud business delivered operating profit in Q2 resulting in a 5% operating profit margin. After Q1, analysts were expecting the Cloud business to generate -$1.2 billion in losses for the rest of the year. Coming into Q2, expectations were getting revised upward and moved to a $423 million profit for 2023, including a break-even result in Q2. However, Alphabet delivered $395 million in Q2, exceeding the consensus estimate of break even for the quarter, and approaching the current 2023 full-year expectation.

New Question: Will the Cloud business exceed $1 billion in operating profit in 2023 and 2024?

2. Will revenue growth continue to outpace expense growth?

Revenue growth exceeded expense growth this quarter and helped drive a higher-than-expected 29% operating profit margin. Alphabet remains focused on optimizing its cost structure and headcount. CFO Ruth Porat is moving into a new role, as President and Chief Investment Officer. Will she and her successor bring more discipline to the unprofitable businesses and to the company overall?

Analysts expected Alphabet’s operating profit margin to dip to 24% in Q1, but it came in higher at 25%, driven by Search and Cloud. This margin was projected to improve from Q2 to 27% levels for 2023, but ultimately came in at a better-than-expected 29% after the release. Currently, losses from Alphabet’s other bets and unallocated business lines are projected to be -$10 billion by the end of 2023. Based on Visible Alpha consensus projections, having these businesses break even could potentially add up to 12% upside to operating profit in 2023 and 8% in 2024.

The company noted that its CapEx came in lower in Q2 due to data center delays, but will continue to be higher for the rest of the year and into 2024, as it plans to step up investment in AI. The largest component came from servers for AI. It is worth noting that Microsoft’s CapEx has not only been outpacing Alphabet’s, but is expected to be $5 billion higher than Alphabet’s by the end of 2024, according to Visible Alpha consensus. Will Alphabet accelerate CapEx going forward?

New Question: When will Alphabet’s other bets break even?

3. Is the strength in Services sustainable?

Services revenue came in at $66 billion, up 7% quarter over quarter and 8% year over year, but the operating profit came in better than expected, up 8% quarter over quarter and 24% year over year, resulting in a 35% margin.

Coming into Q2, Search revenue was expected to generate $42 billion ($42.6 billion actual) for the quarter and $172 billion (now $174 billion) for 2023. Retail continued to support ad revenues in Search. Analysts now expect this business to be up 7% in 2023, up from 4% in Q1. Will this business continue to show increases for the remainder of the year?

YouTube revenue came in at -3% in Q1, but analysts have been expecting this business’s growth outlook to improve from Q2. In the Q2 release, YouTube delivered revenues of $7.7 billion, ahead of the $7.4 billion expected by analysts. CFO Ruth Porat noted a recovery in advertising at YouTube. This business is now expected to deliver $31.2 billion in 2023, up 7% year over year. Will the strikes impacting Disney and Netflix be a tailwind in H2 for YouTube?

Operating profit for Services beat expectations by over $2 billion in Q1. At the time of the Q2 release, analysts expected Q2 to deliver $22 billion, but it came in stronger at $23 billion.

For 2023, analysts are expecting Services to deliver $270.7 billion in revenue and $93.6 billion in operating profit, for a 34.5% operating profit margin. Given the performance in Search and YouTube, will expectations increase for H2 2023 and 2024?

New Question: Alphabet highlighted the focus on multi-modal AI. How will these innovations drive ad revenues going forward?