Meta Platforms, Inc. – This sell-off is an opportunity
In this post, we take a close look at Meta's Q1 results, released last Wednesday. Shares sold of by double digits, potentially offering investors an opportunity to buy!
Meta META 0.00%↑ released its Q1 earnings report last Wednesday, and, well… saying the results weren’t well received by the market is quite the understatement. Shares eventually ended the Thursday trading session down 10.5%, erasing around $130 billion in market cap. This stands in sharp contrast with an over 20% gain shares made following the prior earnings release, which was the biggest market cap gain in a single day ever!
Staggeringly, this sell-off on Thursday wasn’t even a reaction to an earnings miss. Meta actually beat the EPS consensus by a very solid 9% and revenue by a more meager $240 million. The bigger issue seemed to be guidance, which came in somewhat light, and management's intention to significantly grow investments made in AI.
I last discussed Meta on this platform on February 7, following its Q4 earnings report. Back then, we argued that Meta shares remained attractive, even after over 200% gains in just around 1.5 years, as shares were still attractively valued and presented with plenty of long-term upside.
Ever since, shares have fallen by 6%, and we continue to view Meta as one of the most promising and cheapest among its big-tech peers. The sell-off seems like a massive overreaction on pretty much nothing that changes the financial projections.
Therefore, we can already tell you that our buy rating remains unchanged, but in this post, we will still go over the numbers, highlight the most notable developments, discuss our financial projections, and set an updated target price.
Let’s get to it!
Meta’s Q1 results are nothing short of excellent
Meta remains one of the most impressive companies and definitely one of the most important to advertisers. The company has an estimated 3.2 billion people globally using at least one of its apps daily, which is just an insane stat.
However, possibly even more important is the company's consistent growth of this number at quite an impressive pace. The 3.2 billion DAP number was up a very impressive 7% YoY, driven by growth across its platforms.
Meanwhile, the company was also able to grow user engagement, which increased the number of ad impressions by 20% in Q1. This progress is beautifully highlighted in the graph below, which shows average revenue per user, trending up nicely on a YoY basis. This means that Meta is growing not only its user base but also the value of each of these users, creating quite an impressive growth machine.
This growing engagement, which is probably the most important metric as it protects Meta's moat and makes it more valuable to advertisers, is driven by several factors and developments. One of the most significant ways to increase engagement has been Meta's recommendation system, which shows users content they like but don’t follow to keep them active. It sounds simple, but it is working exceptionally well for Meta.
Also, the company has shown a tremendous ability to develop its platforms to match our interests, preferences, and trends. A great example of this is the success of video on its platforms, now representing 60% of time spent on both Facebook and Instagram. The most significant driver here is Reels, which continues to be a massive success and engagement driver, already making up for 50% of the time people spend on Instagram, highlighting how Meta is able to develop its platforms to become more attractive to its users, improving engagement and user value.
Positively, the company’s advertising business is also once more firing on all cylinders after a number of challenging years, with advertisers once more heavily spending on Meta’s Family of Apps. This has driven a 6% growth in the price per ad, driving revenue growth.
Revenue came in at $36.5 billion in Q1, representing a 27% increase YoY as growth continues to accelerate, as shown below. Granted, it lapped a relatively weak Q1 last year, but the uptick nevertheless is an important and impressive one. Let’s not start taking this kind of growth for granted.
By geography, revenue grew the fastest in the Rest of the World, and in Europe, growing by 40% and 33%, respectively. However, growth in Asia and North America also came in strong at 25% and 22%, respectively.
Growth in the reality labs segment was also relatively good, with revenue up 30% to $440 million. However, the segment continues to be a bottomless pit, reporting an operating loss of $3.8 billion in Q1.
While this continues to drag on the bottom line, the company still reported impressive margins and cash flows. This was helped by only a 6% growth in operating expenses, driven mainly by a 3% growth in headcount but offset by tight cost control in other areas. R&D grew by only 6%, and Marketing and Sales were down 16%, driven by lower restructuring costs.
This improved the operating margin by a significant 13 percentage points to 38%, driving operating income growth of 91% to $13.8 billion. The net income margin also improved by 14 percentage points to 33.9%, leading to $12.4 billion in net income, up 117%.
This translates into an EPS of $4.71, up 114% YoY and, as mentioned before, 9% higher than Wall Street expected.
Finally, Meta reported $12.5 billion in FCF, representing an FCF margin of over 34%. It's safe to say Meta remains a cash flow machine with pretty insane margins.
This allowed it to repurchase $14.6 billion worth of shares in Q1 and pay its first dividend of $1.3 billion in the quarter. Even as these expenses exceeded FCF, Zuckerberg and co. have little to worry about, as the company still ended the quarter with $58.1 billion in cash and just $18.4 billion in debt.
This company is firing on all cylinders and maintains a pristine balance sheet. Just tremendous!
AI remains a leading subject and for good reason
Of course, during the earnings call, AI was once again at the center of it all, with the technology mentioned tens of times. To be precise, including the Q&A, AI was mentioned 106 times, but for good reasons!
Meta’s possibilities with AI through both integrations into its existing apps and services and potential new offerings are incredible. Through its apps, it has a massive customer base it can easily reach without too much effort, which gives it an important edge. This is what management said during the earnings call with regard to these opportunities:
“We are building a number of different AI services from Meta AI, our AI assistant that you can ask any question across our apps and glasses, to creator AIs that help creators engage their communities and that fans can interact with, to business AIs that we think every business eventually on our platform will use to help customers buy things and get customer support, to internal coding and development AIs, to hardware like glasses for people to interact with AIs and a lot more.”
There also was this quote from the earnings call regarding ways to earn money with these services:
“There are several ways to build a massive business here, including scaling business messaging, introducing ads or paid content into AI interactions, and enabling people to pay to use bigger AI models and access more compute.”
Of course, it is also worth pointing out here that AI has already been an important technology in Meta’s apps for years, used to improve a person’s feed and overall user engagement. Today, roughly 30% of content people see on Facebook and 50% on Instagram is delivered by an AI recommendation system, which has more than doubled in a few years.
As AI advances further, and Meta is a technology leader on this front, these capabilities alone should improve strongly, improving engagement and, therefore, ad value. But of course, Meta’s possibilities in AI reach even further than this.
Meta is seeing the rollout of Meta AI progress well. After testing the software since last fall, management is now confident enough in its quality that it will start rolling out the AI model to the larger public in English-speaking countries.
Meta released its latest LLM in recent weeks, Llama 3. With 8 billion and 70 billion parameter models, the model is best-in-class for its scale. Meanwhile, Meta is already working on a 400-plus parameter model, which should be industry-leading by the time it's finished and position Meta favorably within the AI assistants/services industry.
For reference, the AI as a service industry is projected to grow at a staggering 33% CAGR through 2032, reaching a value of $124 billion, according to projections from Global Market Insights. Clearly, this is a big opportunity for Meta, which is positioning itself as a leader already! Meta claims its AI assistant is the most advanced and highest quality.
Recognizing this potential, AI is now very much the investment focus for Meta. However, management did clarify that this will be another multi-year investment cycle paying off in several years. This tempered Wall Street expectations, which led to some pushback from investors looking at Wednesday's share price movements aftermarket.
Meta management explained that it will invest “significantly” in more infrastructure for AI in the coming years. Investors seem to worry about profitability, fearing Meta will throw more cash into the bottomless Metaverse again, and understandably so. Metaverse losses have now risen to close to $46 billion since the end of 2020, which is insane and has shown little return. Therefore, the news of even more investments into a technology that should pay off in several years wasn’t well received.
However, considering AI's significance worldwide and across industries and Meta’s position here, it seems like a good choice and an investment with terrific potential. However, Zuckerberg indicated that the scaling, development of services, and integration into apps will be one of the largest it has ever done and will take “several years” to be completed and start paying off. Investors will need to be somewhat patient here.
As pointed out by management during the earnings call, Meta has a strong track record of integrating new services and technologies into its leading apps and monetizing these effectively. As a result, I do not view the new investment cycle as a big negative or a massive risk, especially with its Family of Apps still firing on all cylinders, driven by an uptick in the digital advertising industry.
Above all, Meta further diversifying its revenue streams through AI would definitely be a big positive.
Outlook & Valuation
Clearly, Meta is seeing strong advertising demand for its Family of Apps, so growth is also expected to remain relatively strong heading into Q2. Management now guides revenue to be in the range of $36.5 billion to $39 billion, representing YoY growth of roughly 18.5% at the midpoint.
Now, while this might not sound overly impressive, considering the 27% growth in Q1, we should consider that Q2 last year already showed the first signs of recovery and that economic growth is slowing down, potentially putting a break on growing advertising budgets. Therefore, I view 18% growth as pretty solid.
Meanwhile, the bigger setback for investors seems to be the meaningfully increased Capex budget, boosting the expense guidance. For the full year, management now expects to spend $35 billion to $40 billion, up from $30 billion to $37 billion, which is quite a meaningful increase to fund its AI infrastructure expansion plans.
This, of course, also leads to an increase in 2024 expenses overall, now expected to be in the range of $96 billion to $99 billion, up from a previous $94 billion to $99 billion. This will lead to slightly lower profitability.
For the following years, we can expect a similar trend, with management guiding Capex to continue growing significantly to fund its plans, potentially pushing margins down a bit, though not overly much, thanks to cost savings in other areas.
All things considered, we do not view it as too much of a thesis-changer and have only slightly lowered our profitability forecast, offset slightly by marginally increased revenue projections. This leads to the following financial projections, including lowered profitability projections for the second half of 2024.
Based on these estimates and a share price of $441, shares now trade at only 22x this year’s earnings, which is just below its 5-year average and far from expensive considering the company’s prospects and incredible moat. Yes, we do acknowledge this company is rather cyclical, but we firmly believe this kind of moat and growth profile certainly deserves more of a premium. For reference, Google is trading closer to 24x earnings.
Honestly, we believe a 24x multiple is fair for Meta. Still, considering some investor pushback on management’s heavy investing plans, we’ll use a 23x multiple to be conservative, which is also in line with its 5-year average.
However, even based on this conservative multiple, shares continue to present investors with significant upside and potentially market-beating returns. Using our FY25 EPS projection and a 23x multiple, we calculate a target price of $531, representing potential returns of 11.2% annually. This should be enough to beat global indices while offering additional upside.
Therefore, we remain very bullish on Meta and view this earnings sell-off as a great opportunity to buy shares at a discount. Clearly, the market is overreacting, so we suggest taking advantage of it.
We most certainly are looking to add some shares.
Let us know your thoughts in the comments! Also, please leave a like if this post was of value to you!
Please remember that this is no financial or investment advice and is for educational and informative purposes only. We are simply sharing our views, actions, and opinions, which we hope will be insightful!
Nicely done. I’m inclined to believe you but think they really need to do something with their metaverse division, Reality Labs. Cumulative operating loss since 2020 is now $46 billion ($3.5 billion in Q1). Just an elephant graveyard of capital.
Great commentary Daan.
Post earnings movements lately have just been insane. Look at $SOFI yesterday. Opportunities galore.