To The Moon

Meta Platforms: A Top Pick Even After 100% Jump

Summary

• Meta Platforms has bounced strongly from the lows.
• User growth was slow, but respectable, but it was instead a sentiment shift that defined the narrative.
• The company appears committed to controlling costs, rightsizing CapEx spend, and repurchasing stock.
• Trading at 20x earnings, META stock can still soar higher as multiples expand.
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The 2022 year saw tech stocks crash. While the bulk of the losses were in unprofitable names, the crash ended up pulling down $Meta Platforms, Inc.(META)$(NASDAQ:META) in spite of its high GAAP profit margins. Itappears that the stock is ready to break the trend. The stock has doubled from the lows and sentiment has changed for the better, as Wall Street seems to finally believe that the company is focused on profit margins. While the company continues to invest heavily in its metaverse segment Reality Labs, the company’s commitment to making 2023 “the year of efficiency” and its newly announced $40 billion share repurchase program may help the stock continue re-rating higher. META remains a top pick - even if plans to ban TikTok do not materialize.

META Stock Price

After falling heavily from2021 highs, META has rallied strongly from the lows, making its fall over the past 52-weeks look more modest.

Data byYCharts

Ilast covered META in January where I rated it a buy on account of the overly pessimistic valuation. The stock has since returned 50%, but I see significant upside still ahead as the sentiment trade has more room to it.

META Stock Key Metrics

After previously guiding to revenues between $30 billion to $32.5 billion, META delivered $32.2 billion in revenues in the quarter.

2022 Q4 Presentation

The company operating margin stayed steady sequentially at 20%, representing a steep 1,700 bps decline YOY. That margin contraction was in large part due to the increasing losses in Reality Labs, which hit $4.3 billion in the quarter. Family of Apps operating margin stood solid at 34%.

It is worth noting that operating expenses continued to grow as headcount grew 20% YOY. META had previously announced alayoff of 11,000 employees in last Novemberbut that will not show up in operating results until the end of the first quarter of 2023 (so it will probably also affect the next quarter’s earnings results).

Earnings declined by more than 50% to $1.76 per share.

2022 Q4 Presentation

That was higher than the 49% decline in operating income as the 500 bps expansion in the tax rate more than offset share repurchases. The company notes that it had recorded $4.2 billion in restructuring charges during the quarter which impacted operating margins by 13 percentage points. Diluted EPS would have been $1.24 higher absent those charges.

The resilience of the profit margin is already impressive given the tough macro backdrop, but I was most impressed by the operating metrics. META continued to grow its monthly active users across its platforms, seeing 4.2% overall growth YOY to 3.74 billion.

2022 Q4 Presentation

That growth rate is all the more impressive when factoring in the slow growth rates at the maturing Facebook platform, which saw growth of only 1.8% YOY in the quarter (that is arguably very respectable considering that younger generations do not seem to care for the platform).

2022 Q4 Presentation

While average revenue per user (‘ARPU’) declined YOY, that 6.1% decline was rather modest especially compared 15% decline seen at SNAP.

2022 Q4 Presentation

Capital expenditures continued to grow rapidly as the $32 billion spent in the full year represented 67% growth YOY.

2022 Q4 Presentation

The company ended the quarter with $40.7 billion in cash versus $9.9 billion in debt. After the recent rally, net cash made up just around 6% of the market cap.

Looking ahead, META is guiding for revenue between $26 billion and $28.5 billion (first quarter revenues were $27.9 billion in 2022). That guidance includes a 2% projected headwind from foreign currency.

Given the deteriorating profitability and rising CapEx spend, one may wonder: why has the stock rallied so strongly in recent months? The answer is sentiment. The layoffs announced last November have helped set the tone. The company remains committed to its share repurchase program as it repurchased $6.9 billion of stock in the quarter and $27.93 billion in the full year. For reference, free cash flow was $5.3 billion and $18.5 billion in the quarter and full year, respectively. The company announced a $40 billion increase to its share repurchase program (it had $10.87 billion available under the prior authorization).

What’s more, META lowered its full-year expense outlook to a range of $89-95 billion, down from the prior outlook of $94-100 billion. META also lowered its CapEx outlook to a range of $30-33 billion, down from their prior estimate of $34-37 billion. If investors were worried that CapEx would grow sizably again, such fears have been alleviated. On theconference call, management stated that the reduction was attributable to their shifting to a more “cost efficient” data center architecture that can support both AI and non-AI workloads.

CEO Zuckerberg went on to call 2023 “the Year of Efficiency,” a term which seems to have caught on with investors. In addition to the aforementioned cost reduction efforts, management also touted its improvements in AI - which among other things is expected to help the company improve the monetization efficiency of the fast growing Reels (the company’s answer to competitor TikTok). Regarding Reels, management expects the revenue headwinds from its lower monetization rates to persist until early next year before the company returns to growth.

The company had previously also been battling the data privacy changes from Apple (AAPL). The company noted that while it still was experiencing headwinds, it will be now lapping its rollout and expects its AI investments to help offset the headwinds over time.

To cap it all off, META also committed to “slower payroll growth” as it noted that it has “a broad hiring freeze in place right now.” This isn't just talk - META announced anew 10,000 layoff in March. These are exactly what the market wanted, as this has been a market which has been willing to overlook near term growth headwinds so long as companies show a commitment to profit margins. META may face some headwinds on top-line growth in the near term, but investors can now look forward to an increased focus on profit margins to compensate for it.

Is META Stock A Buy, Sell, or Hold?

Even after the steep jump from lows, META is still too cheap at just around 21x forward earnings. Perhaps that is not so surprising considering that the stock remains around 50% lower than 2021 highs.

Seeking Alpha

While I expect growth to return in earnest at some point when the economy stabilizes, that might not be necessary for strong returns from here. I can see the stock deliver strong returns based on multiple expansion alone. Based on consensus estimates for 22% growth and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see META trading at 33x earnings. I note that the company continues to buy back stock and earnings might be 67% higher excluding Reality Labs spending. At some point I expect Reality Labs to either start producing profits or for CEO Zuckerberg to give up on his metaverse ambitions - either result may prove to be a real catalyst for strong upside. For a name with over $30 billion in net cash, the stock looks highly attractive here even after the bounce from the lows.

What are the key risks here? It is difficult to forecast how the company might perform under the tough macro conditions. While I expect the company to continue to benefit from the secular trend of online advertising, that will probably be unable to offset declining demand in a tightening environment. The company is thus likely to report depressed revenues - and earnings - in the near term as it navigates recessionary risks. I don’t expect the company to turn unprofitable in such a scenario and even if it were to in the near term, the net cash balance sheet is present to fund any cash shortfalls. Longer term risks stem from the company’s reliance on user data. The company was greatly affected by the iOS ATT changes and may also be negatively impacted when Alphabet (GOOGL) eventually rolls out its own similar changes. It is possible that its AI investments may prove unable to offset such headwinds. Even though META is the most dominant social media platform, it is possible that it loses market share to newer rivals moving forward. While threats from Snapchat (SNAP) have appeared to dissipate in recent years, TikTok remains a formidable competitor. Investors hoping for aban of TikTok in the United Statesmay be disappointed as I find such a scenario to be highly unlikely - and that may lead to near term volatility as the stock may be pricing in some likelihood of a ban. From my own anecdotal experience, META’s Instagram seems to be doing a better job of recommending new posts, but I am admittedly of the wrong demographic in determining the company’s progress relative to TikTok. In spite of these risks, the company’s strong profit margins, visible levers to boost margins, and reasonable valuation make it look like a perfect stock for the current environment. I view a portfolio of profitable tech stocks as being thebest strategy for 2023- META is one of my top picks in such a portfolio.

Source: Seeking Alpha