Meta's Upcoming Earnings: Can It Weather the Storm?

After Meta released its Q4 earnings report for 23Q4, the stock price soared by 20.32% on the same day, not only due to strong earnings but also because the company announced a $50 billion increase in stock buybacks and its first dividend distribution during the earnings call, boosting the shareholder return rate to the 5% mark. However, this upcoming earnings release is not expected to see significant changes in shareholder returns. Without the "magic" of buybacks, can Meta still surprise investors?

It's worth noting that before Meta, tech giants like Netflix and TSMC have already posted their earnings, and despite stellar performance, their stock prices still faced a Waterloo under the high valuation pressure and market expectations. How will Meta's stock price perform after this earnings release?

As a social networking company, Meta fundamentally earns revenue through a suite of social media applications. Looking at the company's revenue composition, we can see that in 2023, 98.59% of Meta's income came from its social applications, the vast majority of which was advertising revenue, while the remaining less than 2% of income came from its Reality Labs business, which is currently operating at a loss. Therefore, it's fair to say that Meta is essentially an advertising company, and when analyzing it, we can utilize the logic of advertising revenue.

Chart: Main Business Composition

Advertising revenue has a very clear strong correlation with the macroeconomy. It can be understood that the reason for the increase in advertising industry revenue is because advertisers (i.e., companies that need to advertise) believe that consumers still have a very strong demand and purchasing power, and the advertisers themselves have sufficient budgets and are optimistic about future economic prospects. Therefore, they are willing to make substantial advertising investments to attract consumers. Whether consumers have sufficient purchasing power and whether corporate budgets are adequate are indicators of an active macroeconomy.

The U.S. economy remained very strong in the first quarter of 2024. Looking at retail sales month-over-month, U.S. retail sales in March increased by 0.7%, with the largest growth in e-commerce, while the February data, after revision, also showed a month-over-month retail sales increase of 0.9%, indicating that U.S. consumer spending continues to be resilient. In terms of employment data, nonfarm employment in the U.S. increased by 303,000 people in March, and the unemployment rate further declined to 3.8%, suggesting a very optimistic employment environment in the U.S. A positive employment climate is also an important factor supporting consumer spending.

Chart: Year-Over-Year Growth Rate of Advertising Rates (%)

Meta's advertising revenue growth rate continues to significantly outperform its peers this quarter for several reasons:

Meta owns globally renowned social media applications such as Facebook, Instagram, and WhatsApp, holding a near-monopolistic position in the social ecosystem. With such a large user base, the number of active users of the app continued to steadily increase according to the Q4 data from '23, reflecting the strong social ecosystem barriers.

With its massive user traffic, Meta naturally becomes the preferred choice for many advertisers.

Chart: Continuous Growth in DAU (Daily Active Users) for the Main Site Facebook (Millions; %)

Meta has fully utilized AI tools, launching many automated ad products that empower advertisers. The scalable Gen AI advertising tool has significantly increased the return on investment for ad placements.

Additionally, Meta possesses a powerful open-source AI model called "Llama," which was upgraded last week to "Llama 3" and included updates to the Meta AI chatbot assistant. Although "Llama" is not yet profitable, it showcases the company's strength in AI, and the path of AI empowering digital advertising has been proven successful.

As an internet company with a light-asset operation, Meta's net profit growth will significantly outpace revenue growth during the company's upward cycle.

With ongoing cost optimization and control, the company's expense ratio for the first quarter is expected to remain stable, with the sales-to-revenue ratio and general and administrative expenses ratio likely to see year-over-year reductions. Although R&D expenses may increase due to greater investment in AI, the R&D expense ratio is expected to remain at a normal level of around 43%.

Furthermore, the company's net profit declined by 23.52% year-over-year in Q1 '23. Under the effect of such a low base, the year-over-year growth rate of the company's net profit will be amplified, with the EPS growth rate in Q1 '24 expected to be close to 100%, but this is slower than the 202.84% in Q4 '23.

Chart: Operating Margin and Net Margin

The company previously projected revenues for Q1 '24 to be in the range of $34.5 to $37 billion, with current consensus estimates from Bloomberg at $36.223 billion, at the higher end of the guidance.

With the U.S. economy still very strong and e-commerce retail sales growing rapidly, digital advertising is expected to see further growth. Moreover, with Meta's vast social ecosystem advantage and strong AI capabilities continuously enhancing the product strength of its advertising tools, Meta's advertising revenue is set to significantly outpace its peers. It's anticipated that Q1 '24 revenues will approach $37 billion, slightly exceeding market expectations.

However, with ongoing cost optimization and the low base effect from Q1 '23, the year-over-year EPS growth rate for Q1 '24 is expected to be close to 100%. This represents a noticeable slowdown compared to the growth rates in Q4 '23 and Q3 '23.

Meta's explosive EPS growth started in the second half of '23, so under the effect of a high base, the performance growth rate for Meta may slow down significantly in the second half of '24, returning to a relatively stable growth level. Close attention should be paid to the performance guidance provided by management during the earnings call.

Meta's current valuation is not low, with a PE (TTM) of 32.4x. Such a valuation requires a very high growth rate to sustain. Therefore, if management mentions a slowdown in performance growth for the second half of the year during the earnings call, it could impact the company's stock price, potentially replicating the post-earnings stock price decline seen with Netflix last week.

In terms of shareholder returns, Meta announced a $50 billion buyback last quarter, and with a free cash flow of $43.847 billion for FY '23, assuming steady growth in '24, the company is expected to buy back approximately $30 to $40 billion, resulting in an annualized yield of roughly 2.5% to 3.3%. With the current risk-free rate in the U.S. at around 4.6%, a shareholder yield of 2.5% to 3.3% is not particularly attractive and is insufficient to provide a margin of safety for the company.