Kevin Dietsch
Meta Platforms, Inc. (NASDAQ:META), like many of its peers, has been diligently coping with the year-long slump in social media ad demand due to the combination of industry-specific and macro-driven challenges by “cutting jobs and culling projects that are no longer seen as a priority” to preserve margins. And CEO Mark Zuckerberg’s vision for a “year of efficiency” appears to be paying off so far.
The company reported a strong double beat for the first quarter, with a robust guidance set for the current period supportive of consistent progress in regaining share within the digital advertising market after a tough year navigating through macro adversities, alongside added pressure from having to overcome Apple Inc.’s (AAPL) signal loss. Meta’s delivery of sustained progress in preserving margins amid a difficult demand and operating environment also bodes favorably, with investors’ continued focus and preference for durable profitability amid signs of ongoing economic deterioration.
Considering META stock’s rapid run-up this year, much of the investor optimism over incremental value driven by ongoing initiatives in bolstering efficiency within Meta’s underlying business has likely been priced in, with continued momentum in the shares’ upsurge supported by the company’s consistent delivery of progress. The next core focus for investors would likely shift towards Meta’s ability to capture incremental ad dollars after related spending left social media formats following the double-whammy of Apple’s signal loss, followed by mounting macroeconomic uncertainties over the past year. We view Meta’s solid guidance for the current quarter as supportive of said investors’ demand, which continues to sustain optimism over the durability of the stock’s upside potential through the year.
Aggressive Cost Cuts Are Preserving Margins Without Compromising Growth
Meta’s vision for its year of efficiency has continued to play out with consistent progress. First quarter operating margins continued to improve, expanding five percentage points from 74% during the fourth quarter to 79%. The impact of aggressive cost reduction initiatives implemented over the past several months, including workplace consolidation and job cuts, were also evident in opex despite one-time restructuring charges, with operating margins expanding five percentage points from 19.9% during the fourth quarter to 25% during the first quarter.
As mentioned in the earlier section, the results were in line with management’s revised opex guidance released in mid-March after completing the reduction of its workforce by 11,000 positions announced earlier in November, and foreshadow further improvements ahead. The company also announced at the time incremental plans to cut another 10,000 positions, alongside elimination of “about 5,000 additional open roles” in the coming weeks. This has accordingly led consensus estimates for current year earnings to re-rate upwards by 15% over the past quarter, outperforming expectations for the broader tech sector’s earnings to finish 7.7% lower in 2023. And Meta continues to progress favorably on the trajectory towards market expectations for outsized profit outperformance this year, with first quarter earnings of $2.20 per share, beating the consensus estimate of $1.97 per share.
Meanwhile, guided opex for the current quarter implies a continued pace for margin expansion, as cost reductions from the completion of recently announced job cuts and project cancellations are expected to place a more evident impact on earnings through the second half of the year. Specifically, management has lowered its opex guidance for a second time this year, from a revised range of $96 billion to $100 billion in mid-March to now $86 billion to $90 billion, inclusive of one-time restructuring costs in the range of $3 billion to $5 billion. With the average estimate for full year revenue at about $122 billion – consistent with reaccelerated growth observed in the first quarter and management’s better-than-expected guidance for the second quarter – the revised opex guidance would imply operating margins of 26% to 30%, bolstering optimism over the durability of the stock’s uptrend this year.
The Need for Incremental Ad Spend Towards Meta
Easing PY comps after a full year of lapping post-IDFA revenues, alongside consistent signs of improvement on ad take-rates following the roll-out of new formats aimed at restoring effectiveness of targeted delivery continue to contribute favorably towards restoring investors’ confidence in the stock. With revenue returning to growth at 3% y/y (or +6% y/y constant currency basis) towards $28.6 billion during the first quarter – which outperformed both management’s guidance and consensus estimates – Meta continues to demonstrate an unmatched ability in overcoming acute challenges facing its business, reversing a bleak outlook clouded by industry-specific and macro-driven challenges with consistent progress towards restoring its leadership in social media advertising.
Looking ahead, investors will likely place greater focus towards Meta’s ability in recouping ad dollars previously lost to competitors during the peak of post-IDFA challenges, despite the looming overhang of impending recession risks over the inherently macro-sensitive industry. And we view Meta’s revenue guidance for the current quarter supportive of gradual progress on this front. Specifically, by guiding revenue growth of 2% y/y to 11% y/y towards $29.5 billion to $32 billion for the current quarter, Meta looks well-positioned to outperform current consensus estimates for full year sales expansion by 4.8% y/y towards $122.2 billion by the end of the year, taking into consideration seasonality-driven demand acceleration typically expected during the second half. This compares with market expectations for broader tech sector sales to finish 0.5% lower this year on average amid persistent macroeconomic weakness, with Meta’s anticipated outperformance reinforcing bullish narratives over the durability of the stock’s uptrend this year.
In addition to its tech peers, Meta is also expected to outperform within the social media subfield of the broader digital advertising industry. Admittedly, risks of a recession later this year remain elevated as economic data continues to exhibit signs of continued deterioration in financial conditions. Declining retail sales for the second consecutive month by 1% y/y observed in March, despite the decelerating pace of price increases over the past quarter, alongside “emerging cracks” in the resilient labor market points to a continued slowdown that would weigh further on ad demand over the coming months.
This has accordingly led to a conservative forecast on the broader digital advertising industry’s expansion this year. Media intelligence company Magna Global reduced its growth expectations for all-media ad demand this year by 30 bps from +3.7% y/y in December to +3.4% y/y during March, primarily dragged by “mixed macro-economic signals,” offset by easier PY comps from stalled demand observed in late 2022. However, the digital advertising subfield will likely perform better amid vulnerabilities to the uncertain macroeconomic climate given secular growth trends, with demand expansion estimated at 9% this year.
Looking at the economic environment, concerns about the financial system are grabbing headlines in recent weeks, but the economic fundamentals are stronger than 2008 or 2020, and several indicators have in fact stabilized or improved in the last few months…With food inflation slowing down, gas prices back to pre-Ukraine levels, and unemployment remaining low, the consumer confidence index has recovered from its all-time low of 50 in June 2022, to reach 57 in November, and 67 in February. However, 67 is still low by historical standards; consumers and marketers are likely to get nervous and cautious again following the recent turbulence in the banking system and stock market…Marketing activity and advertising spending are typically vulnerable in times of economic slowdown and low visibility.
Source: “U.S. Advertising Market Remains Resilient Thanks to Media Innovation”, Magna Global, March 2023.
Although social media ad formats are expected to trail the broader industry’s performance, which remains subdued given ongoing macroeconomic uncertainties, they are expected to reaccelerate this year from 2% y/y growth in 2022 towards 6% y/y growth in 2023, helped primarily by easing PY comps coming off of normalizing “data targeting limitations established in 2021.” And Meta continues to exhibit strength in leading the anticipated recovery in social media ads.
As discussed in our recent coverage on the stock, Meta continues to demonstrate structural improvements to its ad targeting effectiveness after a swift diversion of focus towards bolstering its AI capabilities at the onset of post-IDFA challenges announced in 2021. Robust first quarter results and the solid second quarter guidance continue to corroborate strong ad take-rates as the Advantage+ format ramps up alongside improving Reels engagement. This is consistent with acceleration in ad impressions from 23% in the fourth quarter to 26% during the fourth quarter despite decelerating average price per ads, suggesting stabilizing ad demand despite a slow growing ad market. Specifically, enhanced returns on ad spending (“ROAS”) and lower overall costs enabled by AI-driven efficiencies in ad creation and deployment via the Advantage+ format remains a key competitive advantage at Meta in mitigating the company’s exposure to the acute challenges of persistent macro-driven and industry-specific challenges.
The company’s recent announcement to integrate generative AI capabilities into its ad formats to further improve the effectiveness and economics of ad delivery, as well as measurability of performance metrics is expected to further bolster Meta’s case in capturing incremental ad dollars amid ongoing macro-driven conservatism in demand within the industry – something we view as key to unlocking further upside to the stock by complementing existing optimism over operational efficiency-induced margin expansion. As discussed in our previous coverage, Meta’s recently announced plans to integrate generative AI capabilities into its ad formats is expected to complement Advantage+’s ongoing ramp-up:
And in the latest development, Meta has announced plans earlier this month to commercialize its achievements in generative AI via its portfolio of ad offerings by the end of the year. While Advantage+ already depends on AI/ML to automate and optimize ad creation, delivery and placements, the added implementation of generative AI capabilities can further “improve an ad’s effectiveness partly by telling the advertiser what tools to use in making it”…
Source: “Meta Platforms Q1 2023 Earnings Preview: The Bar Is Still Low.”
[CTO Andrew Bosworth] said that instead of a company using a single image in an advertising campaign, it can “ask the AI, ‘Make images for my company that work for different audiences.’ And it can save a lot of time and money.”
Source: Nikkei Asia.
This is also consistent with key rival Google’s (GOOG / GOOGL) plans announced earlier this week to integrate its generative AI chatbot, “Bard,” into its ad business to enable creation of “sophisticated campaigns”:
According to the internal presentation, advertisers can give certain types of content, such as images, videos or texts and the generative AI tools will “remix” it to generate ads depending upon the audiences or sales targets.
Source: Seeking Alpha.
With Meta being the only social media ad distribution format with a pioneering role in generative AI innovations to compete against rivals in the broader digital advertising industry, the company continues to exhibit a competitive advantage favorable to its ongoing efforts in attracting incremental ad dollar allocations needed for bolstering its valuation prospects.
The Bottom Line
After more than doubling its valuation since sentiment bottomed in November, Meta Platforms, Inc. price action ensuing from the year of efficiency narrative, alongside easing PY comps from post-IDFA challenges is expected to lose steam over the coming months. Focus will likely revert to Meta’s underlying operational durability, which will drive a growing search for evidence that the company is attracting incremental ad dollar allocation as Advantage+ ramps up, alongside adoption of generative AI enabled innovations later this year.
With Meta’s forward guidance indicative of favorable progress on that front – which is also in line with its commitment last year to actively restore growth momentum via a multi-year roadmap to revamp its approach towards digital advertising with greater focus on AI/ML capabilities – we expect continued durability to the stock’s uptrend. Meta continues to trade at favorable levels considering its current discount relative to both its historical average and its peer group, which remains sufficiently de-risked for near-term macro uncertainties despite the stock’s run-up this year. This, accordingly, leaves further headroom for upside realization in Meta Platforms, Inc. stock to account for the anticipated continuation of favorable progress in recouping social media ad dollars, alongside the return of cyclical tailwinds over the longer-term.
