Alphabet: A Q3 Beat Will Return the Stock’s Momentum, Says Morgan Stanley

Morgan Stanley’s Brian Nowak today reiterates an Overweight rating on shares of Alphabet (GOOGL), and raise his price target $10 to $1,050, after concluding that a beat on revenue in Q3 can return “turn sentiment” and bring investors back to its lagging stock.

Alphabet’s stock has been weak, he writes, “lagging our large-cap universe by ~650bp YTD” compared to shares of Amazon (AMZN), Expedia (EXPE), and eBay (EBAY), among others, up just 3% this quarter and 21% for the year.

Moreover, the “current EV/EBITDA [is] a 25% discount to its peer-based regression multiple.”

So, writes Nowak, investors often ask him “what will turn GOOGL sentiment and drive outperformance?”

Nowak thinks a Q3 beat will do it, and he’s modeling revenue of $27.46 billion and EPS of $8.67, which is up from what he had been modeling previously as $27 billion and $8.54. That is above the consensus for $27.15 billion and $8.32 per share.

Among the elements of the beat, “We model ~20% y/y ex FX Websites revenue growth, based on accelerating RKG Merkle digital ad checks, historical 1-and-2 year stacked growth patterns, and our U.S. bottom-up ad market sanity check implying GOOGL drives 46% of overall US online ad growth, vs 44% in 2Q:17,” writes Nowak.

“We haven’t heard of any emerging online ad player that would change this contribution to growth trajectory in 3Q…and note too that if anything our implied 2-year growth deceleration could prove conservative.”

Mind you, Google’s “traffic acquisition cost,” or TAC, will continue the pattern of taking a bigger bite out of profit:

Given the relative unpredictability (our view) of GOOGL’s quarterly distribution TAC, we take a conservative approach and model reported distribution TAC to “consume” a rising percentage of incremental Google Websites revenue growth, modeling a 24% TAC contribution to growth in 3Q:17 up from 23% in 2Q and 19% in 1Q. As a further sanity check, our model implies that overall…

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