Meta Platforms, Inc. (NASDAQ:META) posted weaker-than-expected Q2 financial results. The report had some positives, including a low valuation and a robust financial sheet. Meta is interesting for long-term investors since its Metaverse investments should pay off.
Meta Missed on Both Lines
The 4% earnings miss wasn’t dramatic, but lower-than-expected profits aren’t good. Quarterly revenue was down, but only marginally. The market originally sent shares down 8% after the opening bell on Thursday.
Meta Platforms, one of the world’s largest tech businesses, is a growth stock. A 1% revenue decline is negative for a growth stock. There are several different aspects to consider, so we must go deeper. A strong U.S. dollar hurt Meta. When the currency rises, non-U.S. revenues are worth less in USD.
Forex swings significantly negatively influence Meta’s reported performance due to its exposure to non-U.S. markets (the company has billions of users while the US has only 330 million). Investors will be glad to hear that underlying sales growth in constant currency rates was likely higher. The results report didn’t break this out, but the company said current-quarter (Q3) revenues are down 6%. If the impact was comparable in the second quarter, organic revenue growth was around 5%. Considering Meta’s low valuation, that’s not an alarming growth rate for a tech business.
Meta Continues to Add Users
Meta’s business growth wasn’t spectacular but wasn’t horrible. Daily active users increased 3% year over year to 1.97 billion. A year ago, the epidemic was a significant issue; many stayed home and rarely traveled. This year, more people went out. This means they spend less time at home on their phones or tablets, which limits their social media use. The macro-environment hurt Meta’s daily active user (DAU) count.
Meta’s profits fell year-over-year due to rising costs. Meta’s U.S.-based team keeps costs in dollars. When the USD strengthens, revenues fall, but expenses don’t. Meta has invested considerably in its unprofitable Metaverse company. Meta’s CEO and visionary founder Mark Zuckerberg sees Metaverse as a long-term growth driver, but it will take several years to become viable and contribute to Meta’s bottom line. Metaverse is now losing money, which harms Meta’s near-term profitability.
Meta’s revenue fell, while expenses rose. This cut Meta’s profits by 32% and 36%, respectively. Analysts had projected a 32% fall in net income, not the 36% we saw. A growth company’s profit drop is terrible news. Profits should grow faster than revenue, not shrink.
Meta stays lucrative. Despite an increase in its tax rate, the company’s net margin was 23%. In contrast, Apple’s (NASDAQ:AAPL) net profit margin was 26% last year. Since a significant amount of the higher expenses causing the profit decline are an investment in future revenue sources, the near-term profit decline should not be overstated. Meta raised R&D investment by 43% year-over-year, or $2.6 billion. Meta’s EPS would have dropped by 10% instead of 32% if they hadn’t done that.
Meta’s R&D efforts have paid off in the past, as the company has grown rapidly, e.g., by incorporating Instagram reels. With the same leadership that brought success in the past and the belief that present investments will pay off in the future, we can expect that the current earnings reduction will be temporary and that the company will benefit from more robust business growth in the future.
Meta has made changes to its hiring changed recently. Slowing R&D isn’t a good idea if you’re passionate about new goods or markets, but cutting administrative costs can boost profitability without damaging long-term business growth. Meta has revised its full-year spending expectation from $87-$92 billion to $85-$88 billion, a $3 billion drop. Meta wants to be more efficient, which is excellent for shareholders. Even with the reduced spending projection, 2022 will be a down year compared to 2021.
Cheap Valuation, Good Cash Returns
Meta trades at 17x net profits if it earns $2.50 per quarter. It’s not an unreasonably expensive valuation for a company with a strong track record that’s spending aggressively on its next multibillion-dollar business. Mark Zuckerberg believes the Metaverse industry will grow as huge as social media over time. Investors who trust Mark Zuckerberg’s vision may see Facebook quadruple in 5-10 years, even without core business growth. A 17x earnings multiple when profits are artificially suppressed doesn’t seem costly.
Meta is valued at less than 7x projected EBITDA based on current expectations.
That’s 40% of the historic norm. Meta’s 3-year and 5-year median enterprise value to EBITDA multiples might improve by 160 percent if it gets back on the growth track and the market believes the prior valuation norm wasn’t too inaccurate. If it happens, it won’t be fast. The market will want to examine how Metaverse’s business progresses, expense trends, etc. Even if it took 5 years, the annual return would be good. Even a 160% increase over 10 years would be good, with 10% annual yields.
Long-term investors can benefit from Meta’s below-average value. Meta seems to agree, as it bought back $5 billion in Q2 and $20 billion annually. That’s better than Apple‘s buyback pace (3%-4% traditionally, less in the last two years).
Bottom Line
Meta’s situation isn’t ideal. Due to high expenses and large FX risk, the company failed earnings projections. But that doesn’t mean the company is dying. The company has a solid balance sheet with $40 billion in cash, and if management is right about the Metaverse, the current price could be low.
Meta investors are betting on the company’s continued growth. Investing in Meta may entail betting on Mark Zuckerberg’s vision. In the past, that worked, but there are no assurance Metaverse investments will pay off.
High expenses/investments are lowering Meta’s profitability. Despite lower profitability, shares are not costly and trade at a discount to historic valuation.
Featured Image: Megapixl @Wutzko
