Shares of Facebook (NASDAQ:FB) gained 10% after the tech giant announced better than expected first-quarter results on April 29. FB stock has now made up all the ground it lost since the beginning of the year.
With people sheltered at home, user engagement numbers soared, as daily active users grew at an impressive 11% year over year. Additionally, the platforms monthly users climbed to 2.6 billion, up 10% from the prior-year quarter.
The company revenues were up by 18%, but down 8% from the same quarter last year. Excluding the $3 billion legal expense in the prior-year quarter, net income fell by 9.7%. Perhaps the company’s primary concern is its ad revenues.
In an interview with CNBC, Facebook’s Chief Financial Officer David Wehner said that there had been a broad-based pullback in advertising revenues from small and large enterprises. Nonetheless, Facebook’s problems seem to be short term in nature, and the FB stock is expected to soar in the latter half of the year.
Here are some of the reasons as to why I believe that the company’s apparent concerns are nothing to worry about.
FB Stock and the Balance Sheet
Facebook’s balance sheet numbers are robust and are enough to weather any storm that comes its way. In its latest quarter results, the cash and cash equivalents increased by 23.79%, and total assets outpaced total liabilities by 1.45%.
Working capital increased by 6%, continuing from where it left off in the previous year. The company’s current assets are roughly $70 billion, gaining handsomely in the past five years. Its marketable securities alone, are enough to cover its total liabilities.
In addition to this, shareholder equity also increased by 4.21% in the quarter. Facebook currently has zero long term debt, which is astounding for a company worth over $550 billion. It continues to grow organically with enough resources to cancel its minimal financial obligations.
Declining Ad Revenues
Social networking, live-streaming, and messaging platforms have witnessed a surge in online traffic, but that doesn’t necessarily lead to more conversions.
Facebook can only tap into this surging traffic if it is paid by its advertisers. However, ad spending has taken a significant hit. Additionally, small and medium-sized enterprises (SMEs) have also cut down on their advertising as part of their belt-tightening initiatives.
Marketing research company eMarketer estimates total media ad spending to increase to $691.7 billion, from $646 billion in the previous year. It expects a rebound in the second half of the year and forecasts a jump to $712 billion.
In the short term, though, Facebook is likely to suffer substantial losses due to their reliance on SMEs. However, on a recent conference call, CFO Dave Wehner revealed that ad spending is already starting to recover.
“After an initial steep decrease in ad revenue in March, we have seen signs of stability reflected in the first three weeks of April,” he said. Despite these affirmations, analysts expect a more significant deceleration in ad revenues in the second quarter.
The pullback in ad revenues is mainly dependent on how the SMEs recover in the second half of the year. The situation is still developing, but with countries around the world lifting restrictions, it is an encouraging sign for small businesses to kick start their business activities again.
Exploring New Avenues for Growth
Facebook is amongst the most innovative companies in the world, which continues to explore new opportunities for expansion. Recently, the company announced a suite of new products, including Messenger Rooms, to expand on its video presence.
Messenger Rooms enable users to start virtual hangouts with up to 50 users, who can pop in and out anytime. The company also announced that it would be rolling out new live-streaming features for Facebook and Instagram.
Additionally, Facebook also released its gaming mobile app, its most decisive move into the video game streaming business. With most of the world indoors, the video game business is soaring during the pandemic. Originally slated for release in June, the company decided to release the app in April once the scope of the pandemic became clear.
One of the most significant developments in the quarter was the company’s $5.7 billion investment in the minority stake of the Indian telecommunication giant Jio.
Jio has become India’s largest mobile network that is owned by India’s most successful conglomerate businesses, Reliance Industries. The network currently has over 387.5 million subscribers and has consistently added more customers since its launch in September 2016. India’s fragmented market presents a massive opportunity for Facebook to gain access to more consumers through its diverse services.
Valuation
The majority of analysts believe that FB stock is currently undervalued. Refinitiv data pegs the average price target for the company at $237. With FB stock price at $203, Refinitiv’s consensus estimates suggest that the company is undervalued by 17%.
Three of the top Wall Street firms, including JP Morgan and RBC Capital Markets, also believe the company is undervalued. The company’s forward PE ratio is 26.9, which is considerably lower than the current industry average at 33.6.
Therefore, it seems that the company’s multiples are not in line with the market and point towards an undervaluation. Hence, the stock is currently trading at a bargain, and investors can buy into the stock through an attractive entry point.
Bottom Line
Facebook has enough in the tank to fend off its short term challenges. Decreased ad spending is not going to continue forever, and profits will eventually rebound in the latter half of the year.
Even if the company’s performance in the year is sub-par, its strong fundamentals and cash reserves will ensure that it fends off short-term risks. It is currently free cash flow positive with sizeable assets to cater to its minimal liabilities. Therefore, this is the time to get a hold of the stock while it’s trading at a bargain.
As of this writing, Muslim Farooque did not hold a position in any of the aforementioned securities.
