Meta Platforms (NASDAQ:META) has staged one of the strongest recoveries in big tech this year, with its shares gaining close to 80% on a year-to-date basis and more than 140% from its November 2022 trough. The stock has been one of the biggest beneficiaries of this year’s tech rally as optimism grows on monetary policy easing in the second half, alongside a broad-based rotation back into big tech amid the banking sector turmoil. And specific to Meta, aggressive cost cutting initiatives implemented in recent months have also been crucial to restoring investor confidence, while evident enhancements to its previously-reeling advertising business alongside expectations for easing PY comps in the second half remain core drivers for potential fundamental and valuation improvements going forward.
Meta’s stock currently trades at an estimated earnings multiple that is about 35% below its historical 10-year average of 26x, and remains relatively less expensive compared to valuation multiples observed across its big tech peers and the broader tech-heavy Nasdaq 100. The bar is also set relatively low given the stock’s relatively modest valuation over the past year has already sufficiently de-risked for anticipated macro sensitivities ahead. The company’s upcoming earnings release will likely take on the role of an informative session for reinforcing investors’ growing optimism and serve as a potential positive catalyst to further the stock’s rally. Considering consistent progress over the restoration of Meta’s structural advantage within the ailing social media advertising industry, and improved sentiment on the business’ outlook and capability in overcoming near-term macro-driven and industry-specific challenges, the company’s near-term fundamental prospects are expected to remain durable and help sustain the stock’s performance even in the midst of a looming economic slowdown.
Structural Advantage in Social Media Ads
While sentiment has improved for Meta, expectations remain on the conservative end as many stay cautious about near-term ad demand in the macro-sensitive industry. It also remains uncertain on the extent of which optimism has been priced into the stock pertaining to Meta’s aggressive margin preservation efforts in recent months will reflect as reality in its fundamental performance. Meanwhile, it is expected that capital spending will remain substantial, nonetheless, to ensure restoration of effectiveness in its core targeted ads business, second to investments in speculative long-term growth projects like the metaverse. While consensus expectations on Meta’s near-term performance have grown, they remain at a modest pace, which further corroborates cautious optimism among investors still regarding the company’s recovery.
But after a tough year on righting its course, sentiment checks performed in the broader ad industry implies Meta might be starting to see a meaningful payoff, indicative of a potential 1Q positive surprise. Specifically, sentiment over both U.S. and global ad spend appears to have improved from the December quarter, with demand still largely robust in verticals like travel and automotive despite an ongoing overhang from looming macro uncertainties. While ad sales were flat during the 4Q22 from the prior year period, global demand within the industry during the first quarter is expected to have increased by 2% y/y, inclusive of considerations for a seasonality slowdown.
Specifically, persistently prominent macro headwinds in the first half of the year, paired with easing prior year comps in the second half of the year provides a “back-end-loaded” set-up for the digital advertising industry. Although social media ads are expected to remain the largest declining segment this year, Meta’s structural improvement with its AI-driven Advantage+ format will be a key competitive advantage in mitigating the company’s exposure to the acute challenges of persistent macro-driven and industry-specific challenges – namely, the ongoing impact of Apple (AAPL) signal loss which has upended targeted advertising.
Based on recent industry sentiment checks performed by RBC Capital Markets, the perception on Advantage+’s effectiveness and performance is improving. This builds on observations of enhanced returns on ad spending (“ROAS”) and lower overall costs without compromising on engagement and conversion performance upon early stage roll-out of Advantage+ as discussed in an earlier coverage.
The effectiveness of Advantage+ in partially compensating for challenges stemming from Apple’s signal loss is further corroborated by positive user feedback. Close to half of Advantage+ users recently surveyed by RBC Capital Markets is “seeing [key performance indicator] improvement around campaign performance…, while half of those that reported ROAS improvement attributed it to Advantage+”.
Source: “A+ for Advantage+”
Specific to Advantage+, the new ad distribution format has already been well-received by certain verticals that had initial access to the feature, with many observing better return on ad spending (“ROAS”) and lower overall costs (see more here). However, we expect ad sales to remain muted in the fourth quarter for Meta given advertisers remain in a conservative stance amid mounting macroeconomic uncertainties, and are progressively favouring discounts and promotions this holiday season instead to reach price-sensitive consumers under the current inflationary environment.
Source: “Meta Platforms: Expect More Turbulence In 2023”
While ad sales growth, normalized for FX, remained modest as expected in the second half of 2022 due to conservative ad spend, the improved economics and performance enabled by Advantage+ remains a competitive advantage for Meta in its attempt to clawback previously lost market share and rise on top in the diminishing TAM for social media ads against peers like Snap (SNAP) and Pinterest (PINS). The upcoming earnings release will likely be a key gauge on whether there has been incremental allocation of ad spend to Advantage+ despite the broader decline in social media ad demand due to persistent macro and industry-driven headwinds. Any signs of continued improvements to Advantage+ take-rates – even if modest – will likely complement Meta’s ongoing cost optimization efforts as well, thus reinforcing profitability and cash flows needed to sustain growing optimism on its recovery.
This is corroborated by EPS estimates for Meta which have increased by 15% on average during the first quarter, outperforming expectations for a 15% decline in profits on average among the broader tech industry, and an 8% decline in profits on average for the broader S&P 500 as markets expect corporate fundamentals to take a turn for the worse since 2009 ahead of the looming economic downturn. As such, improving Advantage+ performance metrics will be a key focus area ahead of the social media giant’s upcoming earnings release, as investors look for signs of Meta’s ability in clawing back on previously lost market share and recapturing incremental ad spend needed to unlock incremental fuel to the stock’s recovery.
A Pioneering Role in Generative AI
AI has always been at the core of Meta’s business, ranging from ad distribution formats like Advantage+ to social media features like Reels discovery. This has allowed Meta to swiftly join in on the conversation over generative AI via organic developments, unlike peers like Snap which have needed to forge strategic partnerships with external providers of large language models (“LLMs”) to enable related solutions. As discussed in detail in our previous coverage on the stock, Meta has put its name on the map of pioneers leading the development of generative AI with the recent introduction of Large Language Model Meta AI, or “LLaMA”, a non-commercial service that makes its compilation of LLMs available to researchers aimed at making further advancements to the nascent technology.
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”:
[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 consistent with our previous expectations that while LLaMA is not directly monetizable by Meta over the immediate term, it potentially paves the way for cost-effective LLM deployment in the future, while also enabling cost-efficient solutions critical to growing and retaining its SMB-focused customer base. As discussed in our previous coverage, “growth opportunities stemming from demand for generative AI is expected to grow at a CAGR of more than 30% towards the end of the decade and potentially become a $50+ billion market”. This accordingly complements favourable secular tailwinds in digital advertising, bolstering Meta’s ability in mitigating, and potentially, overcoming challenges facing social media ads over the medium- to longer-term.
The anticipated roll-out of generative AI capabilities across Meta’s ad formats also coincides with an anticipated back-end-loaded year for digital ad demand alongside continued take-rate improvements enabled by Advantage+. This will likely support continued durability to Meta’s fundamental improvements observed in recent quarters, and offset potential impacts from the impending recession later this year. Specifically, recent economic data – including a stubbornly tight labour market encouraging of further rate hikes, uncertainties over the banking sector turmoil, and deterioration in consumer spending power that is becoming “increasingly reliant upon credit” – continue to indicate a potentially inevitable recession before the end of the year. And considering Meta’s recession-prone SMB-heavy customer base, the anticipated roll out of generative AI-enabled ad formats capable of driving cost and performance efficiencies will be critical to mitigating impacts from the cyclical industry downturn on the company’s ongoing fundamental improvement trajectory.
The Bottom Line
Meta’s stock currently trades at about 17x estimated earnings, which remains well below its 10-year average of 26x. Even taking into consideration moderating growth and profitability in the underlying business over recent quarters, the stock continues to trade at a low multiple relative to its big tech peers and continues to underperform the tech-heavy Nasdaq 100’s current valuation of 24x estimated earnings.
Yet, Meta continues to demonstrate commitment towards remaining the leader in social media advertising, with a proven structural advantage in overcoming the persistent macro-driven and industry-specific challenges facing the industry compared to peers like Snap and Pinterest. And diversification into generative AI with commercialization of related technologies is also expected to further reinforce Meta’s ad recovery strategy, and support a sustained trajectory of fundamental and valuation improvement over the longer-term.
In the meantime, the market’s optimism for Meta’s fundamental performance likely remains cautious still, with acknowledgement of the broader ad industry’s inherently macro-sensitive nature, alongside ongoing hurdles in regaining ad targeting effectiveness. The conservatism is largely corroborated by still-subdued market forecasts for social media ad demand this year as discussed in the earlier section, setting a low bar of expectations in which Meta is potentially well-positioned to outperform.
Looking ahead, Meta’s first quarter earnings release (scheduled for April 26) will be a tell-tale on whether the company can differentiate itself from what is expected to be the worst fundamental pullback across big tech since 2009. Any details supportive of restored market share gains in digital advertising with the ramp up of Advantage+, and commercialization/monetization of upcoming generative AI developments will be key to ensuring durability of the stock’s latest rally. With anticipation for a back-end-heavy demand environment for Meta to support incremental fundamental improvements through the year, and macro headwinds potentially subsiding entering 2024, the company looks to be gradually regaining its footing as a prominent name in big tech after a tumultuous 2022.
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