Morning Note: Market news and updates from Alphabet and Assa Abloy.

Market News

US equities moved higher last night – S&P 500 (+0.7%); Nasdaq (+1.4%) – as investors navigate the trade war and earnings from Wall Street’s big tech companies. Google owner Alphabet (see below) fell 7% after hours.

In another sign of trade tensions between Washington and Beijing, the USPS suspended parcels from China and Hong Kong, a move that may disrupt Shein and Temu shipments. Trump earlier said he’s in no rush to talk to Xi Jinping. Gold continued to march upwards, hitting new all-time highs. It currently trades at $2,868 an ounce.

The Fed’s Mary Daly said the US economy is in a good position, and the central bank doesn’t need to react quickly to Trump’s policies. Philip Jefferson also said it’s appropriate to be cautious in adjusting rates, as long as the economy and labour market remain strong. The 10-year Treasury yield ticked up to 4.49%.

In Asia this morning, stocks were mixed: Nikkei 225 (+0.1%); Hang Seng (-0.9%); Shanghai Composite (-0.7%). The yen gained against the dollar. Caixin China services PMI unexpectedly fell to 51.0 versus a forecast of 52.4. The FTSE 100 is currently little changed at 8,570, while Sterling trades at $1.2510 and €1.2020.

Source: Bloomberg

Company News

Last night, Alphabet released quarterly results which were slightly below market expectations on revenue but ahead on earnings. The growth rate in the Cloud business was slightly disappointing and the market focused on the big step-up in capex forecast for 2025. The shares have had a strong run and needed a good set of results to keep the momentum going in the near term – this wasn’t the case, and the stock was marked down 7% in after-hours trading.

Alphabet is the public holding company for Google, one of the world’s most recognised and widely used brands. In addition to the core search engine, the group owns digital video platform YouTube, Google Cloud, web browser Chrome, mobile operating system Android, Gmail, Google Maps, Fitbit, autonomous driving company Waymo, drone delivery company Wing, among others.

The group has a strong track record of innovation, leaving it well placed to capitalise on a wide variety of technological themes, such as digital media, e-commerce, video advertising, the cloud, the internet of things, driverless cars, and artificial intelligence. We believe the shift to internet-connected devices and streamed TV means the growth of advertising dollars on Google Search and YouTube has much further to run. Machine learning capabilities should also help advertisers get higher return on investment and encourage them to continue to allocate their advertising budgets to Google.

The company has seven products with more than two billion users each and another eight with more than 500m users, most of which we believe are far from being fully monetised. The group’s structure allows it to own a portfolio of businesses with different time horizons, while its broad offering provides a competitive edge. Capital allocation is strong and spread across internal R&D, accretive M&A, and massive shareholder returns.

Alphabet has continued to launch a range of innovative devices, tools, and features, many of which are designed to make AI more helpful. Recent launches include the Willow, the group’s latest quantum chip, Gemini 2.0, and Android XR, an operating system for extended reality (XR) devices.

Political and regulatory headwinds have become more elevated in recent months. Most importantly, last November, the DOJ filed its list of requests and potential remedies in the Google search case. These included:

-        The company must sell its Chrome browser to a buyer approved by the US government and should not be allowed to re-enter the browser market for five years.

-        Google may elect to fully divest Android to a buyer approved by the US government. If Google chooses to retain control of Android but fails to comply with presented remedies, the government may petition the court to order the divesture of Android.

-        Google should be prohibited from making payments to third parties to make Google the default general search engine in their products, including ending exclusive agreements with third parties such as Apple.

-        The company must share data and search results with rivals to end its monopoly on online search.

-        The company may also be forced to unwind its AI partnership with Anthropic.

Google responded with its proposed remedies and reiterated its intent to appeal the case, leaving little chance of a settlement. Next month, the DOJ and Google are expected to submit their respective final revised remedy proposals. As a result, in the absence of a settlement, the case is likely to drag on. The focus will also be on how the new Trump administration views the case in light of Google’s importance in technology competition with China. Overall, we believe the current valuation of the shares already discounts many of the less favourable outcomes, albeit not the worst-case scenario.

Back to last night’s results. In the three months to 31 December 2024, revenue grew by 12% on a constant currency basis to $96.5bn, versus the consensus forecast of $96.6bn, reflecting strong momentum across the business. Revenue for the full year grew 15% to $350bn.

The group reports its results across three segments: Google Services, Google Cloud, and Other Bets. Google Services is the largest division (87% of revenue), generates revenue primarily from digital advertising and the sale of apps, digital content products, hardware, and YouTube subscription fees. During Q4, Google Services revenue grew by 10% to $84.1bn, reflecting the strong momentum across Google Search & other and YouTube ads.

Google Search (which accounts for 75% of ad revenue) increased by 13%. Advertising from Google Network Members’ websites (11% of ad revenue) fell by 4%. The group separates out YouTube, which accounted for 14% of ad revenue in the quarter and grew by 14%.

Other sales within the Services division (known as Google Subscriptions, Platforms, and Devices) include Play, content products, hardware, service, licensing fees, Nest, and YouTube’s non-advertising revenue. They grew by 8% in the quarter to $11.6bn.

Traffic acquisition costs (TAC) are the fees Google pays to other companies (such as Apple) to carry its search service and adverts (i.e., cost of sales). During Q4 they grew by 6% and currently account for 20.5% of advertising revenue.

Google Cloud includes Google’s infrastructure and data analytics platforms, collaboration tools, and other services for enterprise customers. Fee revenue comes from Google Cloud Platform services and Google Workspace collaboration tools. In Q4, Cloud grew by 30% to $12.0bn. This was slightly below the market forecast and the 35% growth in the previous quarter. Growth was led by Google Cloud Platform across AI Infrastructure, Generative AI Solutions, and core GCP products. Although the group continues to invest to grow the cloud business, the division’s quarterly profit grew from $864m to $2,093m.

The group’s Other Bets division (less than 1% of revenue), which is effectively an incubator fund for new products and technologies, made a quarterly loss of $1,174m, 36% higher than last year. The group continues to wind down non-priority projects.

Alphabet continues to ‘durably engineer’ its cost base to support its investment in long-term growth opportunities, most importantly AI. The number of employees held fairly steady at 183k, while actions are being taken to optimise global office space and use AI to increase business productivity and efficiency. The company has previously highlighted that 25% of new code is being written by AI.

In the latest quarter, ongoing efforts to improve efficiency helped deliver improved margins from 27.5% to 32.1% as costs and expenses increased at a slower rate than revenue (+5%). For the full year, margins were 32%. EPS grew by 31% in the quarter to $2.15, slightly above the consensus forecast of $2.13. For the full year, EPS rose by 39% to $8.04.

As expected, capital expenditure rose rapidly, from $11.0bn to $14.3bn in the quarter, as the company continued to pour money into AI products. The company is confident about the opportunities ahead, and to accelerate its progress, it plans to increase its capital expenditure in 2025 from $53bn to $75bn. There is some concern across the industry regarding the level of spend on AI and the potential return on investment. On the call, the company highlighted that demand was currently exceeded supply, justifying the ramp-up in investment. We also note the group has a strong track record for generated returns – together, Cloud and YouTube (two businesses developed from scratch) exited 2024 at an annual revenue run rate of $110bn.

Free cash flow generation was strong ($24.8bn in the quarter), despite ongoing spend on R&D and capex, while its huge cash pile (including marketable securities and long-term debt) stands at $84.8bn. This has allowed the group to significantly increase its returns to shareholders. During the latest quarter, the company bought back $15bn of its shares.

During the year, the group also approved the initiation of a cash dividend programme and declared a dividend of $0.20 per share that was paid in December. Looking forward, the company intends to pay quarterly cash dividends. This is positive news and puts the company on an equal footing with Microsoft and Apple in the minds of investors looking for yield.

AI remains a hot topic. We believe the Alphabet is well placed – the company has been incorporating AI functionality into its search capabilities and other products for years and is expected to launch a steady stream of innovation in the future. Furthermore, Google’s position in cloud services – it is one of the big three public providers – leaves it well placed to provide the infrastructure and computing power needed by AI, while the group’s user scale and usage frequency supports a wealth of data, providing another competitive advantage.

Looking forward, although the regulatory outlook will remain a headwind in the near term, the shares continue to trade on a valuation (19x ex-cash) below most of the other tech majors and at a level we believe is very attractive for a company exposed to several areas of long-term secular growth.

Source: Bloomberg

Assa Abloy has today announced 2024 full-year results which were slightly better than market expectations. The group achieved its margin target and raised its dividend by 9%. Ahead of this morning’s analysts’ call, the shares have been marked down by 1% in early trading.

Assa Abloy is the global leader in access solutions to physical and digital places, with a portfolio of well-known global and local brands, such as Yale, Union, HID, and Lockwood. Products include doors, sensors, locks, alarms, fencing, gates, and identity systems. The key long-term drivers of the $100bn industry are increased demand for safety and security; growing urbanisation; increased emerging market wealth; the shift to new digital and electronic technologies; the development of sustainable buildings to meet climate change objectives; and changing market regulations. Furthermore, one of the legacies of the pandemic is likely to be a shift towards touchless (hygienic) activation points, automated doors, and location services, which also provide recurring revenue from licenses and software. As the brand leader in most markets, with a large installed base and strong distribution channels, we believe Assa Abloy is well placed to take advantage of these trends.

The long-term financial target is to generate annual sales growth of 10%, half organically and half from acquisitions, and to earn an operating margin of 16%-17% over the business cycle. The aim is to actively upgrade the installed base, generate more recurring revenue, increase service penetration, and expand exposure to emerging markets. The group is on track to exceed its target to generate SEK 25bn of profit from SEK 150bn of sales by 2026, with new 2028 targets – SEK 35bn of profit from SEK 220bn of sales – outlined at the last Investor Day.

The group has previously said it needs to generate organic top-line growth of 3% to offset inflation and drive the margin forward, although clearly more was needed to recoup the elevated raw material cost increases experienced over the last couple of years. The group has a strong track record of innovation and aims to generate 25% of sales from products launched in the last three years.

The company has a very strong track record on cost control. A ninth Manufacturing Footprint Programme (MFP9) is currently underway to further increase efficiency and optimise operations. The target savings are SEK 0.8bn (4% of operating profit).

In 2024, net sales rose 7% to SEK 150bn. In organic terms, which strips out the impact of acquisitions & disposals (+8%) and currency (flat), sales fell by 1%. Electromechanical and electronic locks grew by 8%, while sales of subscription-based solutions grew by 18%.

During the final quarter, the group showed resilience and agility in a mixed market environment. Net sales rose 7% to SEK 39.6bn, ahead of the market forecast of SEK 38.6bn. In organic terms, sales were flat, with growth made up of a 1% volume decline and 1% price growth.

By business division, in the final quarter, Global Technologies (a separate global division) delivered strong organic growth of 5% with strong performance in most business areas and with Physical Access Control having comparable figures at normalised levels for the full quarter. Americas delivered organic good growth of 2%, with strong growth in the North America Non-Residential segment and in Latin America. Sales growth was stable in the EMEIA region, with commercial segments compensating for continued weak residential demand. Entrance Systems (also a separate global division) declined by 2% because of weak residential markets and weak demand for loading docks. Asia Pacific suffered a significant decline (-11%), mainly due to very weak demand in China.

For the full year, operating income grew by 10% to SEK 24.3bn, with the adjusted operating margin rising from 15.8% to 16.2%, and within the target range of 16-17%.

In Q4, operating income increased by 14% to SEK 6.53bn, well above the market forecast of SEK 6.26bn, and the operating margin was 16.5%. This was better than expected and driven by continued price/cost tailwind and strong operational execution, overcompensating for dilution from recent acquisitions.

The company highlights it has further opportunities to improve the underlying margin performance, however the target level of 16-17% remains unchanged as the group will continue with its acquisition strategy and continue to invest in innovation. EPS rose by 4% to SEK 14.09 in the full year, and by 7% to SEK 3.81 in the final quarter.

Operating cash flow fell by 9% in the year to SEK 23.1bn, although the group generated a record SEK 8.0bn in the final quarter. Cash conversion was 110%. The group’s financial position remains robust, with net debt to EBITDA holding steady at 2.3x. Looking forward, gearing is expected to fall rapidly thanks to strong free cash flow generation. The group has declared a dividend up 9% for the full year to SEK 5.90, and equal to a yield of 1.8%.

M&A will continue to be a core driver of growth, with over 900 potential acquisition targets identified globally. The focus is on acquiring new customers in the core business, extending the core offering, access new technologies to deepen the group’s competitive position, and increased service capacity. However, there is some concern that recent M&A has been skewed towards lower value-added segments (e.g. DIY, window and door hardware components, fencing products, gates, padlocks, cylinders, etc). Although these acquisitions fit the purpose of growing earnings at lower multiples than the group average, they also dilute the group’s exposure to the fast-growing and structurally more attractive electromechanical and mobile segments, potentially posing a risk to long-term valuation multiples.

In 2023, the group acquired the HHI division of Spectrum Brands for $4.3bn to fill a strategic gap in its US residential business. The unit is performing well, with integration proceeding to plan and the company is even more confident than a year ago that it will be able to realise the five-year synergy target of $100m.

Elsewhere, M&A activity remained buoyant with 26 deals completed in 2024 with combined annual sales of about SEK 8bn. The pipeline remains strong, and the group still plans to make its usual 15-20 acquisitions per year. Since the year end, the group announced the acquisition of Uhlmann & Zacher, a German supplier of access control handles and knobs and corresponding software, and InVue, a US-based provider of precision-engineered connected asset protection and access control solutions. The group has also recently sold its under-performing Citizen ID business.

Assa Abloy doesn’t usually provide guidance but has previously pointed out that the macroeconomic environment remains uncertain, in particular the speed of recovery in construction markets. Management is dedicated to mitigating any impact from potentially negative changes in demand, through local agility and focus on cost-control. Assa has previously said that during both the global financial crisis in 2008/09 and the Covid-19 pandemic, its decentralised operational model and agile cost base provided flexibility. In addition, the group’s large exposure to after-market service and its structural pricing power leaves the business better positioned to navigate through these uncertain times.

Source: Bloomberg