Meta Platforms: Loved The Earnings, Hated The After Hours Rally (NASDAQ:META)

Meta Platforms, Inc. (NASDAQ:META) just released its second quarter earnings. The results easily surpassed analyst expectations. Revenue came in at $39 billion, up 22%, while earnings per share (“EPS”) came in at $5.16, up 7.3%. Analysts were expecting $38.3 billion in revenue and $4.78 in earnings per share (“EPS”). The results evidently wowed investors, as the stock rallied 5.5% after they came out.

If investors were positively surprised by META’s Q2 results, they could be forgiven for having felt that way. The company’s revisions grade is a mediocre ‘B,’ and it has a major headwind in the form of rising AI CAPEX. So, investors were justified in expecting less. In fact, management told them to expect less.

On their previous earnings call, Meta’s management said that they expected a major increase in capital expenditures. The $35-$40 billion amount they forecast for the full year was increased by $3 billion from previous guidance. More importantly, it implied a very significant increase in capital expenditure in the second through fourth quarters. Meta’s first quarter capital expenditures were $6.4 billion. The second quarter figure was $8.45 billion. $40 billion is $10 billion per quarter. So, we actually got less CAPEX than expected and higher FCF.

Meta Platforms has a long history of doing “investment years” in which free cash flow temporarily declines as the company invests in fixed assets. These years are often planned and announced in advance, typically during fourth quarter/full-year earnings calls. Typically, Meta’s investment years are followed by calmer years in which the profits from the previous year’s investments roll in. Meta has been telling investors about this “stop and go” investment cycle for over a decade, but investors still tend to think that, when the company’s FCF goes down on higher CAPEX, it means that there’s something systematically wrong with it.

For example, in November 2022, free cash flow temporarily declined 98% to $173 million. After the release revealing those numbers came out, META stock declined 19%. Investors apparently thought that the quarter’s massive decline in FCF was the start of a trend, rather than a one-time setback. Their opinions turned out to be wrong because shortly after META’s Q3 2022 earnings came out, the company quickly returned to its previous high-growth, high margin ways. Its stock rallied more than 400%!

That’s why, in the lead up to META’s earnings release, I had my eye on a buy. I was hoping that CAPEX would rise dramatically, that investors would incorrectly interpret the one-time decline in FCF as the start of a trend, and that the stock would sell off, providing a cheap entry price. FCF did, in fact, decline very slightly (0.5%), but not enough to trigger panic selling. The stock was actually up 5% after hours at the time of this writing. The markets unfortunately got this one right, and I am no longer considering an investment in META.

When I last covered META stock, I rated it a hold because it was an excellent company whose shares had unfortunately gotten too expensive. I still feel basically the same way about the stock today. However, I think that good opportunities could present themselves as the year rolls on if CAPEX rises to $10 billion as full-year guidance implies it will. In that scenario, investors might start selling the stock, leading to better entry prices than are available today.

Earnings Recap

Meta Platforms delivered a stellar performance in the second quarter. Headline metrics included:

• $39 billion in revenue, up 22% (BEAT).

• $14.84B in operating income, up 58%.

• $13.5B in net income, up 73% (BEAT).

• $5.16 in diluted EPS, up 73% (BEAT).

• $10.89B in free cash flow (“FCF”), down 0.5%.

As you can see, it was a pretty good showing. There were some points of concern in the release. Reality Labs (the metaverse segment) again lost money, and the release clearly stated that Meta had not begun to turn a profit on its AI investments either. Before the second quarter release, Meta announced that it aimed to have 600,000 NVIDIA H100 GPUs by year’s end. That fact may have contributed to some volatility in the days leading up to the release coming out. Nevertheless, revenue grew at a steady clip and all the daily and monthly active people metrics improved. So, Meta’s core operations improved.

Why Investors Fear META’s CAPEX

On the surface, it might seem strange for investors to be so averse to Meta’s capital expenditures increasing. Isn’t all of this money being spent on new technologies that have the potential to drive considerable growth? And can’t it all be turned off if the investments don’t pay off? The answer to both of those questions is “yes,” but if you’ve read your Graham and Buffett, you’ll know that many market participants are extremely impatient. If they don’t see CEOs promising massive growth on the top and bottom lines in the upcoming quarters, they peace out.

Based on 2024 guidance for $37B to $40B in CAPEX, we’d expect between $9.25 billion and $10 billion in capital expenditure per quarter. The actual first and second quarter CAPEX amounts were far below these averages. If CAPEX for the year comes in at $37B-the low end of the range-then there will be $22 billion in CAPEX spread across the third and fourth quarters. That works out to $11 billion per quarter over the next two quarters.

The increase in CAPEX that META is undergoing is therefore unprecedented for the company. For reference, the company’s all-time high CAPEX was $9.35 billion, in the third quarter of 2022. The averages for the next two quarters could be higher than the previous one-quarter record. Short-termers are right to be worried: Meta’s next two quarters will probably not feature a massive explosion of growth and profitability.

The above is why I was hoping Meta would sell off after hours and provide a good entry price. I figured that CAPEX would explode, FCF would decline massively, and I’d get a good entry price at which to bet on next year’s earnings. Unfortunately, the actual Q2 CAPEX was below guidance, FCF declined only a little, and the stock rallied after hours. As of right now, I do not see any chance of an entry price below my $430 target, so I’m no longer considering an after-earnings buy.

Why My Rating is Still Hold

After reading all the positive things I wrote earlier, you might be wondering why my META stock rating remains “hold.” After all, I just said the earnings were great–why then the neutral rating?

The problem has to do with the stock’s valuation. META is expensive, and the stock’s after hours rally prevented it from getting cheaper.

Below, you can see some of the multiples that META traded at by the end of trading on Wednesday. They were all quite high.

Why is this an issue? Because stocks are valued as the discounted value of their future cash flows. The multiples above make it quite apparent that META needs a lot of growth to be worth the investment. If you discount the trailing 12-month FCF at the 10-year treasury yield, you get a $430 price target. If you add a 6.5% risk premium, you get a $193.20 price target. You can get an upside using more complex models that involve assuming perpetual growth rates, but it’s difficult to tell what the future holds. For this reason, I think that Meta stock is still too expensive today. I’d be interested in buying it at prices below $430, and ideally closer to $193.20.

The Bottom Line

The bottom line on Meta Platforms, Inc.’s Q2 earnings release is this: it delivered on the things that count. Revenue grew, earnings soared, and investments in the future continued being made. Unfortunately, market participants appear to have understood these points, and acted accordingly. So, I will not actually buy the stock, as there appear to be no bargain opportunities on the horizon.