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Barclays Capital has trimmed estimates for Alphabet’s (NASDAQ:GOOG) (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN) and Meta Platforms (NASDAQ:META) on increased depreciation expense, amid the costs related to AI.
Analysts led by Ross Sandler noted that the street is mis-modeling the not-so-hidden cost of AI, to the tune of 5%-10% of EPS. Price-to-earnings, or P/Es, are inflated by a similar amount, but fortunately the street has likely factored in more than enough capex to account for the coming AI boom.
The analysts said they were trimming their estimates across the board for higher depreciation expense and a return-to-normal headcount rhythm in 2025 and 2026 for the Internet mega caps. This depreciation and amortization trend is fairly well understood by the buyside, but not yet factored into consensus estimates, in their view. Depreciation of AI compute assets is the biggest expense for these leading companies (though non-cash), with other costs, such as power, cooling, and personnel, also representing increased costs.
Stepping back, the analysts are broadly bullish on AI and on the mega cap names heading into the second quarter earnings, but they think this is a risk that may surface as they start looking ahead into 2025, so they are flagging it early.
Sandler and his team noted that it looks like the street (consensus) is using rudimentary percentage-of-revenue to forecast depreciation, which admittedly worked before the AI boom, but looking ahead they think this is not the right way to approach this key line.
The explosion of compute capex is changing the mix, and thus depreciation is likely to start to enter the picture as a significant earnings headwind going forward.
This depreciation and amortization expense hit has been masked to some degree over the past few years by lengthening the useful life of servers for accounting purposes, but once META goes to a six-year server lifespan (likely in 2025), the analysts think this benefit is going to be gone, and mega cap investors will have to start dialing in the correct depreciation and amortization costs.
Barclays keeps an Overweight rating on Amazon but lowered the price target on the stock to $220 from 230.
Alphabet and Meta, both have Overweight ratings at Barclays, with a $200 price target for the Google parent and $520 price target for the Facebook owner.
Alphabet has a Hold rating at Seeking Alpha’s Quant Rating system, which consistently beats the market. Meanwhile, the Seeking Alpha authors’ average rating is more positive with a Buy and so is the average Wall Street analysts’ rating, Buy.