Wayfair: After 13-Fold Increase, Take Profits Today
With its stock up more than 13-fold since bottoming out in March, home goods e-tailer Wayfair is one of the biggest business beneficiaries of the Covid-19 pandemic.
If you bought its shares at its March 19 bottom of $23.52, now is a great time to take profits.
That’s because an S&P report that Wayfair has a 24% chance of defaulting in the next two years highlights the chance that the factors that sent Wayfair’s stock so low in the year before that bottom could come back into play.
Wayfair’s Strong Second Quarter Report Fell Short On Revenue Growth
Wayfair’s revenue growth in the second quarter jumped 84% — which was above estimates, but short of the Jefferies estimate of 90% growth. On August 5, Wayfair reported $4.3 billion in revenue — $260 million more than estimates and earnings per share of $3.31 — $2.34 more than the consensus, according to TheStreet.com.
Wayfair said it saw this quarter as providing evidence of a payoff on its investments. As CEO and cofounder Niraj Shah said, “Our strategic long term investments positioned us well to serve our customers and to quickly adapt during a challenging time. We experienced unprecedented demand in Q2 and saw record numbers of new and repeat customers choose Wayfair. [We generated over $1 billion in free cash flow in the quarter as we] paired our strong growth characteristics with consistent profit delivery.”
Wayfair’s revenue growth in the quarter was considerably below what Jefferies expected. Jefferies analyst Jonathan Matuszewski said he expected 90% growth for the second quarter — while other analysts forecast 73% growth, I wrote last month.
As he said on July 13, “My estimate is $4.454 billion — 90% growth — while the FactSet Consensus is at $4.407 billion — about 73%. They overstate the rate of deceleration in June. We saw 43% growth in June whereas the rest of Wall Street saw mid-30% growth. We see the rate of deceleration is not as sharp as they think.”
In his view, growth for Wayfair was very strong in April and May and slowed in June. “We know that Wayfair grew 90% in April. Our analysis of SimilarWeb data that tracks the number of visitors per day to a website, how long they stay, and so on found that in May Wayfair grew at a triple digit rate. In June, there was deceleration,” he said.
Wayfair Just Added To S&P List of ‘Most Vulnerable Public American Retailers’
On August 18, S&P Global Market Intelligence added Wayfair to its list of of “Most Vulnerable Public American Retailers,” according to Barron’s. More specifically, S&P added Wayfair to the list because it concluded that the company has a 24% probability of “defaulting and not paying its debt obligations, whether that be through bankruptcy or other means” in the next two years.
Despite adding five million new customers in the second quarter, “analysts believe that Wayfair’s good fortunes could be coming to an end. With business restrictions lifting, more people are shopping in stores rather than online. And eventually people will have less interest in fixing up their homes,” noted Barron’s.
S&P Global Market Intelligence told me in an August 20 interview that Wayfair’s inclusion on this list was due to its “negative balance sheet equity [in the second quarter Wayfair’s total equity was negative $790 million] and negative EBIT for the recent quarter” while Wayfair’s sales growth offset an even higher probability of default.
Three Risks To Wayfair’s Future Prosperity
This shot across Wayfair’s bow recalls three issues facing Wayfair about which I wrote in February:
- Giving customers less value than rivals. While Wayfair had previously offered better prices, selection, and convenience than rivals, Amazon was eroding customer brand loyalty by charging lower prices than Wayfair. In 2019, Wayfair (with a ninth ranked score of 80) lagged Amazon’s industry leading score of 83 in customer satisfaction, according to the American Customer Satisfaction Index.
- Out of control costs. Wayfair was spending more to improve order fulfillment and to acquire customers. Wayfair was spending too much money on shipping, advertising, and marketing and its customer service needed improvement, analysts noted.
- Vague path to profitability. Following last fall’s collapse of WeWork, investors gave the cold shoulder to companies without a path to profitability. Wayfair lacked such as path — although Shah admitted in February that the company had “built some excess, inefficiency, and even waste at times, in almost every area.”
Wayfair’s second quarter financial report suggested to one analyst that the company is making progress on the second two concerns. According to Morningstar MORN senior equity analyst Jaime Katz, Wayfair’s rapid growth improved its cost position and shortened its path to profitability.
Wayfair achieved “expense leverage” in the second quarter. Wayfair’s gross margin increased 680 basis points to 30.7% — way ahead of Morningstar’s 26% forecast. Wayfair’s operations, technology, general and administrative (SOTG&A) ratio declined 570 basis points to 10.7% — below Morningstar’s 11% estimate.
In addition, Morningstar had expected Wayfair not to achieve positive EBITDA until 2023. Katz now expects the company to achieve this goal in 2020.
Can Wayfair Sustain 84% Revenue Growth?
Wayfair struggled mightily to provide investors guidance for third quarter revenue growth — a figure that I’d guess will likely fall below 70%. As CFO Michael Fleischer told investors in an August 5 conference call, “Quarter-to-date, our gross revenue growth is trending at approximately 70% year-over-year…Thus far in Q3 compared to what we observed in Q2, [we] expect…revenue growth rate deceleration may continue through the quarter.”
32.7% of Wayfair’s float is sold short — meaning that there is a considerable amount of smart money betting that this company’s best days are behind it.
If Wayfair can lower expectations far enough before it reports third quarter earnings, those short sellers could get burned. For those who have enjoyed the huge increase in Wayfair stock since March, it would be wise to take your profits.