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No Profits and Slow Growth Show Wayfair Stock Needs To Cool Down

Red-hot shares of Wayfair (NYSE:) ran into a road bump in early May when the company reported a wider-than-expected loss for the first quarter, while delivering a below-consensus revenue guide for the second quarter. Investors, who had pushed W stock up more than 80% year-to-date into the report, were disappointed with the weaker-than-expected numbers.

Breakout Stocks of 2019: Wayfair (W)

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How disappointed? Wayfair stock consequently shed nearly 10% and this newfound downturn in W stock will persist.

Why? Three reasons. Growth is slowing. Losses are widening. And the stock isn’t priced for either.

Broadly speaking, Wayfair is one of those growth companies that spends at all costs to fuel market share expansion and robust revenue growth. Over the past several years, the Wayfair story has been one of big revenue growth and equally big losses. Investors have honed in on the big revenue growth part, mostly neglecting the big losses part, on the assumption that scale and operating leverage will ultimately produce huge profits down the road. (Hmmm, did someone say “Amazon (NASDAQ:)”?)

This will still happen. But, the Q1 numbers imply that it will happen much more slowly than anticipated. As such, investors are reassessing how much they are willing to pay for Wayfair stock today. That’s why the stock is under pressure following not-so-great numbers.

What’s next? More downside. Relative to the fundamentals, the current valuation underlying W stock is still stretched. The stock doesn’t look reasonable until around $140. As such, until the stock normalizes a few points lower, I’d avoid buying the dip.

Growth Is Slowing, Profits Are Nowhere To Be Found

There are two big takeaways from Wayfair’s first quarter earnings blunder: growth is slowing and profits remain elusive.

On the first point, Wayfair’s growth trajectory is slowing across the board. Direct retail revenue rose 39% in Q1, versus 40%-plus growth last quarter, and higher growth in the prior quarters. U.S. revenue growth has likewise slowed consistently over the past several quarters. So has international revenue growth. Growth is also projected to slip further next quarter.

In other words, while Wayfair is still a big 30%-plus revenue growth company, the company’s top-line growth rates are consistently dropping every quarter. So long as revenue growth keeps decelerating, investors will increasingly look for signs that margins are improving.

And that brings us to the second problem facing W stock investors. Margins aren’t improving, and profits remain elusive. U.S. adjusted EBITDA margins dropped from -0.7% in the year ago quarter, to -1.7% last quarter. International EBITDA margins fell nearly 500 basis points year-over-year. Both businesses remain wildly unprofitable, and there is no expectation for either to become meaningfully in the black anytime soon.

Overall, then, this is a hyper-growth story losing top-line momentum while at the same time not improving its margin profile. Ultimately, that isn’t a winning combination for the stock.

Too-Rich Valuation

To be clear, I’m actually bullish on the long-term growth trajectory for Wayfair. The company has a head-and-shoulders lead in the secular growth home furnishings e-retail market. It is tapping into a small portion of its addressable market at scale. It’s growing very quickly and has a huge opportunity to expand margins rapidly. All in all, the long-term story reminds me a lot of a smaller Amazon.

Having said that, valuation matters, and at current levels, that valuation appears to be too rich for a growth stock that is suffering from both slowing growth and widening losses.

    Realistically, Wayfair projects as a big revenue grower over the next several years, mostly thanks to continued e-retail expansion in the global home furnishings market and Wayfair’s aggressive international expansion initiatives. Concurrently, because gross margins are already above 20% and improving, operating margins should eventually inflect into positive territory as operating leverage kicks in as a result of increased scale and reduced investment.

    All together, I think Wayfair can realistically do about $20 in EPS by 2030, and indicates that $20 in EPS by 2030 supports a 2019 price target of roughly $155.

    We are less than halfway through 2019, and Wayfair stock is already within spitting distance of that price target. As such, upside from here is limited. But, if the stock keeps dropping towards $140, then that could be the time to buy the dip.

    Bottom Line on W Stock

    Growth is slowing. Losses are widening. And even based on aggressive long-term growth assumptions, Wayfair stock still looks slightly overvalued today.

    As such, this correction in W stock isn’t all the surprising. It should persist until the shares are priced more appropriately considering the current dynamic of slowing growth and widening losses.

    As of this writing, Luke Lango was long AMZN. 

    The post appeared first on InvestorPlace.

    The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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