NEGG - Newegg: Overvalued Retailer With Headwinds Ahead

Summary

• Newegg Commerce, Inc. is an e-retailer specializing in electronics products in North America.
• Newegg has carved its niche in the e-commerce space, gaining an impressive market share.
• We are concerned that the business is straying from its core competencies, alienating its core customers.
• With economic conditions weakening, we are forecasting a decline in demand. We are already seeing early evidence of this in the LTM numbers.
• Newegg is currently overvalued based on the assumption that consistent profitability is achievable, which is not even certain. We consider NEGG stock a sell.

Who is Newegg?

Newegg Commerce, Inc. ( NEGG ) is an e-retailer specializing in electronics products in North America. It offers a wide range of products including computers and accessories, gaming equipment, audio and video devices, digital cameras, car electronics, and home improvement tools among others. The company operates B2C and B2B platforms.

Share price

Newegg's stock price has had an eventful time since its IPO in 2021, which occurred via a SPAC transaction. The company's financial results have been volatile, with this reflected in the share price movements in the last 2-years. The current decline in the share price is due to a reversal in the company's financial performance and negative sentiment driven by uncertainty in the retail sector.

Investment thesis

Our aim in conducting this analysis is to determine if Newegg's recent decline in share price and change in sentiment is due to the stock being oversold or if the market has accurately priced in a bleak future for the company. To do so, we have performed a bottom-up analysis of the business, taking a view of the current retail environment and Newegg's financials.

Specialist E-commerce businesses in this space are rare

Retail is currently an incredibly competitive industry, with many looking to improve their market share in the e-commerce space due to the greater scope for growth. This includes both traditional brick-and-mortar businesses and online-only retailers. The difficulty for businesses is that consumers do not have any default loyalty, as they will go to the place with the best price unless a business can adequately differentiate itself. In the case of Newegg, we believe they have succeeded in somewhat differentiating themselves.

Statista estimates revenue in the Consumer Electronics market to be $1,103BN in 2023, with annual growth forecast at 2.17%. This represents the relative maturity of the industry.

The electronic retail industry can be categorized into two segments: companies that both manufacture and sell their own products, like DELL , and companies that only act as retailers. Newegg falls into the latter category as it primarily serves as a marketplace where third-party products are sold.

Newegg has established itself as a successful player in the electronics retail market by prioritizing three key factors: competitive pricing, stocking popular brands, and a tailored shopping experience. They have built a reputation for offering a wide variety of electronics products, with a particular focus on PC hardware catering to demanding computing needs. In addition, they also offer a range of peripherals targeted at more casual users, which helps to draw in a broader audience. This broad product offering, combined with strong product knowledge and customer service, has enabled the company to develop a loyal customer base. Newegg has gained a particularly strong following in the gaming community, where they are well-known and respected for their extensive range of gaming-related products.

One would expect a company like Newegg to be eaten alive by a giant like Amazon ( AMZN ), however, this has not happened. Newegg has differentiated itself by prioritizing a personalized shopping experience for its target audience. For instance, Newegg offers the ability to build a custom PC with parts sourced directly from their website using a helpful system.

Aspects such as this have allowed the business to carve out its niche in the industry, allowing it to operate alongside traditional retailers.

The company has also been successful in expanding internationally by offering global delivery. This has allowed the business to broaden its total addressable market, with the online-only nature of the business working to its advantage. This said further investment in this area is required as the current shipping and delivery rates diminish any pricing advantage Newegg offers.

Marketplace

Newegg has adopted a fee-based marketplace model as a part of its expansion strategy, which involves producers using its platform for a fee. This approach is beneficial for Newegg as it operates as a transaction facilitator only without having to bare the risk of holding inventory.

Newegg has a large following in the Reddit community and so we looked to investigate what the current opinion is of the service, relative to other retailers. A recurring theme we noticed in our research is an issue with quality control, which is a drawback of this model.

Commenters seem to have arrived at the consensus that Newegg is far less reliable than it once was by allowing these new retailers to sell through their platform. The comments we have clipped below summarize the main message conveyed in the 390 comments.

This is a serious issue for Newegg, and it seems the business has been negligent in its pursuit of growth, losing sight of what consumers valued in its service. Not only this but Newegg is essentially competing with itself, giving consumers the option to purchase from a lower-margin segment of the business. Newegg once had the reputation of being customer-focused, but this perception has seemingly declined noticeably, posing a risk to the long-term website traffic and by virtue its revenue growth.

Lack of brick-and-mortar

The growth of e-commerce has been phenomenal, while brick-and-mortar retail has been stagnant and lost market share in recent years. However, 2021 was an exception when brick and mortar retail outgrew e-commerce . Despite the technological capabilities of online shopping and the motivation following over a year in lockdown, many consumers still value in-person shopping experiences, especially when making large purchases. This is reflected in the data, as Shopify found that over 50% of buyers prefer to shop online and pick up in-store or view the product in-person before making an online purchase. This presents an issue for Newegg, as they cannot offer an in-store option. While they do provide free returns, not all consumers want to deal with the hassle, and it comes at a cost to Newegg with each transaction. This limits Newegg's growth potential, attracting mainly tech-savvy gamers and serious technology-centric individuals, rather than the broader market.

Economic consideration

The current economic landscape is problematic for retailers as we are seeing pressures on finances contributing to reduced retail spending. The primary factor is inflation in key living expenses, which has remained persistent since 2022.

In an effort to bring inflation under control, monetary policy has shifted towards the use of interest rates, with the aim of cooling demand-driven inflation.

Our outlook for the next 12 months is not particularly promising. The persistence of inflation will likely contribute to further interest rate hikes, which will only further reduce demand. Recent CPI figures support this assertion. Although we are forecasting inflation to reach a stable level in the latter part of the year, the high cost of living will cause further damage until then.

This is not a positive sign for Newegg, as declining disposable income will likely lead to decreased spending on electronics. LTM revenue has dropped 21% compared to FY21, indicating that this is already having an effect.

This issue is compounded by the effects on the supply side, as greater wages and transportation costs will erode margins. Again, if we compare LTM to FY21, Newegg has seen GPM fall by 1%. Our financial forecast for 2023 would be more of the same, a decline in margins and revenue.

Newegg's financials are disappointing, and not because it is loss-making

Looking at Newegg's financial performance in recent years, we can see why negative sentiment surrounds the business. Revenue seems to have flatlined, with it declining at a CAGR of 2%. COVID-19 provided a bump, but this was only to return it to FY18 levels.

Management has achieved some efficiencies, with CoS declining at a greater rate than revenue but this has been offset by S&A increasing. The net impact has been a return to negative EBITDA.

The improvement seen during the COVID-19 pandemic appears to have been completely undone. This may simply be because the business can't be profitable unless its revenue surpasses $2 billion, which is not out of the question. However, it's possible that it could take up to 24 months to reach this level of revenue again.

The positive news is that Newegg has not materially damaged its balance sheet through the losses it has incurred. Debt only stands at $100M, with net debt at $18M.

Newegg's inventory turnover rate has only slightly decreased, which given the sharp decline in demand in the LTM period, looks to be a fairly good performance. Although the company's CCC has increased slightly, a 10 day turnaround time is considered a market-leading achievement in the retail space.

Newegg's valuation is currently unattractive

With the current state of retail and Newegg's financial performance regressing, our expectation would be for a relatively low valuation.

Seeking Alpha's Quant considers the business a sell, as the current valuation does not compensate investors for its poor profitability and lackluster growth.

The Wall St. rating is derived from one analyst, who rates the stock a strong buy.

In order to assess the company ourselves, we have conducted a DCF valuation of the business. The assumption we have made are:

• Revenue growth of 2.5%, conservatively reflecting what is a niche retail service.
• Another loss-making year in FY23F, followed by consistent FCF conversion of 3%.
• An exit EBITDA multiple of 12x and a perpetual growth rate of 2.5%.
• A discount rate of 10%, derived from Newegg's WACC.

Based on this calculation, our view is that the stock is currently overvalued by 7%.

Final thoughts

Newegg did a fantastic job of carving out a segment of a highly competitive industry. They clearly understood their target audience and tailored their service to their needs. Rapid growth and the desire to turn consistently profitable have likely led the business away from its core competencies and we have seen performance dip as a result.

Our outlook for the coming 12 months is not positive but the business can use this to restart. There is very little they can do with consumer demand softening in the area and so we expect further negative sentiment around the business.

We do see a scenario where Newegg gets back on track in the future. By refocusing on its strengths, the company has the potential to regain growth. The question is whether this can be done while achieving profitability. If this does occur, and FCF conversion exceeds 2.5%, we could see its valuation rise significantly. At present, however, it would be far too risky for investors to purchase this stock. In our opinion, it is a sell.

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