W - Wayfair: Positive EBITDA Coupled With Undervaluation A Formula For Upside Potential

2023-10-12 01:01:24 ET

Summary

• Wayfair is a leading e-commerce platform specializing in home goods, offering customers a wide range of choices.
• Despite market challenges, Wayfair has shown consistent financial performance and effective growth strategies.
• Wayfair's valuation currently lags behind its peers, but its recent achievements and anticipated growth signal a promising upward trajectory.

Summary

Wayfair Inc. ( W ) is a leading e-commerce platform specializing in home goods. With a vast selection spanning furniture, décor, and home improvement products, Wayfair offers customers an extensive range of choices. The company combines its wide product assortment with proprietary brands and a technology-driven approach to enhance the shopping experience. Headquartered in the U.S., Wayfair has expanded its reach globally, serving multiple international markets. Its commitment to customer service and strong supplier partnerships further solidify its position in the online retail landscape.

W stands out as a compelling investment option thanks to its consistent financial performance and effective growth strategies. Despite market challenges, W's recent results highlight its ability to navigate fluctuations effectively. Achievements like reaching a gross margin reminiscent of peaks during the pandemic, highlighting operational proficiency and the efficacy of cost-reduction initiatives, further emphasize this ability. Moving to revenue growth initiatives, W has a well-diversified growth strategy that ranges from physical retail expansion to innovative technological ventures. In addition, their incentive award plan accentuates W's dedication to harmonizing employee and shareholder interests to drive long-term growth. On the valuation front, while W's valuation currently lags behind its peer, its recent achievement of positive adj. EBITDA and management’s anticipated mid-single-digit growth signal a promising upward trajectory. Given W's strategic initiatives and recent accomplishments, I recommend a buy rating.

Financials / Valuation

A number of connected factors caused Wayfair to experience an 11% decline in revenue and a negative adj. EBITDA margin of 3% in 2022. The year presented a challenging macro environment for the industry, with the pandemic's disruptions affecting the usual seasonal revenue patterns. A noticeable shift in consumer spending patterns, which may have been a leftover effect of the pandemic, made this situation worse. As the company strategically pivoted towards cost efficiency, these changes, although essential for long-term growth, might have contributed to short-term revenue impacts. Additionally, Wayfair's international markets, especially in Europe, grappled with macroeconomic headwinds and geopolitical uncertainties. Despite these hurdles, Wayfair maintains an optimistic stance, emphasizing its commitment to returning to its roots of lean and efficient operations.

Throughout 2022, W faced significant challenges, with both its share price and valuation experiencing substantial declines. Yet, a glimmer of hope emerged in the second quarter when W reported a positive EBITDA, breaking a streak of six consecutive quarters in the negative. This turnaround was fueled by the company's unwavering commitment to bolstering profitability. W posted an adj. EBITDA margin of 4%, mirroring the levels seen in 2021. Notably, this stands as the second-highest positive margin the company has achieved in the past six years.

Valuation

Based on my view of the business, I project a 3% revenue growth for FY23 and expect a subsequent 4% rise in FY24, aligning with the general market consensus. This projection draws from W's multifaceted growth strategy and commendable financial performance in the second quarter, where its decline was notably milder compared to the broader market's downturn. In addition, the success of the company's strategic initiatives is evident in recent milestones, such as achieving positive adj. EBITDA, positive free cash flow, and a growing active customer base.

Currently, W's forward EV/Revenue stands at 0.7x, which is notably lower than its peers, such as RH ( RH ), with an EV/Revenue of 2.4x. This difference in valuation is largely due to W's negative adj. EBITDA margins when compared to its peers. Specifically, W has an adj. EBITDA margin of -3.4%, while its peer, RH, reports a robust 25.8%. However, it's worth noting that W's expected growth rate for the next 12 months is 8%, outpacing RH's 2%.

In a positive development, W reported a positive adj. EBITDA for the current quarter, marking its first since 2022. This improvement can be attributed to the company's effective cost management strategies. Given the success of the strategies, I anticipate W will continue on its positive EBITDA trajectory. As a result, I expect an upward trend in W's valuation multiple, potentially nearing the levels of its peers. With a target of 0.85x EV/revenue, a markup of 19% based on W’s average discount to peers, my projected share price for W is $74. If the upcoming adj. EBITDA exceeds expectations, I expect to see a more significant multiple expansion, drawing it even closer to RH's 2.4x. Moreover, given W's higher next 12 months growth forecast compared to RH, it further emphasizes the undervaluation of W. Therefore, I recommend a buy rating for W.

Comments

W offers a compelling investment opportunity, as evidenced by its recent financial performance, strategic initiatives, and management’s positive outlook. Drawing from W’s second quarter 2023 earnings results, insights from its Investor Day, and management's guidance, it provides a comprehensive understanding of the company's current position and future outlook.

In the challenging market environment of the second quarter of 2023, W's financial resilience shone through. The company reported net revenue of $3.2 billion, marking a mere 3.4% year-over-year decrease. This performance is particularly commendable when compared against the broader market decline of 10–20%. Such resilience, combined with a sequential increase from the first quarter, underscores W's adeptness at navigating market fluctuations and capitalizing on seasonal trends.

Further emphasizing W's commitment to operational efficiency is its achievement of a gross margin of over 30% in the second quarter of 2023, a milestone previously attained only during the 2020 pandemic peak. This improvement can be attributed to the execution of over 70 cost-saving initiatives, showcasing the company's dedication to bolstering profitability while ensuring competitive pricing.

On the strategic front, W's growth vision is multifaceted. Not only is the company investing in physical retail expansion and international business, but it's also pioneering technological innovation with ventures into areas like generative AI. This diversification ensures W's adaptability and readiness to capture a more significant market share.

A key highlight from W's Investor Day was the introduction of the " 2023 Incentive Award Plan ". This initiative signals the company's dedication to aligning the interests of its key personnel with those of its shareholders. By offering a diverse range of equity incentives, W aims to retain and motivate its team, ensuring sustained company growth and value creation.

Recent achievements by W, combined with management’s forward-looking guidance, highlight the company's promising trajectory. Last year, the management laid out a strategic plan to fortify the business, emphasizing a path to sustainable and growing profitability. This commitment has been evident in their recent milestones, notably achieving positive adj. EBITDA and positive free cash flow. Their execution strategy has been to reduce costs, focus on foundational aspects, and earn increased loyalty from both customers and suppliers. The tangible results of this strategy are evident in their improved performance, marked by positive year-over-year order growth and a rising active customer count. All these accomplishments have been realized while simultaneously investing in initiatives poised for future growth. Adding to this optimism, W's management anticipates net revenue growth in the mid-single digits for the upcoming third quarter, signaling a positive outlook for the near future.

Risk & conclusion

W's recent achievement of positive adj EBITDA is a significant milestone, but it also sets heightened expectations for future performance. Sustaining or improving upon this positive adj. EBITDA could be challenging in an e-commerce sector that's rife with competition. As other major players in the online retail space continue to enhance their offerings and logistics capabilities, W might face intensified competitive pressures. This could put downward pressure on margins and potentially impact W's ability to sustain its recent financial achievements. Moreover, while positive adj. EBITDA is an indicator of operational efficiency, it's essential to ensure that it doesn't come at the expense of necessary investments in growth and innovation. Striking a balance between profitability and growth investments in such a dynamic market will be pivotal.

In conclusion, W's recent achievements and strategic direction position it well for the future. The company's recent financial results, marked by commendable net revenue amidst broader market challenges, highlight its resilience and operational prowess. This is further emphasized by its impressive gross margin, a testament to W's commitment to efficiency and profitability. Strategically, W's multifaceted growth approach, from physical retail expansion to cutting-edge technological ventures, showcases its forward-thinking mindset and adaptability. The incentive award plan underscores the company's focus on aligning internal and external interests, fostering a culture of growth and value creation. Furthermore, the management's clear vision and recent milestones, especially the achievement of positive adj. EBITDA, reflect a company on an upward trajectory. If W's upcoming adj. EBITDA outperforms, combined with its higher expected growth outlook, there's potential for a more significant multiple expansion. Therefore, I recommend a buy rating.

For further details see: