2023-06-01 14:33:42 ET
Summary
- OSTK faces challenges as revenue growth and profitability decline due to macroeconomic slowdown impacting the home furnishing industry.
- I expect downward trend to continue until sometime in FY 2024, with limited catalysts at present.
- At its current price of ~$18 per share, the stock is overvalued in my opinion, and I rate it as neutral.
Overstock.com ( OSTK ) is an online retailer that offers a wide range of home products, such as furniture and small appliances.
OSTK experienced significant benefits from the stay-at-home trend during the COVID-19 pandemic in 2020. However, since then, the company has faced challenges as revenue growth and profitability deteriorated due to the macroeconomic slowdown, which has been impacting the home furnishing industry.
The outlook suggests a high chance of continued growth and profitability decline, possibly until the first half of FY 2024, presenting downside risks in the near term. While a rebound is possible in FY 2024, there do not seem to be any visible catalysts at this time.
Furthermore, my modeled target price indicates that the stock is slightly overvalued at its current price of ~$18 per share. I initiate this coverage with a neutral rating.
Risk
I think that while the ongoing economic slowdown has negatively impacted various offline and online retail companies of all industries, the impact on companies in home furnishing retail like OSTK, which sell big-ticket items, has been more severe. My view is that given OSTK's steep decline in performance since 2022, the timeline to recovery for OSTK will probably be longer and more uncertain than for most retail companies.
The overall macro pressure was evident across all OSTK categories. In Q1 2023, OSTK's revenue saw a steep decline of 29% YoY, and much of that was driven more by the macro slowdown than by the non-home category exit. Looking at OSTK's past performance, with the exception of COVID-19 year of 2020, I would probably expect OSTK to see quarterly revenue continue its downtrend throughout the rest of 2023, and then bottom around the Q1 2020's revenue figure of +$340 million sometime in Q1 or Q2 2024.
My view is primarily based on an assumption that OSTK's growth outlook will mostly be driven by macro development on the housing/mortgage market and inflation.
During a macro slowdown, consumers often scrutinize their spending and may reduce their expenses on bigger-ticket items like furniture and home appliances. Due to the inflation, the prices of these items have also been rising. As inflation is expected to soften around the back half of FY 2023, the recent macro forecast by Goldman Sachs suggests that the prices for supply-constrained big-ticket items are normalizing as their share of the US PCE inflation has been decreasing since the start of the year to a negligible level today.
However, since inflation on shelter/housing, travel, and other services may still remain elevated, it is more likely that OSTK will only see some rebound after Q1 2024, when the big ticket items are expected to see a decline in prices to not only offset the overall inflationary effect but also drive demand recovery for those items.
In the end, I think that it remains the best-case scenario for OSTK, though it means that investors are likely to see OSTK in the defensive mode for quite some time. The finding here is also consistent with the management's view in the Q1 earnings call in regard to lower consumer sentiment due to the overall prioritization of spending toward other items at present:
We are being cautious in our expectations for the rest of the quarter with a big portion of the spring summer sales still ahead of us. And while I'm hopeful for continued improving trends. It's just too early to know how the quarter will go. There remains uncertainty around consumers spending. Housing market remains under pressure. Consumers continue to allocate dollars to services such as travel and recreation.
As the top-line growth sees pressure, OSTK continues to see margin contractions. Though the management suggests that the near-term objective would be to deliver positive adjusted EBITDA in FY 2023, I think that it would seem unlikely. Given that the slowdown may remain for quite some time, it is more possible for adjusted EBITDA margin to continue contracting and be in the negatives in either the next quarter or the following, resulting in a negative outlook for the whole FY 2023.
With gross margin remaining steady at a +20% level, OSTK will probably need to significantly reduce its operating expenses to maintain positive EBITDA if sales continue declining at current pace. Since technology and G&A expenses were ~8% and ~5% of revenue already, there may probably be room for cost-cutting measures in sales and marketing, which was ~12% of revenue as of Q1. In 2019, when OSTK had a negative ~2% adjusted EBITDA, sales and marketing were ~9.8% of revenue , though technology and G&A were both at +9% of revenue. Nonetheless, given the ongoing marketing campaign , it is unlikely for OSTK to make a significant cut there today.
Catalyst
I am unable to identify near-term catalysts for OSTK at the moment, though I would probably like to highlight the fact that the management has done its best in minimizing the company-specific risks through managing the sales decline as well as positioning the business to be able to absorb longer-term shocks.
In particular, the management team has done quite well in managing top-line profitability to ensure a lot of room for operating expense reduction. I think that such capability will be valuable for OSTK not only today during the downturn but also when the business is entering a recovery phase.
Despite the declining sales, OSTK was able to keep its gross margin steady within its target model range of +22%. It is even more impressive that the gross margin expanded to +23% in Q1 despite the higher discounting activities to drive sales during the downturn. As per the Q1 earnings call , solid operational efficiencies and merchandising actions have been the contributing factors:
Rick like I said, we mentioned merchandising actions and operational efficiencies, these kind of happened quarter in quarter out at different magnitudes, just things like negotiating with partners, things like kind of sponsored product opportunities, customer care efficiencies, warehousing improvements. So we're always looking kind of in those buckets, and quarter and quarter out trying to improve our results there.
Overall, I think that the CEO's experience has played a role in OSTK's operational performance. It is noted that the current CEO, JJ Johnson, though only stepping in as CEO in 2019 pre-COVID, has been with OSTK since 2002 in different capacities - including as chairman, and certainly has seen OSTK going through different economic cycles.
With that in mind, there is a conviction that while OSTK should expect a long road to recovery, it will probably avoid a catastrophic downturn and be in a good position ahead of the rebound.
Valuation/Pricing
My target price for OSTK is driven by the following assumptions for the bull vs bear scenarios of the FY 2027 5-year revenue projection:
- Bull scenario (50% probability) assumptions - I expect OSTK to see a -17% decline in revenue growth for FY 2023 and also negative, yet improving growth into the first half of FY 2024, followed by a significant rebound in the second half, ending FY 2024 with 8% growth. I would expect OSTK to experience steady 10% growth and achieve single-digit adjusted EBITDA all the way into FY 2027.
- Bear scenario (50% probability) assumptions - I expect OSTK to see a -20% decline in revenue growth for FY 2023 and -5% growth in FY 2024, driven by the prolonged macro slowdown. OSTK will experience a minimal rebound only in FY 2025, and achieve a 5% growth as well as low-single-digit adjusted EBITDA throughout the rest of the projection years.
I assign OSTK a P/S of 1.3x under the bull scenario, which is the midpoint of P/S performance in 2021 (1x - 1.6x). I consider the overall performance in FY 2021 as a possible target model for OSTK, where it already saw a normalized growth level post-COVID in a pre-slowdown environment. My expectation of 10% growth in FY 2027 is also similar to that of FY 2021, even though I expect OSTK to have a +3% adjusted EBITDA level that is more similar to the outlook in FY 2022. I think that 1.3x would be a fair figure to capture those assumptions. On the other hand, I assign OSTK a P/S of 0.5x under the bear scenario, the current P/S figure.
Consolidating all the information above into my model, I arrived at an FY 2027 weighted target price of ~$40 per share. Discounting that target price with a 20% discount rate, I reached a Present Value/PV weighted target price of ~$16 per share. The 20% discount rate represents the expected annual return for holding OSTK.
The ~$16 per share is the highest price point at which investors can purchase the stock to realize a projected 20% annual return should my FY 2027 target price of ~$40 be achieved. At ~$18 per share today, the stock trades at a ~12% premium to my target price, indicating that it is overvalued.
Conclusion
OSTK has experienced a decline in revenue growth and profitability due to the macroeconomic slowdown. I expect the downward trend to continue until FY 2024, presenting near-term downside risks.
Nonetheless, I still expect OSTK to navigate through the slowdown without a catastrophic downturn and to maintain a favorable position ahead of the recovery. With limited catalysts at present, my analysis suggests that the stock is slightly overvalued at its current price of ~$18 per share. At this time, I rate the stock as neutral.
For further details see:
Overstock: Potentially Long Road To Recovery