2023-05-30 01:52:42 ET
Summary
- Pinterest stock has sold off significantly after its latest earnings report and a volatile profitability picture.
- Looking at its financials in more detail, however, there is a lot to like. The company has continued to grow and has a truly excellent balance sheet.
- It also has a track record of positive operating cash flow, indicating that eventual profitability should be achievable.
- The stock is discounted on a historical price basis as well as on its earnings growth multiple.
- Taken together, these attributes align to make it a good buy over a 3-5 year investment horizon.
Overview
Pinterest ( PINS ) stock is at an interesting inflection point. Losing close to 20% in one trading day in the aftermath of its latest earnings report, PINS stock has since bottomed out and began to regain some of its value. Nonetheless, it is still trading at a significant discount to the NASDAQ Composite year-to-date, something which doesn’t appear to have persisted for more than a few weeks at a time so far this year.
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On a longer time horizon, Pinterest has had a volatile path since its Q2 2019 IPO. Worth noting is that its underperformance relative to the NASDAQ Composite is a longer-dated trend, apparently being the case for most of the stock’s trading history. Even though the company has added 65% to its market capitalization since going public, the price return on its shares has ended up being negative due to dilution from stock-based compensation.
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Suffice to say that Pinterest hasn’t done so great since becoming a public company. Furthermore, its latest earnings report has injected fresh uncertainty as to its margin expansion initiative and introduced the volatility that we are seeing now.
Yet, Pinterest does have something that stands out, in my view: continued growth. As a middle-market digital advertising player, Pinterest could very well have experienced a revenue decline in recent quarters. This happened to Snap (NYSE: SNAP ), a company nearly identical in size ($16.47B market cap), with that company posting a flat quarter followed by a y/y revenue decline of 7% in its latest quarter. This has not been the case for Pinterest, which has continued to grow revenues – albeit in the single digits.
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This indicates a certain durability to its product and digital advertising offering. That is a valuable thing to have, and this durability becoming apparent during a time of such significant stress in the digital advertising market makes it that much more significant. I will also note that the company has continued to grow its active user base, which increased 7% to 463M monthly active users last quarter.
Altogether this indicates that the company may still have a good foundation upon which to achieve eventual success. To that end I wanted to review its potential as an investment in more depth, starting with the fundamentals.
Financials
Overall Pinterest’s business appears to have crossed the threshold from high-growth into something more standard. While it had brisk double-digit revenue growth of roughly 50% for 4 years running, this came to a halt in 2022. Q1 2022 was the last double-digit y/y growth period that the firm posted.
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This trajectory is a common one for high-growth software companies and most likely indicates a saturation of its target market. While this growth trajectory is not ideal to see, it allows us to clearly delineate where Pinterest is in its lifecycle. At this stage Pinterest should be focused on unit economics and profitability, which is indeed the case according to its management team.
The trajectory here is significantly more volatile. Pinterest only had one year with positive operating income and has seen this metric go negative again since.
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Over the last 10 quarters, we can see that Pinterest’s business remains quite variable but is still able to generate operating income half the time. Management stated on the most recent conference call that operating expenses this past quarter were actually below guidance due to some investments being pushed out into Q2. Q1 2023’s negative 40% operating margin looks even worse in light of that.
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Indeed, last quarter actually showed a significant acceleration in the company’s expense footprint. This doesn’t look like the cost structure of a company focused exclusively on profitability; Pinterest pivoted back to growth mode. This indicates that management does not actually believe that Pinterest’s product is saturated in its market and that they are aiming to return to higher rates of revenue growth. Perhaps it is too early to conclude that Pinterest’s high-growth days are done, although we will see the results of this heightened cost profile over the next few quarters.
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Now looking over to the balance sheet, I am pleasantly surprised: Pinterest’s balance sheet is rock-solid. This company is cash-rich and has an excellent leverage profile.
As of its latest earnings report, Pinterest has $2.73B of cash on hand, $0.51B in total liabilities, and only $0.16B in total debt. It doesn’t get much better than this in the technology sector. Overall the firm’s balance sheet yields an Altman z-score of 19.06, an exceptionally high number that represents a significant margin of safety for ongoing operations. No matter what the future holds, we can rest assured that Pinterest is not going out of business any time soon.
Pinterest has also reduced its share-based compensation, which is stabilizing and set to go below 3% y/y next quarter.
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This dilution is currently being counteracted by the company’s $500M buyback authorization, which has $400M left on it. That $400M amounts to 2.41% of the company’s $16.57B market cap as of this article. Assuming the buyback program wraps up over the course of the next 2 quarters, we can compare this against expected dilution over that time. At current share-based comp rates it’s fair to say that stock-based comp will result in 2.5% share float growth over each of the next two periods, yielding a 5% dilution. Subtracting the effect of the buyback we end up with a 2.59% dilution overall over the next 2 quarters.
While this is still a decent amount of dilution intra-year, I consider it to be just below the level of material. This means that Pinterest stock is now trading without a significant dilution overhang, a new phase for the company and an added positive factor to consider.
Now looking to its cash flow statement, we can see that Pinterest has been cash-flow positive for several years running. Like some of the other line items here, this number is also quite variable between periods and has declined from its peak.
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On a more granular level Pinterest has had positive operating cash flow for 9 quarters running. Year-over-year results vary significantly, and the last 3 quarters have seen y/y operating cash flow declines.
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Pinterest’s financial picture overall indicates a robust, yet volatile, business. Significant variability in fundamental metrics is to be expected here due to Pinterest ultimately being a business reliant on digital advertising. As with other firms of this nature, it experiences large swings in earnings and cash flow between periods. The highlights here are the firm’s continued revenue growth as well as its ironclad balance sheet. It is still too early to determine the margins that it will operate at long-term, but I can comfortably say that this is at its core a profitable and cash-flow generative business.
Valuation
Pinterest is still priced as a growth stock, with a significant P/E premium on both a trailing and forward basis.
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Yet, the firm is now at the scale where it can start to increase its profitability. This is reflected in its expected forward growth rates, which are below average for the year ahead but very far ahead over the medium term.
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We can compare the stock's price, earnings multiple, and growth rate in one metric using the PEG ratio. Here we see that Pinterest is trading at a solid discount. This is a solid buy signal and indicates that Pinterest is a buy for investors with a 3-5 year horizon.
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Risks
The core risk to Pinterest is seeing it grow earnings below expectations over the next several years. While it appears to be trying to get revenue growth back up, the market is also expecting earnings growth and margin expansion. Indeed, this has a topic that management has covered several recent conference calls. The problem here materializes if management is not able to balance growing both its top line and margins at the same time. One requires investment, the other improved unit economics. These are contradictory forces which can be balanced but are often not. The strong balance sheet here is a hedge against difficulties that may arise from that dual focus.
Conclusion
Pinterest brings a lot to the table. It is crossing the threshold at which stock-based compensation is no longer dilutive while also continuing to post strong user metrics, all the while continuing to grow revenues. It is also ostensibly focused on improving profitability, but the picture here is a lot more uncertain. Last quarter indicates that management is not committed to giving up on growth as of yet.
I nonetheless believe that profitability is achievable given the company’s business model and operating cash flow track record. All of this is assured by one of the best balance sheets that I’ve seen for a technology company of this size. Considering all of this along with its cheap growth-adjusted valuation, I am calling it a buy.
For further details see:
Pinterest: High Potential And A Healthy Balance Sheet