2023-08-13 22:16:11 ET
Summary
- Rover Group's recent performance has been exceptional, exceeding expectations in key financial metrics such as gross booking value, revenue, and adj. EBITDA.
- ROVR's international expansion, particularly in Europe and Canada, has outperformed projections.
- This expansion broadens the company's growth opportunities and indicates its ability to tap into new markets successfully.
- The revised guidance is positive, but I am concerned about the elevated risk of missing guidance.
Summary
Following my coverage of Rover Group ( ROVR ), I recommended a buy rating due to my view that ROVR was still undervalued back then. The stock has done fantastically well over the past few months, and the recent earnings have caused another gap up to a high of $7 (my target price). This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating as I remain positive on ROVR growth and margin expansion potential, which were well demonstrated in 2Q23. International growth also continues to gain traction, suggesting a longer growth runway than I had expected. I expect valuation to continue to stay at a premium to peers as ROVR has a better growth profile, profitability outlook, and balance sheet.
Investment thesis
ROVR reported a very strong 2Q23 performance that beat guidance across all key lines in the P&L. Rover reported Gross Booking Value of $266 million, a growth of 25%; Revenue of $59 million, a growth of 35% above management's own guidance of $51 to $53 million; and lastly, adj. EBITDA of $11 million, more than double the top-end of the management guide ($3 to $5 million).
There are a few key highlights in these 2Q23 results. One of the most noticeable is that ROVR is still going strong, with increased bookings from customers. The robust EBITDA performance further validates ROVR's business model's strong operating leverage, suggesting that the company's EBITDA will continue to grow rapidly over the next few years as margins expand from a low starting point. Regarding profits, I think it's also worth noting that ROVR didn't try to minimize either expenditures or investments. As such, these margin gains are sustainable. The fact that management increased their EBITDA margin guidance for FY23 supports my assessment.
The second surprising realization was that ROVR's international expansion has been going even better than I had hoped. ROVR's quarterly gross booking value increases were 59% in Europe and 34% in Canada. This is intriguing because it means that ROVR's potential for future expansion has been greatly widened. Despite Europe and Canada's smaller size compared to the US market, they still present a sizable enough opportunity for ROVR to cash in. I expect the market to react favorably as ROVR continues to expand this aspect of the business and release more key performance indicators. Management has increased its marketing expenditures in Europe in light of the continued improvement in unit economics, and the response has been particularly strong in France and the United Kingdom, leading me to believe that this rapid growth can be sustained.
Finally, one thing I noticed was that ROVR's customer growth was muted after the pandemic, which management attributed to a slowdown in pet adoptions. While this is obviously undesirable, I don't see it as a huge warning sign because the covid period did "pull forward" a wave of new customers and the current state of affairs is just a return to normalcy. Over the next few quarters, we should be able to determine this trend.
Guidance
The increased guidance indicates management confidence in the business, which is likely a major factor in the stock price gap. Management guided to 3Q23 Revenue of $61-63 million, representing a growth of 22%, and 3Q23 adj. EBITDA of $12 to $14 million, representing a growth of 27% and a margin of 21%. This has naturally led to an increase in FY23 guidance, with revenue now ranging between $222 and $227 million and EBITDA ranging between $37 and $41 million.
The increase in guidance is definitely great for the stock. Nonetheless, I am worried that ROVR is becoming overconfident, especially since the global economy is still weak. Management has shifted their expected timing of a moderate recession from 2H23 to 1H24. I can understand that a positive outlook for FY23 performance is supported by the expectation that the robust summer business outperformance will persist. But I don't think anyone can predict what will happen in the last four months of FY23; anything is possible at this point. The possibility of a severe economic downturn is not one I would dismiss. As a result, I believe this revised increase in guidance has increased the likelihood of ROVR falling short of both its guidance and consensus estimates.
Valuation
Own calculation
I believe the fair value for ROVR based on my updated model is $9. My model assumptions are that ROVR will grow at the low end of its long-term guided range for the next three years. As I have no idea when a recession might occur, my growth assumption of 20% is on a CAGR basis. The increase in price target vs. my previous model is largely driven by the increase in multiples. I expect ROVR to continue trading at this multiple as it continues to grow way above its peers, its profitability is at a point of positive inflection, and it has a much better balance sheet than peers.
Peers include Wag! Gorup, Chewy, and Petco Health. The median forward revenue multiple peers are trading at is 1.11, the expected 1Y growth rate is 20%, and the debt-to-equity ratio is 127%. In contrast, ROVR is expecting to continue growing above 20% with a debt-to-equity ratio of 8%.
Conclusion
In conclusion, I reiterate a buy recommendation. The stock's robust performance and recent earnings highlight its growth potential and margin expansion. The impressive 2Q23 results, with substantial increases in Gross Booking Value, Revenue, and adj. EBITDA, reinforce ROVR's solid operating leverage and sustained profitability. International expansion, notably in Europe and Canada, has exceeded expectations, broadening the growth horizon.
For further details see:
Rover Group: Reiterate Buy As Performance Continues To Be Strong