Shutterfly Zooms In on Digital Printing

| About: Shutterfly, Inc. (SFLY)

We are upgrading our recommendation on the shares of Shutterfly Inc. (NASDAQ:SFLY) to Outperform. Increased usage of digital cameras combined with accessibility of high-speed internet provides significant expansion potential for the company. Product innovation, strategic partnerships with retailers and opportunistic acquisition also augur well. We believe Shutterfly’s focus on developing a successful commercial printing business aided by strategic partnerships will significantly contribute to its earnings.

Shutterfly’s third-quarter loss of 25 cents per share was 4 cents better than the Zacks Consensus Estimate, primarily driven by a better-than-expected growth in revenue.

Shutterfly is innovating in the Personalized Products and Services category to drive print customers toward higher revenue and higher margin products. The company has already begun to realize leverage in its business model in gross margins, operating margins and capital expenditures. The capital expenditures are arriving from its strategic storage and manufacturing initiatives. These structural improvements should benefit the company, going forward.

Shutterfly has teamed up with Target Corp. (NYSE:TGT), a leading discount retailer in the United States, to increase brand awareness and make its services available in Target stores and on the website. During 2008, the company entered into a strategic relationship with Group O, a leading provider of marketing services, to provide commercial print services. Additionally, the company acquired Nexo in 2008 and TinyPictures in September 2009.

Shutterfly is focused on building a successful commercial printing business and forming a sponsorship and advertising program. The company has made a steady progress in developing a suite of products, services and capabilities to expand its commercial printing. Its partnership with Group O has already started to pay off.

On the downside, a weak economy and rising unemployment will negatively impact the company’s profitability as discretionary spending by consumers is expected to be restricted in the near term.

Shutterfly’s results are impacted by vacation and other travel trends, as these are the major occasions requiring a greater use of digital cameras. Therefore, downturns or weaknesses in the travel industry hurt Shutterfly’s business. Since the onset of the economic downturn last year, the company has experienced a seasonal slowdown in site traffic and order volumes for its products. Given the magnitude of the continuing financial crisis and the recessionary pressures on all consumers, we believe earnings will be negatively impacted in the near term.

Additionally, we see a continuation of pricing pressure in its printing business. Competitive pricing pressures, particularly for 4x6 prints pricing, have had and may continue to have a significant impact on net revenues as well as net income.

However, we believe that the positives outweigh the negative factors. Therefore we have upgraded the recommendation to Outperform.