Roku: Good Question, Great Answer

|
About: Roku, Inc. (ROKU)
by: Elazar Advisors, LLC
Summary

I went to Strong Buy March 14 after seeing the potential earnings upside and getting excited about 2020 numbers.

After yesterday's earnings, our price target went to $111.

But one question and one answer on the call gave us much more conviction and may have helped the stock launch.

We had the opportunity to ask a question on Roku's (NASDAQ:ROKU) earnings call. It was a simple question, but the answer was oh so sweet. I think it may have helped to catapult the stock, but not sure. The stock was up 8%-9% at the time of the question and the next day kept rising to be up 27%.

Good Question

On Roku's earnings call they managed to slip us in as the last question.

Here's what we asked,

"Our next question comes from the line of Chaim Siegel with Elazar Advisors.

Congratulations on a great quarter. Talking about the EBITDA that you raised your estimates this year. Looking out to next year and kind of the trends with the gross margins and revenues, I'm just wondering if you could talk about profitability going into next year. Looks like that you have some leverage going in your favor."

Before we show their answer, here's what we saw.

If you've read our stuff you know we love to look at the two-year revenue growth rates. We add this year's quarter's revenue growth plus last year's same quarter's revenue growth. That gives us an underlying trend. People don't use it for whatever reason. That's fine by me.

Here's what we saw.

(000) 2017 2017 2017 2017 2018 2018 2018 2018 2019
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
A
Total Net Revenue 100093 99627 124782 188261 136576 156810 173381 275740 206662
1yr 27.6% 18.9% 40.1% 27.8% 36.4% 57.4% 38.9% 46.5% 51.3%
2yr 50.8% 51.5% 73.8% 44.3% 64.0% 76.3% 79.1% 74.2% 87.8%

Notice anything?

Q1 was a breakout quarter. It was the fastest two-year growth rate we've seen. Business is getting better. When we see an accelerating two-year growth rate we can model future quarters to also accelerate.

That takes our EPS way higher than the Street. We're at strong positive earnings for next year (full earnings model: paywall) vs. the Street at negative earnings for next year.

Seeing that improving trajectory made me think this story is about to get even more powerful.

While revenues have accelerated operating expense growth has stayed the same. If these trends were to continue you can start to get big earnings leverage.

That's probably why our earnings numbers are much higher than the Street's for next year. The simple math of faster revenue growth combined with steady expense growth gets you there.

That's why we asked Roku, "Looking out to next year and kind of the trends with the gross margins and revenues, I'm just wondering if you could talk about profitability going into next year. Looks like that you have some leverage going in your favor."

Great Answer

And their answer was confirmation that I think we're right. I don't think the Street with losses for 2020 thought about the EPS leverage potential, but based on the company's answer I think the company sees it coming.

Here's what Roku said,

"Steve Louden, Roku, Inc. - CFO [69]

...But certainly, the business has been accelerating on a revenue basis. We have very robust gross profit.

...However, we do think that over time, and again we haven't provided specific guidance for 2020 right now, that there is a lot of leverage in the business. As I mentioned, mixing into a faster-growing, higher-margin platform business is a great long-term position for the business and there's a lot of leverage in that business model overall as we continue to grow."

I think our 2020 EPS profits are more right than the Street's 2020 losses.

The company sees "a lot of leverage in the business." I think Street numbers have to come up.

Ahead of earnings this is what we told subscribers (paywall),

"I do think the trends are very strong and the stock has the ability to break out. It's not far from new highs.

... The real reason we're at strong buy rating though is that 2020 EPS could be a breakout.

... I doubt the company talks about that but there's lots of leverage coming. Because the revenue base is growing so fast I don't think they can find reasons to invest as fast which will likely drive earnings leverage. That's 2020."

At the time I didn't think to ask the company about my 2020 thesis. But after a great quarter, I decided to lob in my question. I think my thesis was confirmed by their answer. I guess the one thing I was wrong about in my earnings preview was that they did, in fact, "talk about lots of leverage coming." I thought they wouldn't. Good thing I asked.

As a side note, after seeing the earnings report come out and seeing the revenue acceleration we told subscribers at around 4:20 PM we'd add to positions with the stock up 6%-or-so in the after market. I was just so impressed with the results. That was yesterday at this time, but 20%-plus lower. 24 hours ago. Who knew? If only we could annualize that, right?

Where's The Street?

The Street is nowhere on Roku. They have losses for 2020. Roku is a leader in over-the-top ("OTT") streaming. Huge swaths of ad dollars are coming from linear TV to OTT. Yet this is so undercovered.

Roku Analyst Ratings Source

Out of 14 people following the company, half like it, half don't. Roku's stock is breaking out to new highs. Revenues are accelerating growing faster than Netflix (NASDAQ:NFLX) (Netflix' revenue growth is slowing). Roku is telling you there's huge leverage in the business. I think that leverage could potentially blow past estimates next year. And practically nobody's aboard on the sell side.

Let's compare that to the type of coverage Netflix is getting.

Netflix Analyst Coverage Source

No doubt Netflix is a great company, but Roku is too and younger and growing faster. I think it's fair to expect Roku gets some new exposure from some new bullish coverage over the course of this year.

Roku stock chart Source

If the stock already is breaking out without that coverage imagine what it can do with that coverage.

Conclusion

We've had some good ones, but Roku stacks up there with our better ones. You never really know which one has the ability to be up 27% the next day on earnings, but that's what we're looking for. Really what we're looking for are companies with at least 45% 12-month upside, our quarters above the Street, and a "wow" story. Roku had all of that. But the accelerating revenue growth was so key for me.

That and a great answer to a good question helped this stock catapult. Probably more to go.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: All investments have many risks and can lose principal in the short and long term. The information provided is for information purposes only and can be wrong. By reading this you agree, understand and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Elazar Advisors, LLC, and their related parties harmless. Elazar and its employees do not take individual stock positions to avoid front running and other potential customer related issues.