Wayfair: A Failure Of The 'Growth-At-All-Cost' Model
Summary
- Wayfair reported its Q4 earnings that missed expectations on surging costs and expenses while growth continues to decelerate.
- The company has established itself as a major player in e-commerce but is challenged by what is a fundamentally low-margin business and the logistical challenges of shipping furniture.
- Management has acknowledged inefficiencies in aggressive expansion but still thinks the strategy can work over the long run.
- Recurring negative free cash flow and weak financial metrics will continue to weigh on sentiment as it's unclear if the business model can ever reach consistent profitability.
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Wayfair Inc. (NYSE:W) has made a name for itself as one of the major players in e-commerce by specializing in home furnishings and furniture. While revenues have more than doubled in the past 3 years to approach $1 billion in 2019, the company has struggled to translate that operating momentum into profitability as losses continue to accelerate adding to questions over the sustainability of the financial model. The company just reported its latest quarterly result highlighted by a record cash burn driven by ballooning expenses suggesting its expansion was too aggressive and inefficient. The stock is now down over 60% from highs just one year ago in a case of the market largely abandoning the prior bullish thesis.
(Source: finviz.com)
Q4 Earnings Recap
Wayfair reported its fiscal 2020 Q4 earnings on February 28th with a GAAP EPS loss of -$3.54. The adjusted non-GAAP EPS loss of -$2.80 was $0.18 worse than expectations. Revenue in the quarter at $2.53 billion was up by 25.9% year over year and in line with estimates.
(Source: Company IR)
The story here was a combination of higher than expected costs and expenses leading to deepening losses across both the U.S. and international segments. The combination of customer service and merchant fees, advertising, and SG&A grew by 44% y/y, far exceeding the revenue trend. This year the company is integrating new technology infrastructure along with a hiring push for engineering talent that added to salary costs and overall expenses. For the full year 2019, Wayfair lost $984 million, up from $504 million in 2018.
The other concern here is a relative deceleration at the top line compared to stronger trends previously. U.S. segment growth in the quarter at 23.9% y/y is fine at face value, but this is in the context of a stronger 38.5% y/y growth rate in Q4 2018. The international segment which represents about 16% of total sales, also saw growth decelerate to 37.1% y/y from 49.8% in the period last year. The international business has been a real money pit, with the company reporting a negative adjusted EBITDA margin of -23.4% in Q4 compared to -4.1% in the U.S, and also a deteriorating compared to last year.
(Source: Company IR)
Negative free cash flow ballooned to -$598 million in 2019 from -$137 million in 2018. The dynamic here is that management continues to invest aggressively for growth even as some operating metrics appear to have reached a plateau.
(Source: Company IR)
We point to the average order value at $226 in Q4 compared to $227 in Q4 2018. The net revenue per active customer in 2019 at $448 was up just 1% compared to $443 in 2018. The number of orders per active customers has also stagnated at 1.86 per year since early 2018. This metric, in particular, has been flat going on two years now and represents a weakness in the bullish thesis. Wayfair simply needs customers to spend more and conduct more purchases.
W Forward Guidance And Consensus Estimates
Management is only offering guidance for the current quarter, estimating revenue growth between 14% and 16% in the U.S. segment, along with an increase of 22% to 25% in the international business. These growth rates represent a deceleration compared to 38% revenue growth in the U.S. in Q1 2019 and 41.7% in the international segment.
An estimated firm-wide adjusted EBITDA margin between negative 7.3% to negative 7.8% compares to -7.1% in Q4. Management sees continued pressures related to its cloud investment and international logistics representing incremental costs through the back half of 2020.
Longer term, the company thinks it can reach positive adjusted EBITDA in the U.S. by 2021. From the conference call:
To be clear, Wayfair's strategy is already a proven winner. We are just sharpening our execution and our cost focus. Over time we expect our efforts to translate to improving profitability and free cash flow trends. But the associated benefits are not instantaneous and it will take some time for them to begin to flow through.
You will see them begin to build over the course of 2020 and the changes we are putting in place will lead to more consistent positive adjusted EBITDA in the U.S. at some point in 2021.
In terms of consensus market expectations, keep in mind current estimates do not expect the company to earn a profit through at least 2024, although with a gradually narrower loss each year. While revenue growth for 2020 is estimated to remain above 19%, we sense that there are downside risks to these targets.
(Source: Seeking Alpha Premium)
Analysis And Forward-Looking Commentary
One of the positive themes that Wayfair has going for it as we alluded to in the introduction is that the company has established itself as a leader in e-commerce. Management noted that the company continues to capture market share given its growth exceeds that of the U.S. online home goods category. From the conference call:
We estimate that we captured $0.36 of every $1 of home goods expenditures moving online and solidified our standing as the go-to home goods retailer.
(source: Company IR)
The problem, of course, is that Wayfair operates in a fundamentally low-margin business and even more complicated by the logistical challenges of moving large pieces of furniture around the country for home delivery. By this measure, the company's strategy of growth-at-all-costs has failed, and it's still unclear if Wayfair can ever reach consistent profitability.
One of the themes in 2018 and into early 2019 was improving margins as the adjusted EBITDA nearly broke even in fiscal 2018 at -0.3% for the U.S. segment. The latest trends reverse that improvement that had helped drive the stock to a previous all-time high over $170 per share at its all-time highs. Wayfair effectively needed top line growth to be even stronger last year to cover its larger investment spending. The company's international expansion has been a strategic failure that only serves to drag lower the more positive momentum the company has in the U.S.
Wayfair has a "long-term" model, a sort of roadmap for how it envisions improving the financial situation. As we've previously discussed in a bearish article from last year, these targets in terms of gross margin between 25-27%, and a positive adjusted EBITDA margin between 8-10% appear both aggressive and potentially unrealistic. Curiously, Wayfair has been referring to these same "long-term" metrics with similar marketing materials going back to 2016 making it unclear what time frame the company is referring too. With the stock now trading at $65, it's clear investors have lost patience.
(Source: Company IR)
The bullish case for Wayfair is that the company can pull some levers to improve near-term financial results. This could be an effort at cutting back on advertising or limiting expansion CAPEX. To its advantage, Wayfair has built enough brand exposure and customer base that the underlying business maintains momentum. Expectations in terms of adjusted margins are so low at this point, an incremental upside could support sentiment towards the stock price. Now is the time for the company to consolidate its logistical and brand investments to firm the financial position.
We highlight that the stock is now trading under 0.7x trailing twelve months sales, the lowest multiple in its history. This should not be confused with a representation of value, as many "distressed" retailers can trade at P/S multiples significantly lower under 0.5x. We see the 1.0x as a sort of line in the sand that will require a major improvement in market sentiment from here, limiting the upside in the stock price.
Data by YCharts
To the downside, it's a question of balance sheet weakness given the large recurring negative free cash flow. The company ended the year 2019 with $1.4 billion in long-term debt, up from $738 in 2018. The company may choose to turn to another capital raise that will only serve to dilute current shareholders. Any type of weaker than expected operating momentum in the upcoming quarter should also keep the pressure on sentiment towards the stock. Risks include weakness from broader macro trends.
Verdict
We expect significant volatility in shares of W with the company's weak financial position balanced by what remains a solid growth story and segment leadership position. While having an overall bearish view, at the current stock price of $65, we think this is no longer a "great short" the stock may have been when it traded above $100 for most of 2019. At this point, Wayfair belongs more in the "avoid" category as highly speculative to both bulls and bears.
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This article was written by
15 years of professional experience in capital markets and investment management at major financial institutions.
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Analyst’s 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.
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Comments (25)
Well done.With respect to CASH, I note that W has been financed in primarily three ways:
1) IPO - $ long gone
2) 3 “debt” raises that are actually call options and now worthless
3) By leaning on Vendors - look at the A/R - A/P differential.I calculate that W will need cash circa June or July. If sales slow, then the AR / AP will turn around and become a run on the bank. This could cause a cash crunch as early as May.I don’t think they can raise debt.
1) No one wants a W call option
2) The financial statements do not support debtI don’t think they can do a secondary offering. I don’t think anyone will underwrite it at any level that makes sense for W.Will you grind through the financials and weigh-in with your view as to when “Cash Becomes CRITICAL?”Much appreciated
here is a short Wayfair article from last year when it was at $137
seekingalpha.com/...
Money in full, but eat the shipping freight charges), they lost almost $1B doing it and there is no sign that the scale
they have reached will yield a profit as W has had years to try. Their business model doesn’t work. One of the few stocks red today when all markets up big.
