Wayfair: Not Too Late To Be Bullish

Summary

• Wayfair has a huge total addressable market and is currently the market leader with regard to online furniture sales.
• Wayfair has a handful of competitive advantages and is adding more to that moat.
• Wayfair has increased a lot in the past few weeks; however, there is still some upside from the current price.

Online retailers have had a fantastic run lately. The "stay at home" sales surge has propelled these stocks to new highs. I wanted to explore one such stock, Wayfair (NYSE:W) to see if the hype is warranted and if an investment opportunity is present.

Wayfair had a blockbuster Q1 2020 due to the bulk of the population being forced to stay at home due to the coronavirus lockdowns. Revenue increased by 20% from last year and is now at $2.3 billion. Gross margins were 25% and gross profit was $579 million. Despite the blockbuster quarter, the company posted a net loss of -$3.04 per share. The loss this quarter was higher than the loss of Q1 2019 which was -$2.20. The company has been losing money since the start of its existence.

The increase in the net loss has caused a few authors in Seeking Alpha to be bearish on the stock. However, digging further into the company's disclosures, we can see that the company has been improving on all the metrics needed for its future success. The number of active customers reached 21 million which is an increase of 28.6% from last year. This doesn't even include the bump due to the coronavirus lockdowns. The company announced it actually had an even better April where sales were up by 90% due to quarantined people buying home office furniture and cookware. In fact, in the early days of the lockdown, Amazon (AMZN) deliveries took longer than usual and prioritized essential products, for a good while Wayfair was one of the only furniture retailers still in operation.

While the absolute increase in number of active customers is important, it is equally important for the company to actually retain those customers and keep them coming back to the platform. This retention rate is important as Wayfair still spends a significant amount on advertising and marketing. Looking at the disclosures, repeat customers actually made up 70% of total orders in 2019 compared to 66% in the same time last year. Given the company's high repeat customers, the increase in sales due to the lockdowns could permanently increase its active customer count. This is great news as it shows that the company is on track to properly scale its business.

While we do not know how long these trends will persist ... we believe this period has certainly and permanently accelerated e-commerce adoption in our category."

Wayfair cites widespread momentum

Wayfair's Total Addressable Market is massive and the company is making headway into dominating

Wayfair is essentially taking a page from Amazon's playbook in its attempt to grow the business. The company has a massive Total Addressable Market ("TAM") that if it plays its cards right, it could eventually dominate. Revenue in the Furniture and Homeware segment in the US amounts to $44.4 billion in 2020 and is expected to grow at a CAGR of 3.6% to reach $51.3 by 2024. Currently, online sales make up only about 18% of the total.

The furniture space is competitive with multiple retailers causing a fragmented market. However, it may surprise you to know that when it comes to online sales Wayfair is actually the clear market leader even besting Amazon in the category. In 2019, Wayfair had a market share of 33.4% followed by Amazon at 29.7%. After Wayfair and Amazon, there is a big drop in market share as 3rd placed Walmart (WMT) only had a 4.7% market share of online furniture sales. More popular names like Costco (COST) and IKEA had less than a 5% market share when it came to online sales.

Wayfair.com dominates online furniture sales

You can see the evidence of Wayfair's dominance in how quickly it has been able to grow its revenue year on year. While growth has been slowly declining in recent years, above 30% growth is still nothing to scoff at. If the company can continue at this historic pace, it will be well on track to dominate the category.

Data by YCharts

Path to profitability

Historically, the main challenge of Wayfair has always been to get customers comfortable with purchasing furniture online. Looking through the financial statements, we can see that the major reason that Wayfair is unprofitable is due to its massive SG&A costs. This isn't too concerning as these are mostly fixed costs that can properly scale with revenue. Meaning revenue can go higher without seeing a subsequent increase in these costs. For example, marketing spend as a percentage of revenue would trend down as repeat customers increase. I don't mind seeing these costs now as it indicates that the company has been building out its platform to make sure that it gets a competitive edge in both technology and logistics.

Wayfair 10-Q

Wayfair actually has a handful of competitive advantages and is adding more to that moat. Furniture has been a challenging area for e-commerce as the items are large, heavy, damage-prone, and, frequently, needs to be "felt". Improvements in technology will help customers "better visualize" the furniture and how it fits within their personal space. Scale in logistics will improve delivery times, decrease damage in transport, and improve customer experience.

Logistics Delivery Network - Investor Presentation

Wayfair Technology - Investor Presentation

Comparing Wayfair's gross margin to the other top-online furniture retailers, we can see that it is definitely on the lower end of the range though not as low as Overstock (OSTK). This is not too surprising as the company has been running sales and promotions in order to obtain market share. Dialing that back a bit to bring gross margins closer to the average would be an easy way to improve profitability.

For gross margin comparables, I picked among the top online retailers of furniture. These may include much larger companies like Amazon and companies with substantial brick and mortar presence like Home Depot (HD) and Walmart. A lot of these companies are more established, therefore, a good indicator of Wayfair's possible margins once it exits its "growth stage".

Author's calculations using data from Seeking Alpha

Note: Williams-Sonoma (WSM) owns potterybarn.com

Furniture & Homeware - United States | Statista Market Forecast

Valuation

In terms of valuation, I am selecting other comparable firms in the online retailing space that are focused on a single vertical, rapidly growing their market share and are upending traditional brick and mortar retailers. I believe these are better comparables in terms of valuation for Wayfair as opposed to Amazon or Walmart which are larger more mature firms. These firms are still growing their market share, so earnings are not reflective of their true potential. Therefore, I will be using the Price to Sales ratio in order to determine the appropriate multiple to use for Wayfair. The companies I chose as comparables are Carvana (CVNA), Chewy (CHWY), Farfetch (FTCH), Overstock.com, and Stitch Fix (SFIX).

Wayfair has a price to sales ratio of 1.67 indicating it is around average in terms of valuation relative to its peers. Applying the average P/S ratio of the comparables of 2.24 to Wayfair, we can arrive at an average target price of $229.51 which implies a 34% upside from the current price of $170.76. Wayfair has increased a lot in the past few weeks, however, there is still some upside from the current price.

I need to warn you though that this stock could be volatile as the company has yet to make a profit and has high expectations baked into its stock price. I believe that this is worth the risk as the company has a lot of growth potential due to its potential addressable market and the way it has dominated the online furniture category. Wayfair is a speculative buy.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in W over 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.