Wayfair Stock: Pandemic Tailwinds Are Far Behind Us

Summary

• Wayfair's growth kick in as the pandemic period has proven short-lived.
• In the company's most recent quarter, revenue growth declined double-digits against the onset of the pandemic last year.
• This showed us that while consumer habits may have shifted permanently to making large furniture purchases online, we may never see those kinds of demand levels again.
• Shares of Wayfair look expensive from an adjusted EBITDA standpoint.
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The story of Wayfair (NYSE:W) in the stock markets over the past year is one of a big boom and bust cycle. Wayfair was one of the highest-profile e-commerce stocks to pop, and early on, during the pandemic. Prior to last year, investors had shunned Wayfair for its relatively slim profits and the seeming unlikelihood that Wayfair would ever reach a significant scale.

Then the coronavirus happened. On top of the fact that Wayfair's brick-and-mortar furniture competitors were closed, leaving consumers with no choice but to order their products online. Wayfair also received a big macro benefit from Americans' mass move out of the cities and into the suburbs, necessitating a flood of furniture-buying.

Now, however, that spurt of growth seemed only temporary. In Wayfair's most recent quarter, it has now fully lapped the onset of the pandemic and its revenue growth is in decline. Versus all-time highs notched above $360, Wayfair stock has lost about a third of its value, and is down ~20% over the past twelve months and roughly flat year-to-date. Easy come, easy go. In my view, Wayfair will continue to trade sideways, and given the slowdown in growth, it will be unlikely for Wayfair to meaningfully outperform the broader market from here.

Data by YCharts

My rating on Wayfair remains a neutral point of view. I see a rather balanced stack of risks and rewards for this company.

On the positive side:

• Consumer buying habits have shifted. Large purchases made online, sight unseen, have become the norm rather than the exception. Slowly but surely, Wayfair will continue gaining market share in the furniture space.
• Large range of inventory. Wayfair continues to excel in "having something for everyone," with its range of brands from the lower-end flagship Wayfair brand to the higher-end Perigold brand does a good job at capturing a wide range of potential customers.
• Scale has granted bottom-line margin expansion for Wayfair. The company has overcome one of its biggest criticisms and is now slightly EBITDA positive.

At the same time, however, we have to be mindful of the risks:

• Slowing growth doesn't look great against lofty ambitions. Visibility on where Wayfair's growth goes from here is limited. The company has set out a very lofty target of hitting 8x its revenue scale by 2030, relative to $14 billion in net revenue for 2020. That kind of scale multiplication will require Wayfair to grow at a 23% YoY CAGR throughout 2030, which is hard to see at the moment with growth in decline versus the pandemic year.
• Valuation is already quite steep. At current share prices near $241, Wayfair has a market cap of $26.29 billion, and after netting off the $2.60 billion of cash and $3.05 billion of debt on its most recent balance sheet, Wayfair's resulting enterprise value is $26.74 billion. For the current fiscal year, Wall Street analysts have a consensus revenue estimate of $14.40 billion for the company; and if we apply Wayfair's YTD adjusted EBITDA margin of 7.0% against that revenue estimate, Wayfair's current-year Adjusted EBITDA is $1.01 billion, and its valuation stands at 26.5x EV/FY21 adjusted EBITDA. Wayfair is already fairly valued, if not even slightly rich at current levels.

The bottom line here: Wayfair had a nice run-up last year amid a coronavirus-driven demand surge. But now as growth fades and as Wayfair is left with a fairly bloated valuation, I think the stock's ~30% dip from highs is consistent with its fundamental profile and that Wayfair isn't likely to meaningfully outperform the broader market index in the near-to-medium term.

Q2 download

Let's now discuss Wayfair's most recent quarterly results in greater detail. The Q2 earnings summary is shown below:

Wayfair Q2 earnings presentation

Wayfair's revenue in Q2 declined -10% YoY to $3.86 billion, missing Wall Street's expectations of $3.93 billion (-9% YoY) - the first miss in a long string of beats for Wayfair since the pandemic began. Note as well that this is coming off a 49% YoY growth quarter in Q1, when Wayfair had not yet started comping the pandemic. We note as well that for next year in FY22, when comps should be more normalized, Wall Street analysts are only expecting 19% YoY growth for Wayfair (per Yahoo Finance); hence we call into question how Wayfair intends to hit 8x revenue growth by 2020 (requiring 23% YoY annual growth throughout each of the years through 2020) unless it starts buying this revenue through acquisitions.

Customer metrics are roughly flat to last year as well: the company has notched about 31 million active customers, and the average customer orders roughly twice in a year.

Here's some additional qualitative context from CEO Niraj Shah's prepared remarks on the Q2 earnings call regarding the demand landscape:

But it's worth noting that while furniture and decor is our strongest and largest vertical, we already enjoy good scale across each of them. We're also building our business across both North America and Europe two immense markets, which combined are more than $800 billion in size.

These dynamics may be hard to see by focusing on Q2 alone, given the challenging year-ago comparison. On the surface, what you'd see is a modest decline in active customer count and slightly lower order frequency. But zooming out, you would recognize that we acquired nearly 18 million new customers over the course of 2020 with about one-third of those in Q2 last year.

In Q2, we also saw more frequent purchasing with smaller basket sizes, as customers outfitted their homes for the demands of sheltering in place, remote working, and schooling. Well, not all of our recently acquired customers will be in the active count at all times, they're now part of our customer file, and are highly engaged."

The company notes that it is also slowly passing on the rising costs of supply chain and logistics woes to its customers, and that so far customers seem to be absorbing slight price hikes without any major downside reactions.

As a result of these price increases, Wayfair's adjusted EBITDA margin has remained high, though slightly below the pandemic period. The company notched $311 million in adjusted EBITDA in Q2, down -29% YoY and representing an 8.1% adjusted EBITDA margin, versus 10.2% in the prior year Q2:

Wayfair Q2 earnings presentation

Year to date, Wayfair's 7.0% adjusted EBITDA margin is up versus 4.7% in the same period last year, but that's because the prior-year Q1 was "missing" one quarter of pandemic benefit.

Directionally speaking, Wayfair's long-term expectations for adjusted EBITDA margin now fall above the 8-10% long-term range it set during its IPO. The company has cited gains in logistics efficiencies and economies of scale as the key drivers to support a gross margin boost, while over time the company should be able to drive down advertising/sales and marketing costs as a percentage of overall revenue as well. Here are the drivers that Wayfair has laid out for margin accretion looking ahead:

Wayfair Q2 earnings presentation

We note as well that the company has succeeded in slightly bringing down headcount since the start of the year, which is a good sign that the company is being cost-conscious.

Key takeaways

In my view, Wayfair will continue to turn in disappointing performance, given its relatively rich valuation against decelerating revenue growth and already-high expectations. Also given investors' recent pessimism toward the e-commerce space as a whole after last year's substantial run-ups, I find it unlikely for Wayfair to rebound from here.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.