When a name that trades on nothing but Revenue guides up based on strong revenue trends – ANY argument that sounds something like ‘but it will never earn money – ever’ is simply irrelevant. Home furnishings is one of the best categories in retail today – keeping in mind that it cratered at this time last year (ie the ‘easy comp’ thing). We’re seeing strength at both ends – W at low end, RH at high end, and ‘meh’ in the middle w BBBY, WSM. But the fact is that Wayfair is – at least this quarter – gaining increased share in a good category.
To be clear, I’ll make the ‘no profit’ argument any day and every day – bc by our math, this business model is structurally incapable of earning a profit as the growth engine is being run today. Moreover, it’s simply not attractive at a $5bn+ enterprise value to an equity investor, strategic buyer, or financial buyer if W slows growth to earns some bank. Consider this…if the company put up a 3% EBIT margin – which, to be clear, Amazon won’t let it do – then we’re looking at $0.84 per share on a $4bn revenue base. Yah…there’s your 70+ multiple. Does a raging W bull really want this to be valued on EPS? Didn’t think so.
There’s no ‘think about what could be’ story here. Maybe we put on the ‘what if’ hat. What could a retail/consumer genius/visionary be doing inside Wayfair today that us Wall Street types simply can’t and won’t appreciate until it smacks us in the jaw? Everyone thought Bezos was nuts three years ago on the drone announcement. Now…maybe not so much. But this is not Amazon. It’s not a business that lends itself to using loss-leaders to retain/own customers in order to dominate more profitable categories. This is the ‘Home’ category – with infrequent purchases (we buy one piece of furniture per capita per year), and higher frequency in lower ticket commodity home goods where margin has been whittled away to lsd at best.
The Only Reason this is not a ‘Best Idea’ Short. One of the biggest flaws in this model is one of the things that keeps this off our ‘Best Idea’ Short list. And that is the lack of Brick & Mortar for Wayfair. Like it or not, stores are critical in nearly every category. In some categories, we need 20% stores 80% ecomm (electronics), and in other categories it’s the inverse. The Home category is about 50/50. RH and WSM have it about right, actually. Not just our opinion, but also based on our consumer survey work. Unfortunately for Wayfair, it has ZERO B&M presence. The likelihood of building one is close to nil. The capital intensity here is so favorable bc of minimal inventory carrying costs that the cash cycle is almost like that of a bank.
Stores are critical – and W ain’t got ‘em. Target does. That leads to the other way for W to fix it’s ‘no B&M’ problem. It can be acquired. Amazon won’t. It already has a ≈ $10bn US home business – which is about 3x the size of Wayfair’s – and it does not need a single thing that Wayfair has. Buy why doesn’t Target buy Wayfair? It would be another great Short opportunity on TGT, but that does not mean Cornell won’t cut the dividend and do the deal to give people a shred of confidence in any kind of growth2.0 algo at TGT. BBBY would be the ideal match up, actually, though it would be a merger of equals with egregiously unfavorable economics for BBBY.
But one of our premises as we enter #Retail5.0 is that NO deal is ‘too big’ or ‘too unfathomable’ to happen – either intra-sector or cross sector. Why would someone buy it at $6bn when they could have bought it 6mos ago for $3bn? No idea…
Mind you that these deals NEED to be considered. Why the Ethan Allen/Amazon is not getting more play is a mystery to us. This allows a ‘meh’ brand like Ethan Allen to access the 55% of US households that have a Prime membership. This is not exclusive…ie Amazon will do more of these, which is likely to put Wayfair on defense.
--McGough
McLean’s callouts…
Wayfair beat revenue by 2.8%, but growth decelerated 450bps, and 480bps on a 2yr basis.
Clearly the category is in a healthier position than we saw 12 months ago. Q2 to date is running at a +40% implying a 1200bps acceleration from 1Q.
EBITDA margin was guided essentially in-line with expectation (-2%), also better than the guidance trend of the last year, which had been to temper margin expectations.
THE GOOD
Incremental Margin
Incremental margin improved 460bps, though against an easier compare. With even easier compares coming, the company could see a positive incremental margin for the first time in 6 quarters by 2H17.
Repeats
Repeat ordering continued to grow, with 60.4% of orders coming from returning customers up 500bps yy. Customer repeating and retention will increase profitability in the long term, however it implies lower advertising efficacy and weaker customer growth which means lower long term share.
Cash Cycle
Much like Amazon the cash conversion cycle of a low inventory model means high returns. Wayfair's 1Q cycle dropped 6 days, now standing at -46.
THE BAD
Ad Spend Per Added Customer
Ad spend is driving fewer customer gains. The ad dollars required to drive an incremental customer was up 56% in 1Q. Maintaining growth is getting more expensive. With the company now at 81% aided awareness, the untapped customer pool is getting smaller and it seems to be showing in this metric. Management talks about a target of hitting 60mm US households, while its at 8.85mm customers, with awareness not far from peak. We think the company will come well short of that 60mm target.
Customer Acquisition
The above chart means customer acquisition cost is up as well (below), which increased 3% yy to $71.11. Growth is getting more expensive, and the big question for an online model that has high price transparency is how much does it cost to get and hold customers. When Amazon has many identical or similar products listed at lower prices, a rising customer acquisition cost is concerning.
