THE HEDGEYE EDGE
Wayfair has been on our short radar, and we’ve been waiting for the right time to get short – and that time is now.
We continue to think that Wayfair will never make money – as its Gross Margin structure is structurally too low to fund the SG&A costs inherent to growing this business. But let’s face it, the stock didn’t care about that at $50, and it probably doesn’t care at $160. That’s why we’ve been so picky about calling the right entry point.
What the market should care about is a change in the competitive set that is materially going against Wayfair. Its success has attracted the wrong kind of competition – as in, the folks you don’t want to compete with... ever. Combine that with more challenging Macro growth headwinds in the US and in Europe, and we’re looking at the growth trajectory being cut at least in half over a TAIL duration – which is dangerous given that there’s no earnings or cash flow to trade on here.
This thing is ALL ABOUT the top line, and we’re currently sitting at an unsustainable growth rate that should begin a multi-year deceleration starting next quarter. In the ‘watch what they do not what they say’ department, keep in mind that Wayfair management is better at selling their W stock than they are at selling furniture (note: I’d challenge you to find more Form 4s for any company... ever).
Competition is stepping up its game. Keep in mind that at the time of the IPO the only real competitor was Overstock. Now that’s become a crypto-company, and we’re seeing real businesses – the kind with deep pockets to invest behind major categories like home furnishings, and also that have real scale to make money where Wayfair cannot.
- Walmart just launched a new line of furniture and home goods called MoDRN available on Jet.com, Walmart.com, and Hayneedle.com. This looks like a direct shot at Wayfair.
- Ikea is exploring a third party marketplace platform on its site to connect more suppliers with buyers. This is essentially the same model that Wayfair uses, as Wayfair holds inventory only when in transit. Ikea is a very recognizable brand that has stores to back up the online operation.
- Amazon continues to move further into home including furniture and kitchen Prime Day deals, new private label furniture brands, deals to sell traditional furniture brands on its site (like La-Z-Boy and Ethan Allen…) and DCs adapted for greater large goods fulfillment.
- TGT and WMT are continuing to invest in ecommerce and delivery. We could potentially see both of these retailers’ ecommerce operations outgrow Wayfair in 2019.
Aside from competition, Wayfair is becoming its own worst enemy. Keep in mind that 20% of incremental growth is coming from Europe. That’s simply a bad idea. The international segment is approaching $1bn at year end. When the US business was around $1bn, it still had growth periods of +50 to +70% ahead of it, with an adjusted EBITDA margin of around -1%. International meanwhile sports a -18% EBITDA margin, and is already seeing revenue slow to the +50% range. That’s an alarmingly fast slowdown given where this business is in its maturation curve and the amount of investment W is putting in. Keep in mind International includes Canada, where customers have been shopping Wayfair for years.
And remember that Wayfair got its start as a bootstrapped US ecommerce company with a collection of successful websites selling various yet specific furniture categories. It grew up in the US market with very unique market knowledge of online furniture retail. What gives it the audacity to think it can replicate that in Europe? It simply can’t, and will either have to pull resources away from Europe – i.e. de-emphasize a growth engine – or else put even more capital towards a perennially money-losing business.
We think the stock's valuation history is about to repeat itself. With mounting competition, revenue will be pressured within a US consumer environment we expect to slow in 2019. A slowing topline is a big risk for a stock with no earnings trading at 1.8x trailing sales. We think growth will slow from low 40s to the mid 20s, or worse, by year-end with no improvement in profitability. That should equate to a re-rating closer to 0.8x-1x trailing sales or ~50%-70% downside.
It’s happened before --- note 2016 when sales decelerated from 70% to 50%...we saw the EV/Sales multiple compress by half. History is about to repeat itself as it relates to slowing growth impacting the stock.