Wayfair Inc. (NYSE: W) shares rose 11% following 3Q20 earnings in early November, reflecting optimism about the company’s prospects heading into the holiday season. We think that strong results over the past two quarters have reassured investors that the company’s recent strength has not been due to the pandemic alone. Looking ahead, we expect Wayfair to continue to benefit from brick-and-mortar store closures and growth in work-from-home arrangements.
Based on Wayfair’s strong second- and third-quarter results and management’s guidance, we now expect nearly 50% year-over-year revenue growth in 4Q20, to $3.7 billion. We also project a gross margin of 27%, at the top of management’s long-term target range of 25%-27%. In February, before the pandemic took hold, management said that it expected to achieve non-GAAP profitability by the end of 2021, primarily by lowering fixed costs. The company achieved this goal in the second quarter as fixed costs were well controlled despite the coronavirus sales surge.
Wayfair reported 3Q20 results on November 3. Revenue rose nearly 67% to $3.8 billion. The gain reflected an increase in active users. The gross margin increased 650 basis points to 29.9%. The gross margin improvement reflected fewer promotions and W’s ability to process more orders. Reflecting profitability initiatives that were underway before the pandemic and strong revenue, Wayfair reported positive adjusted EBITDA of $371 million. Non-GAAP adjusted earnings came to $2.30 per share, compared to a loss of $2.23 per share in 3Q19. The consensus estimate had called for non-GAAP earnings of $0.80 per share.
On February 13, 2020, Wayfair announced layoffs of roughly 550 employees, or about 3% of its workforce – which will help to reduce fixed costs.
EARNINGS & GROWTH ANALYSIS
W ayfair reports earnings for two operating segments, U.S and International. In 2019, the U.S. accounted for 85% of total net revenue (down from 92% in 2016), while the international segment contributed 15%.
Sales in the U.S. segment come from revenues generated on the company’s five U.S. websites. In 3Q20, net revenue in the U.S. came to nearly $3.3 billion, up 66% from 3Q19. Given the company’s increasingly effective marketing and easy prior-year comparisons, we think this strength is sustainable.
International sales come from revenues generated on the company’s international sites, with most of this revenue coming from Canada, followed by the UK and Germany. In 3Q20, net revenue in this segment came to $565 million, up 67% from 3Q19.
FINANCIAL STRENGTH & DIVIDEN
Long-term debt and outstanding lease obligations rose to $5.0 billion.
MANAGEMENT & RISKS
Wayfair was founded by Niraj Shah and Steve Conine in 2002. Mr. Shah has served as CEO since 2002, and is co-chairman of the company. Mr. Conine is also co-chairman and previously served as CTO. Michael Fleisher is the CFO; Thomas Netzer is the COO and Jim Miller is CTO.
R i sks for Wayfair include competition with brick & mortar furniture retailers, many of whom are profitable and have long-established relationships with vendors, suppliers and customers. Wayfair may also struggle to sustain strong top-line growth based on the law of large numbers. In addition, the company could face rising customer acquisition costs, particularly as other brick & mortar and online rivals initiate or increase their e-commerce furniture & houseware offerings. The company could also incur high international expansion costs.
Minority investors also face ownership risk, as the co-founders retain more than 50% of the company’s voting rights.
Based in Boston, Wayfair is a leading online retailer focused on furniture, housewares, and other home decor products. Its websites include Wayfair, Joss & Main, AllModern, Birch Lane, and Perigord. The company’s primary market is the U.S., though it also has operations in Canada and Europe.
On a technical basis, W shares have been whipsawed in 2020 by the pandemic. After falling 76% from February through mid-March to close at a record low of $23.52 on March 19, the shares rose above $330 in late August. However, they have now fallen back to the $260 range.
W is difficult to value on a fundamental basis given its short history of profitability. The stock is trading at an EV/revenue multiple of 1.5, above the average of 1.2 for a group of traditional furniture retailers that includes Ethan Allen, La-Z-Boy, williams-Sonoma, and Restoration Hardware. However, these companies are barely growing, and their brick & mortar business models are imperiled, partly because of Wayfair. As such, we believe that W shares deserve to trade at a premium. Our target price remains $360.
On November 30 at midday, BUY-rated W traded at $252.91, down $7.71.