EUR 850.00 For Business Accounts Only

Morningstar | Ongoing Spending Crimps Near-Term Growth at Wayfair; Shares Overvalued

Faster international growth (94%, at 15% of sales) and the inaugural Way Day helped no-moat Wayfair deliver topnotch sales growth of 47% in its second quarter, for total revenue of $1.65 billion. Key metrics were solid, with the number of active customers rising 34% to 12.8 million, net revenue per customer over the last 12 months increasing 9% to $440, and repeat customer orders (now 66% of the total) growing 65% to 4.3 million. The repeat business is instrumental in leveraging expenses, as keeping existing clients tends to be less expensive than acquiring new ones, which was exhibited in an advertising ratio that leveraged to 10.7%, down 40 basis points.

However, robust growth continues to come at a cost for Wayfair, with the operations, technology, and administrative ratio 110 basis points higher than we forecast, at 14.6%, representing nearly 180 basis points of deleverage. Over the next quarter, these costs are set to remain inflated, acting as a drag on adjusted EBITDA margins, which Wayfair expects will be between negative 3.7% and negative 4%. While this is worse than the 2.4% decline we modeled, some hiring expenses are expected to moderate, so we still see adjusted EBITDA margins clocking in between negative 3% and negative 2% for 2018, in line with our prior outlook.

We forecast sales growth to slow to the high 20s in 2019 as the U.S. market matures and international continues to grow. The higher top line should help cost ratios, particularly in the United States, where advertising and payroll leverage should ensue. However, we anticipate international will remain a drag on overall profitability as Wayfair builds scale and awareness, at least over the next few years. This should still put the company on a trajectory to achieve positive adjusted earnings per share in 2021. Given the unchanged long-term strategy, we don’t plan any material change to our $76 fair value estimate and view the shares as overvalued.

We commend Wayfair for attempting to pivot its model to better resonate with customers. The launch of design services to facilitate better sales conversion, solid customer service, and an endless aisle help to expand its total addressable market, which should help sales rise at a double-digit clip over the majority of our forecast. However, the continued buildout of the CastleGate network both domestically and internationally, supply chain efforts (including recent efforts in shipping), and the perpetual quest for the best technology are costs that will continue to weigh on profits. We think these efforts help customers remain aware and engaged with Wayfair and are a necessary cost of success. However, with no switching costs and ease of substitution, we don’t see the company creating a durable competitive advantage, a key tenet underlying our no-moat rating.