EUR 850.00 For Business Accounts Only

Morningstar | Wayfair Continues to Spend on Enhance Customer Experience, Compressing Margin; Shares Remain Rich

No-moat Wayfair continues to post impressive growth metrics, including active customer growth of 35%, last 12-month revenue per active customer up 9% (to $443), repeat customers composing 66% of mix (up 530 basis points), and 4.6 million repeat customer orders (up 59%). However, third-quarter sales outperformance, with sales rising 47% to $1.7 billion (versus our 34% growth estimate) was offset by lower-than-anticipated EBITDA performance in the U.S., leading us to expect a modest change to our $76 fair value estimate for the time value of money and rendering shares pricey. Fourth-quarter sales growth guidance for the U.S. (32%-35%, lower than the 40%-plus pace attained in the first three quarters of 2018) and International (to 50%-55%, versus up 81% year to date), implies a slowdown has begun to occur. Given the wider than our forecast EBITDA margin loss for the quarter ahead (at around a 4% shortfall versus our 2% prior outlook), ongoing cost deleverage is set to persist as investment rises, crunching profitability.

Our biggest concern surrounds customer acquisition and infrastructure spend, as Wayfair continues to outpace its home furnishing peers in absolute dollars spent on each (for example Williams Sonoma spent 30% less in dollars on advertising versus a 12% higher sales base in 2017 than Wayfair). While we expect the advertising metric will lower to just above 8% over our 10-year explicit forecast, this remains higher than Wayfair’s 6%-8% target, as we expect the home furnishing industry will remain price competitive, a thesis supported by commentary that the gross margin could remain compressed around 23% in the final quarter of 2018 (from 23.7% in 2017). We don’t have Wayfair's gross margin moving into the 25%-plus range target until 2023 despite a rising penetration rate of in-house brands, as this metric could be hindered by spend on the MyWay members program, with insider sales, installation discounts, and shipping expenses eating into gains.

For now, returning the U.S. to a profitable EBITDA status would be satisfactory. Two of the last three quarters have delivered negative adjusted EBITDA performance for Wayfair, after the company as able to string together five modestly positive EBITDA quarters prior to 2018. The lumpiness of the metric, thanks to heavy spend needs for areas like labor and technology, isn’t set to smooth, in our opinion, but we do expect some cost growth around hiring to slow in 2019, as company needs could be less robust turning the domestic market back to EBITDA breakeven.

This aside, we have two other factors that could weigh on share performance ahead. First, the management team called out cyclical risk, noting that changes in consumer spending would adversely impact financial results and that promotional cadence in the category can become aggressive at times. Given our position in the economic cycle, we think being closer to a peak than a trough is a real risk, but that the company’s position in its own life cycle, still on the upswing capturing double-digit top-line growth, mitigates some of the correlation that more established players might experience with a market downturn. Second, rising interest rates provide a headwind on the income statement as the company pays more on lease service costs, as borrowing demand should remain inflated with the ongoing infrastructure buildout (CastleGate and last mile facilities).