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Time to Give This $5 Stock Another Look?

By Jamal Carnette, CFA - Updated May 23, 2018 at 12:06PM

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This low-dollar stock suffers from image problems, which makes it a great turnaround play if you believe in the story.

You can't blame investors for avoiding Groupon (GRPN 0.73%) on account of its track record. Since its 2011 IPO, shares have significantly underperformed the broader markets, falling from $20 per share to less than $5 as of this writing. The company finished its IPO with a market capitalization of $16 billion, at the time the second-largest technology IPO ever, trailing only Google; the company is currently valued at approximately $2.75 billion.

Much of Groupon's poor performance can be pinned on prior management. Groupon's first CEO, founder Andrew Mason, was often faulted with being too immature to run a public company, and was fired within two years of the company's IPO. The second CEO, co-founder Eric Lefkofsky, stabilized the company but was ultimately unable to reverse the company's performance and was replaced approximately two years later.

The third time could be the charm: Current CEO Rich Williams has a plan to turn the company around, and it appears his plan is taking shape.

Stacked coins

Image Source: Getty Images

North America's focus is margin improvement

It's likely many casual observers were surprised with the stock's recent jump after it reported a 7% year-on-year revenue decline. Unlike his predecessors, Rich Williams' strategy is no longer to chase the next incremental dollar with no concern for profitability. A quick look at the company's North American operations shows Williams' strategy in action.

North America Q1 2017 Q1 2018 Change
Local Revenue  $200.50  $187.40 (6.5%)
Travel Revenue  $20.50  $20.10 (2%)
Goods Revenue  $252.40  $185.80 (26.4%)
Total North American Revenue  $473.40  $393.30 (16.9%)
Local Gross Profit  $169.30  $166.80 (1.5%)
Travel Gross Profit  $15.20  $16.00 5.3%
Goods Gross Profit  $36.40  $36.90 1.4%
Total North American Gross Profit  $220.90  $219.70 (0.5%)

Source: Groupon's financial statements. Dollar figures in millions. Totals may not exactly add up due to rounding.

Although the company reported a 17% revenue decrease from all North American divisions, its gross profit only dipped 0.5% because of a shift to higher-margin products. For the North American Local subdivision, the most important due to its high-margin profile, Groupon recorded 1.5% lower gross profit, even though it booked 6.5% less revenue. This more moderate decline in gross profit compared to the decline seen in the segment's revenue was the result of a 5.6-percentage-point margin increase (90% versus 84.4%).

Things are slightly better than advertised, though, as management noted North American Local would have reported a "low-single digit increase" if not for the Groupon + and OrderUp ramp; both will most likely only have transient effects on the income statement. As Local is the largest profit driver, it was likely the company would have reported a gross margin increase without Groupon + and OrderUp. In a similar fashion, Groupon's smaller Travel and Goods segments reported year-on-year gross profit increases even though each segment's top line shrank.

International is heating up, but look for continued volatility

Williams believes the true opportunity is in international markets, as he recently stated: "Our international gross profit is about half of that in North America, yet those markets are about twice as large in terms of addressable population." On the surface, Groupon outperformed in its international segment by increasing total revenue by 16.5% and gross profit by nearly 19%.

However, this quarter's results were not as strong as initially advertised. The company was aided by a falling dollar, which makes foreign sales appear larger due to currency conversion effects. Stripping out currency translation, the company increased gross profit by approximately 1% over the prior-year's quarter.

This is to be expected: as Groupon becomes more dependent on international results, look for the stock to register more variable results on a generally accepted accounting principles (GAAP) basis as foreign currency effects aid or detract from results in the short term. More recently, the dollar is strengthening, which hurts foreign sales.

All things considered, this was a strong quarter for Groupon. Look for the company to build upon Williams' goal of improving profitability in North America while growing opportunistically in the International markets.

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