Please ensure Javascript is enabled for purposes of website accessibility

What Wayfair Wants Investors to Know About Its Soaring Expenses

By Demitri Kalogeropoulos – Nov 2, 2018 at 4:16PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The unprofitable e-commerce specialist sees big but costly opportunities ahead.

Investors reacted harshly to Wayfair's (W -5.40%) third-quarter report, sending shares sharply lower this week despite good news on the growth front. Specifically, the e-commerce specialist surpassed management's forecast for the period to mark its third consecutive beat in fiscal 2018. However, Wall Street pros were more concerned with spiking costs and the potential for a brutally competitive holiday season ahead.

CEO Niraj Shah and his team, in a conference call with analysts, addressed those worries in the context of Wayfair's broader growth plans. Below are a few highlights from that discussion.

A modern home living room.

Image source: Getty Images.

Market share growth

"We're delighted to see our offering engage more and more people with 13.9 million shoppers buying from us over the last year and [12-month trailing] net revenue per active customer continuing to grow, reaching an all-time high this quarter of $443." -- Shah

Sales growth clocked in at 43% overall and improved 40% in the core U.S. market. Both of those results were above the top end of the guidance range that executives had issued, and they imply healthy market share gains.

Other customer engagement metrics, including the proportion of repeat business, the base of active customers, and average spending per customer, support the idea that Wayfair is building a valuable position in its industry niche. "We're thrilled to see customers increasingly shopping with us," CFO Michael Fleisher added.

Cost spike

"We think it would be extremely shortsighted to forego the high [return on investment] opportunities that we have put ourselves in a position to be able to capture." -- Fleisher

Wayfair reported a surprising jump in its spending rate in two key areas. First, selling and development expenses shot up to 12.2% of sales from 11.2% in the prior quarter, despite the 40% revenue spike. Executives pinned the blame on the wide opportunities they've identified for capturing growth in markets like Germany and new shopping categories like mattresses. They didn't hesitate to allocate funds toward those causes, especially by hiring people across the engineering, merchandising, and logistics areas.

The more concerning cost bump was in advertising, which climbed to 11.9% of sales from 10.7% in the prior quarter. Management said that the spike wasn't an indication of increased competition, but instead reflected attractive trade-offs for faster sales growth. "As Q3 progressed," Fleisher explained, "we saw compelling opportunities to lean in and invest further advertising spend behind the strength of our customer [spending]."

Looking ahead

"We expect gross margins consistent with the 23% level of recent quarters. But we will remain [price competitive] to serve our customers and as such there is some risk across profit margins could fall below that level [in the fourth quarter]." -- Fleisher

Wayfair issued a conservative holiday season growth outlook that left room for the negative impact of a potential shift in consumer confidence. The company also noted that it has sourced plenty of discounted products for the fourth quarter but might still be forced to slash prices if traditional retailers go that route.

At the same time, costs, including for advertising, should be elevated over the holidays. As a result, adjusted losses will likely balloon just as they did in the most recent quarter.

The good news is that these expenses are mostly within the company's control and thus reflect management's rising confidence that they can capture a bigger piece of the $600 billion home furnishings market. The bad news is that these expense trends suggest it could be quite some time before Wayfair's growth starts delivering concrete profits.

Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Wayfair. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Wayfair Stock Quote
$33.65 (-5.40%) $-1.92

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.