Snap (SNAP -3.02%) has been performing very well in 2019 with its stock price up more than 173% heading into the release of its third-quarter earnings report on Tuesday. The company has been making a lot of progress and growing its user base, thanks in large part to a redesign of its Android app. The efforts helped Snap hit more than 200 million daily active users (DAUs) last quarter. In Q3, the company continued to build on that progress with even stronger numbers. Let's take a closer look at the report and the guidance for Q4.
Q3 performance beats all major targets
Overall, Snap did a great job on all of its key metrics. Not only were its losses slightly less than what analysts were expecting, but revenues of $446 million came in a full 2.5% higher than the $435.1 million that had been forecast. That number was also 50% higher than a year ago.
What's particularly encouraging is that the company is seeing its cost to generate revenue decline significantly. From being 64% of sales a year ago, that percentage has fallen to just 49%, meaning that Snap's gross margin has now climbed to 51%. If the company can continue this trend, it'll only be a matter of time before it gets to breakeven.
Another positive for the company in Q3 was its cash flow. While Snap isn't generating positive free cash flow (FCF) just yet, it's definitely going in the right direction. In Q3, FCF of negative $84 million was still deep in the red, but it a significant improvement on last year's Q3 figure of negative $159 million. Combining figures from the past three quarters, free cash flow has improved by nearly $400 million from the same stretch of quarters a year earlier.
Not only were the company's financials much improved, but Snap is seeing more active users as well. Global DAU numbers continued to increase for the third consecutive quarter, reaching a new high of 210 million, up 13% from 186 million a year ago and 3.4% higher than Q2's figures of 203 million.
Despite the improved financials and increasing user numbers, there was one area investors weren't all that excited about, and that was Snap's expectations for Q4.
Guidance for Q4 a concern?
While Q3 was full of good news, Q4 guidance was more of a question mark for Snap. The company is expecting revenues for the quarter to be between $540 million and $560 million. The concern is that analyst expectations of $555.4 million of revenue would be at the top end of that range, suggesting that Snap would need a near-best-case scenario to reach or exceed expectations.
One of the reasons Snap is a bit lukewarm on prospects for its last quarter of the year: the calendar. With Black Friday being toward the end of November and later than it was a year ago, the gap between it and Christmas is shorter, and that's a key period during which demand is at its highest levels. CFO Derek Andersen stated, "That's a potential headwind for us, and the guide reflects that." Whether it's people sharing pictures while shopping or looking for inspiration on what to buy, Snap and other social media apps become even more popular during the peak shopping season of the year, and having one less week to benefit from those heightened activity levels will likely impact Snap's performance in Q4.
Key takeaways for investors
There's plenty of good news to be found in Snap's most recent results. While it's a bit disappointing that the company is preparing for a soft Q4, its rationale is sound. And if Snap continues growing its user base, it may still be able to meet expectations. More important, however, is that the company's business is looking a whole lot stronger than it was just a year ago and much more likely to be able to turn a profit. With better margins and less cash burn, Snap is doing all the right things it needs to do in order to help put itself in a good position for future success.
The only negative about the stock today is that it's still a bit pricey, trading at 8 times its book value and 12 times its sales. And those numbers have been aggravated a bit since Tuesday as bearish guidance caused the stock to drop roughly 10% since the release of its results. Long term, we should see the multiples continue to drop in value, especially if Snap can build on these positive results. While it's still not a tech stock I'd buy today, it's one that I will definitely keep a close eye on, as it has made some big steps forward in just the past year.