Wayfair (W -0.28%) recently announced a surprising step backward for its U.S. market, which joined the international segment in posting significant losses. The e-commerce giant beat sales expectations for the sixth straight quarter, but its worsening profit picture dominated investors' attention and sent the stock lower.
In a conference call with analysts following the release of Wayfair's third-quarter earnings last week, CEO Niraj Shah and his team explained why they aren't concerned with the sharp demand shift that happened in their home market, which they say will clear itself up over the next few months. They also detailed their optimistic expectations for the end of 2019 and into 2020.
Let's take a closer look at executives' biggest Q3 takeaways.
Traffic to our site remains healthy and average order value steady, but customers are taking more time to consider their options across the site before purchasing. In many cases, our most popular highly rated products with extensive review count and great imagery are now slightly more expensive than extremely similar products that have lower review counts, often not burdened with a tariff.
-- CFO Michael Fleisher
Growth in the U.S. again beat management's targets, increasing 34% in Q3 compared to 40% last quarter. Yet Wayfair's results showed a few signs of weak demand, including higher advertising spending, slowing order frequency, and increasing net losses.
Management blamed world trade issues, as tariff rates caused major disruptions on its app and websites. Higher prices for popular home furnishings products hurt the business in two ways.
First, they took many of Wayfair's best-reviewed offerings out of contention, making a purchase decision harder to reach for many shoppers. And second, the price boosts made the company less competitive against fully integrated rivals that carry inventory and so could sell products at pre-tariff prices during the summer. The good news is that management expects both of these issues to resolve themselves over the next few months.
As you analyze our results, you'll also see that the average cost of customer acquisition has risen modestly in the quarter. So I want to remind you that we are focused on acquiring high-quality customers who will not necessarily [make purchases] in the same quarter we engage with them.
Being an online business that attracts shoppers through digital marketing means that Wayfair's advertising cost is one of its most important growth and profitability metrics. Investors want to see that figure trend lower over time because sustainable earnings aren't possible without gains here. Rising ad spending also implies a tougher selling environment and points to market share struggles.
That's why it was jarring to see the tech stock's ad spending inch up to over 12% of sales rather than move toward the long-term goal of 7%. Executives said investors shouldn't spend much time worrying about volatility here, though, since Wayfair is managing the business to maximize marketing efficiency over time. "We expect advertising costs to drop as the repeat customer base grows," Fleisher said. "This has been our long-term trend over the last five years and we expect it will continue over time."
Though our growth has moderated some relative to the first half, as we are closely monitoring our business drivers we see underlying fundamentals as broadly healthy. We also feel very well positioned for the holiday period that is right in front of us.
Wayfair has a habit of being conservative in its short-term forecasts, but this latest outlook is notably soft. Sales gains are projected to slow to around 25% in Q4 to mark a sharp break from the 40% gain investors saw through the first half of 2019.
Tariffs are the main culprit behind this downgraded outlook, which will also take the company further away from net profitability. Executives say they see no reason to think there's any fundamental change in the business's growth prospects. Yet it's clear that tariffs will knock Wayfair off its market-thumping trajectory at least into early 2020.