Investors have had a love-hate relationship with Wayfair (W -5.40%). The largest online home goods retailer has delivered blistering sales growth, but even before the COVID-19 outbreak, the shares have been very volatile. One reason is that investors have had a difficult time wrapping their heads around Wayfair's aggressive spending to expand its logistics footprint, which has prevented the company from reporting a profit.
During the fourth-quarter earnings call in late February, management announced it would pull back the reins on spending and start managing the business toward sustainable free cash flow in the long run. Part of this plan involved decreasing the rate of hiring and reducing ad spending. As a result, Wayfair said its revenue growth would decelerate in the first quarter to as low as 15%, a far cry from the 38% reported in the prior-year period.
The stock price plunged in late February, and when COVID-19 reared up in March, Wayfair stock was down as much as 74% year to date. But shares quickly rebounded after management issued a COVID-19 business update on April 6 stating that it expects to meet or exceed its guidance for the first quarter, as shelter-at-home orders encouraged more people to shop online. Wayfair also likely benefited from other retailers delaying shipments of nonessential items.
I wasn't lucky enough to buy shares at the very bottom, but I did manage to add to my holdings when the stock price was around $80. The shares have been rising almost as fast as they fell. Even though they currently sit near $130 as of this writing, setting new highs for this year, they still offer enormous long-term upside.
Beating competitors in delivery speed
Wayfair is wading through criticisms similar to what Amazon endured many years ago. In the early 2000s, analysts would brush away the merits of investing in Amazon, as it was difficult to see value in a company that didn't earn a profit, especially an upstart retailer going up against the established giants like Walmart and Target.
I almost succumbed to the same mindset when first looking at Wayfair. It took me a while to understand that Wayfair might actually be putting together a durable competitive moat in the niche category of home goods.
Despite Amazon's dominance, Wayfair has been around for more than a decade and has come a long way. In 2009, Wayfair had 1,000 suppliers. Today, it has 12,000 supplier partners and 16 million square feet of buildings used for fulfillment and delivery operations.
This logistics footprint is helping Wayfair deliver large furniture items faster than competitors, and even faster, as co-founder and CEO Niraj Shah said on the fourth-quarter call, "than our customers often expect as possible in our categories."
I'm not even sure Amazon can match what Wayfair is offering. The former's warehouses are designed to handle millions of small items such as books, non-perishable groceries, and electronics. Wayfair's warehouses are specifically designed to handle items that are bulky, heavy, and prone to damage -- it's an altogether different animal.
Of course, there is also the major difference in the online shopping experience. Amazon's product page is the same whether you are buying a book or a large TV. Wayfair's website is specifically designed to help people find, say, the right sofa for their living room. To do that, Wayfair has offered advanced technology like augmented reality with its mobile app.
In its annual report, Wayfair states: "We believe that our proprietary logistics network will help drive incremental sales by delighting our customers with faster delivery times and a better home delivery experience." The company also says: "Over time we believe this network will also lower our costs per order by reducing damage rates and leveraging economies of scale in transportation."
Simply put, Wayfair expects its profitability to improve as it continues to grow.
The long-term opportunity
Wayfair is serving a massive and underpenetrated category online. Management estimates that its addressable market in North America and Europe is a combined $600 billion. That includes primarily business-to-consumer commerce. Once you add business-to-business commerce, its addressable market could approach $1 trillion in the next decade.
This is why I believe you shouldn't be afraid to buy shares even though the stock has already recovered from its recent lows. Wayfair's market value is still only $11.9 billion as of this writing, and it generated revenue of $9.1 billion in 2019. Weighing those numbers against its long-term opportunity, the company could potentially return many times an investment made at today's price.
According to its own estimates, Wayfair is currently capturing over one-third of the home-goods spending that's moving online. If it maintains that level of market share, Wayfair will likely generate tens of billions of dollars in revenue down the road. And the stock price will be much higher if it continues to trade at the same price-to-sales ratio.
I bought my first share at $150.82 last year. I've gradually added more shares, which has lowered my cost basis significantly, but my total investment right now is just 4% of my portfolio.
Through the recent volatility, I never sold a single share. The business continues to grow, and I interpreted the fourth-quarter report as positive, despite the subsequent sell-off. The report showed that management is not reckless with spending, and the plan to reach sustainable profitability is a good thing, even if that means revenue growth slows down temporarily.
And I will keep adding to my position over time. If Wayfair is successful, this growth stock could turn even a small investment into a large sum.