Kudos to home goods e-commerce name Wayfair (NYSE:W) for topping last quarter's earnings estimates. And congratulations to shareholders. Wayfair shares jumped by double digits on Tuesday following the release of the company's first-quarter earnings. At one point, the stock was trading up as much as 35%.
However, there's a nagging little detail buried within this organization's numbers. Wayfair is not getting any better as it gets bigger. That's a noteworthy problem given the backdrop.
With millions of consumers stuck at home with tons of extra time on their hands, Wayfair is very much in its element. CEO Niraj Shah even said as much in the official earnings release, commenting that:
The broader market disruption has highlighted the many differentiated advantages we have built as the e-commerce leader in Home over the last two decades. ... Millions of new shoppers have discovered Wayfair while they shelter in place at home, and we are seeing strong acceleration in new and repeat customer orders across almost all classes of goods and across all regions.
Perhaps most importantly, Shah explained, "as we execute on the plans we set in motion late last year, we are making significant strides toward profitability by driving gross margin expansion, increasing marketing efficiencies, and gaining leverage on operating expenses."
The problem is that it's not a perfectly accurate statement. The company's spending continues to grow in step with revenue growth, and that didn't change last quarter, despite the big scale-up.
Moving in the wrong direction
The good news: For the three-month stretch ending in March, Wayfair generated $2.33 billion worth of revenue, up from the year-earlier tally of $1.94 billion. That topped Refinitiv's reported estimate of $2.31 billion. Better yet, the operating loss of $2.30 per share may have grown significantly from the Q1-2019 loss of $1.62, but that was still better than the loss of $2.60 per share analysts had been modeling.
The bad news: It's still another, bigger loss in a situation that was supposed to work to Wayfair's advantage.
The culprits were advertising spending, administrative expenses, and to a lesser degree, the sheer cost of the goods it's selling. Advertising spending grew 13% year-over-year to $275.7 million, while administrative spending surged 38% to $476 million. The company's total cost of goods sold mirrored its revenue growth too, up nearly 19% to $1.75 billion. For perspective, sales were up just a bit more than 20%. That's not exactly the progress one would hope to see as an operation gets bigger.
None of this spending growth is new, by the way. In contrast with Shah's assessment, gross margins aren't improving, and operational spending doesn't appear any more leveraged than it has been for a while now. In fact, it may be less impactful now than it was before.
The graphic below tells the tale. As a percentage of revenue, last quarter's gross profit margin of 21% was an improvement only because the relative costs of goods sold slipped from 81% to 79%. Administrative costs went up by much more, though, and have been inching higher since 2018. Advertising spending -- as a percentage of revenue -- is holding steady between 11% and 12% rather than shrinking. The end result is a pre-tax operating profit margin of right around -12%, which isn't much better than the fourth quarter's operating income margin of -13%. Indeed, operational losses have been steadily worsening rather than improving on 2017's pre-tax profit margins near -5%, primarily due to growing administrative and selling expenses.
It is what it is.
Time to ask questions
Had Tuesday's surge in Wayfair's stock price taken shape following a period of weakness, it would almost be understandable. Investors were pricing in the worst, and things weren't quite as tough as expected.
But that wasn't the case at all. Like most other companies at the time, Wayfair shares took some lumps in February and March. Since the market's bottom around March 20, Wayfair shares had gained more than 450% before Tuesday's report. The post-earnings pop means it's now more than 600% above its March low. That translates into a market cap of $16 billion, for a company that's doing around $9 billion worth of sales per year, but continues to grow rather than shrink its losses.
It's certainly possible these measures will finally start to improve as we move into the rest of 2020. Consumerism has likely changed. People are apt to be less interested in stepping foot in a store if they don't have to, and with Wayfair, home goods shoppers don't have to.
As it stands right now, the company only appears to be expanding its capacity to book losses and is doing so at a time when rivals like Walmart and Amazon.com are stepping up their e-commerce games too. It wouldn't be unfair for Wayfair shareholders to start asking when and where advertising and administrative spending is apt to turn the corner, so to speak, and start improving margins. Last quarter wasn't the turning point despite the cheerleading.