Wayfair (W -8.36%) was a popular destination for consumers stocking up on home goods during the shelter-in-place period. The online retailer posted revenue growth of 83.7% for the second quarter, significantly higher than the first quarter's 19.8% growth.
Wayfair experienced consistent demand across all product categories, which shows the spurt in sales wasn't driven by specific needs related to working from home.
During the company's second-quarter conference call, CEO Niraj Shah said, "Accelerated e-commerce adoption was also an important tailwind in Q2 and should bring longer lasting benefits to our business." One of those benefits was immediate as higher sales volume helped Wayfair generate $1 billion of free cash flow in the second quarter alone, breaking a streak of losses in previous quarters.
The stock price has soared about 250% year to date to $315. One analyst with Barclays recently upgraded the stock and raised the price target from $153 to $321. Wall Street analysts are typically short-term focused, so we don't want to put too much weight on their forecasts, but the analyst cited three items that spell out why Wayfair could deliver more gains long term, even from these lofty highs.
Image source: Getty Images.
A path to profitability
Wayfair's investments in data analytics are providing an advantage during this time when more people are turning online to shop, according to the Barclays analyst. Wayfair has built its entire operation around data -- it shares insights about customer demand and inventory levels with 12,000 suppliers, and this not only drives higher sales for suppliers but also contributes to Wayfair's bottom line.
During the conference call, Shah outlined four primary levers Wayfair uses to improve its gross profit margin: increasing scale (or growing revenue), better utilization of its logistics network, merchandising in-house brands to provide better price flexibility, and the growth of supplier services, including the use of data and technology.
"We saw progress on all four dimensions this past quarter," Shah said. "Via our partner home platform, we also moved to leverage more data and technology to inform supplier decision making when setting wholesale costs, thus unlocking some benefit in the process."
Gross margin had been hovering around 23.5% over the last few years, but the high order volume pushed it up to 30.7% last quarter. "We believe we have a long runway of gross margin gains ahead of us as we continue to invest and reap the benefits from these efforts," Shah said.
Powerful trends fueling growth
In recent years, major cities around the U.S. have experienced a noticeable slowdown in population growth with some cities showing a decline. The Barclays analyst cited the recent trend of households moving away from urban areas to suburbs as a long-term tailwind for Wayfair.
Combining that migration with the tsunami wave of increasing e-commerce demand could be a powerful combo for the company over the next decade. Wayfair estimates the U.S. home goods market is worth $297 billion with Europe showing a similarly sized opportunity. But considering that only 14% of home goods spending in the U.S. is done online, Wayfair has a massive amount of room to grow.
Wayfair is executing its plan to capture more share of the spending that is shifting online. The strong growth last quarter was a great opportunity for the retailer to acquire new customers and build its brand as the premier online home goods store. Total active customers jumped 46% year over year in the recent quarter, reaching 26 million on the platform.
"[The second quarter] demonstrated that Wayfair's now a meaningful, well recognized, and trusted household brand," Shah said. "Millions of customers, new and loyal, are seeking us out when their attention is on their homes."
Valuation
When a company posts accelerating growth and improving profitability, that's a recipe for a rising stock price. Wayfair has typically reinvested all its profit back into the business to drive growth, which makes traditional valuation metrics, like the price-to-earnings ratio, not very useful for investors.
The Barclays analyst noted that Wayfair's recent enterprise value-to-sales (EV/S) ratio of about 2.0 was justified. That multiple is consistent with the valuation Amazon.com earned from 2005 through 2015 when it too was reinvesting heavily in future growth and not showing much profit. Wayfair's ability to post high growth rates while pointing investors to the potential of its business to earn a healthy profit over time has earned the stock a comparable valuation.
Data by YCharts.
Wayfair's second-quarter adjusted EBITDA margin of 10.2% is in line with management's long-term forecast of 8% to 10%. But don't expect that level of profitability to be the new norm just yet.
The company has a lot of expansion opportunities in Europe, so expect the operating margin to moderate as management continues to invest in expanding its CastleGate logistics network.
It's impossible to know how this growth stock will perform the rest of the year. This may not be the best entry point to buy shares, but the Barclays analyst makes some good points that could justify the stock's current valuation level given the company's substantial momentum and long-term growth opportunities.
