Snap's (SNAP -0.69%) stock recently popped after the company's first-quarter numbers exceeded analysts' expectations. The social networking company's revenue surged 66% year over year to $770 million, topping estimates by $28 million and marking its strongest growth in over three years.
Snap remained unprofitable, but its net loss narrowed year over year from $306 million to $287 million on a GAAP basis, and from $81 million to just $2 million on an adjusted EBITDA basis. It also broke even on a non-GAAP EPS basis, which beat analysts' estimates by a nickel.
Those numbers are impressive, but some investors might be reluctant to buy the stock after it nearly quadrupled in price over the past 12 months. Yet I believe Snap could still head higher, for five simple reasons.
1. Stable user growth
Snapchat's daily active users (DAUs) grew 22% year over year to 280 million during the first quarter, which matched its growth rate in the fourth quarter. It expects its DAUs to grow another 22% year over year to 290 million in the second quarter.
Those consistent growth rates indicate Snapchat isn't losing any ground to competitors like Facebook's (META 0.94%) Instagram and ByteDance's TikTok. They also suggest that Snapchat's expanding ecosystem of Discover videos, augmented reality lenses, and in-app games are all attracting more users. That ecosystem is sticky since Snap says its DAUs are opening the app about 30 times each day.
Its average revenue per user (ARPU) also increased 36% year over year to $2.74, which also accelerated from previous quarters. Its ARPU increased 66% in North America and 36% in Europe, though it dipped 7% in the rest of the world due to the impact of its overseas investments.
2. A confident outlook for the future
Snap expects its revenue to rise 81%-85% year over year in the second quarter, buoyed by an easy comparison to its slower ad sales during the start of the pandemic a year ago.
Analysts expect Snap's revenue to rise 55% to $3.9 billion this year. During its investor day in February, it predicted it would generate more than 50% revenue growth over the next few years.
Snap believes the expansion of its ecosystem and its gradual evolution into a social commerce platform for online shopping will drive that consistent growth.
3. Rising ad prices
Snap's eCPM (effective cost per thousand impressions, or the average cost of its ads), surged 67% year over year in the first quarter, accelerating from its 46% growth in the previous quarter.
Snap attributed that acceleration to a higher mix of high-eCPM ad products such as Commercials, its growth in higher-eCPM regions like North America, and the optimization of its auction process.
Snap's rising ad prices indicate its popularity among younger consumers, particularly teens, still makes it a top target for advertisers. Piper Sandler's recent spring survey crowned Snapchat the most popular social network for U.S. teens once again, followed by TikTok and Instagram.
4. Declining infrastructure costs
As Snapchat's DAU, ARPU, and eCPM grew, its infrastructure costs per DAU declined 13% year over year to $0.62, marking its lowest infrastructure costs per DAU since its public debut. It attributed those lower costs to better negotiated rates for several of its cloud services.
Those lower costs, along with its robust revenue growth, boosted Snap's gross margin by one percentage point year over year to 47%. Lower infrastructure costs can also free up more cash for Snap to fund Spotlight, a new feature that awards top content creators with cash prizes; to acquire smaller companies; and to boost its headcount, which rose 19% during the quarter.
5. Positive free cash flow
Snap generated a positive free cash flow (FCF) of $126 million during the quarter, which marked the first time its FCF ever turned positive. It generated a negative FCF of $4.6 million a year ago.
Snap won't generate a GAAP profit anytime soon, but its FCF growth should allay some ongoing concerns about its liquidity. Its cash and equivalents rose 7% year over year to $987.5 million during the quarter.
In the second quarter, Snap expects its adjusted EBITDA loss to narrow year over year from $96 million to a midpoint loss of $10 million. Analysts expect it to generate its first non-GAAP profit for the full year.
Is Snap worth its premium valuation?
Snap's evolution from an underdog into a niche leader in the social networking market is inspiring, but its stock is undeniably expensive at 94 times forward earnings and 23 times this year's sales.
However, I believe Snap's robust growth rates, improving financial discipline, and confident long-term plans all support those premium valuations. Its stock might remain volatile, but it could also generate much bigger gains down the road as it continues to gain new users.