Roku's (ROKU -10.29%) stock tumbled after the streaming media company posted its second-quarter results on Aug. 4. It easily beat analysts' estimates on the top and bottom lines, but concerns about its slower growth in active accounts and streaming hours, along with a negative gross margin at its hardware division, sparked an ugly sell-off. Does this post-earnings dip represents a buying opportunity, or signal worse things to come?
How fast is Roku growing?
Roku's revenue surged 81% year over year to $645.1 million, beating estimates by $26.8 million and accelerating from its 79% growth in the first quarter. It generated a net profit of $73.5 million, compared to a loss of $43.1 million a year ago, and its EPS of $0.52 crushed estimates by $0.45.
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Why were the bulls impressed?
Roku's average revenue per user (ARPU) rose 46% year over year to $36.46, accelerating from its 32% ARPU growth in the first quarter. That growth indicates its software platform -- which generated 83% of its revenue during the quarter -- is successfully monetizing its users with integrated ads and new streaming content. It also suggests its acquisition of Quibi's original shows, which have been rebranded as "Roku Originals" for its ad-supported Roku Channel, was a shrewd strategic move.
The Roku Channel more than doubled its streaming hours year over year during the quarter, and the platform's top ten programs were all Roku Originals. That growth should lock in Roku's users, give the company a firm foothold in the ad-supported streaming service market, and support its expansion onto other third-party devices that run the Roku Channel app.
Roku's software platform revenue surged 117% year over year, marking an acceleration from its 101% growth in the first quarter, and the segment's gross margin expanded from 56.6% to 64.8%. That expansion will reduce Roku's dependence on its lower-margin player business.
Roku expects its revenue to rise between 49% and 52% year over year in the third quarter, which also surpasses Wall Street's expectations.
Why were the bears skeptical?
Roku's active accounts grew 28% year over year to 55.1 million, but that marked a slowdown from its 35% growth in the first quarter. Its streaming hours increased 19% year over year to 17.4 billion -- but fell 5% sequentially from its 18.3 billion hours in the first quarter.
Roku attributed that slowdown to consumers seeking more "out-of-home entertainment," such as dining and travel, "as a result of pent-up demand and the loosening of COVID-19 restrictions." However, Roku noted its 19% year-over-year growth in streaming hours still easily outpaced the growth of traditional TVs and the broader streaming market: Traditional TV viewing hours dropped 19% year over year, while hours spent on all streaming platforms fell 2%.
Roku's other sore spot was its player business. Its player revenue rose just 1% year over year, compared to its 22% growth in the first quarter, and the segment posted a negative gross margin of 6.7%, compared to a positive gross margin of 8.4% year ago.
That decline isn't surprising, since Roku CEO Anthony Wood warned investors back in May that supply chain and logistics issues -- likely related to the global chip shortage -- would result in "slightly negative player margins" in the second quarter and possibly the second half of 2021.
Furthermore, Roku can offset that contraction with its higher-margin platform revenue -- that's why its total gross margin still expanded year over year, from 41.2% to 52.4%. Selling its players at razor-thin margins (or even at a loss) should also shore up its defenses against Amazon (AMZN 3.43%), Apple (AAPL -0.35%), Alphabet's (GOOG 9.96%) (GOOGL 10.22%) Google, and other device makers.
Lastly, the skeptics will point out that Roku's stock had already rallied nearly 160% over the past 12 months before its earnings report, and it was already priced for perfection at about 20 times this year's sales. Therefore, Roku needed to hit a home run -- not a double or triple -- to rally even higher.
Why I'm staying bullish on Roku
Roku's stock isn't cheap, but I believe it will easily beat Wall Street's expectations for 55% revenue growth and a net profit this year. Analysts expect Roku's revenue and earnings to grow 38% and 144%, respectively, next year.
We should take those forecasts with a grain of salt, but they indicate Roku could benefit from the secular decline of traditional pay TV platforms, as well as the secular growth of streaming media services and integrated ads on connected TVs, for the foreseeable future.
Roku remains the market leader in streaming devices in North America, according to Conviva, and it's repeatedly held Amazon, Apple, and Google at bay. All these strengths arguably justify Roku's higher valuation, so investors should consider buying this high-flying stock after its post-earnings pullback.
