Roku (ROKU 3.60%) was in an advantageous position at the pandemic's onset. Millions of people were suddenly spending a lot more time at home, and that meant they needed to entertain themselves. Enter Roku, which serves as the platform that connects consumers with their favorite streaming content.
Unsurprisingly, sales and customer acquisition surged for Roku. But now, as billions of doses of COVID-19 vaccines make their way around the world, people are increasingly confident in reestablishing their old routines. Even then, supply chains are struggling to get back to full strength, and together with robust consumer demand, materials shortages and rising prices are all too common. These trends are likely taking their toll on Roku as investors will see when it reports third-quarter results on Nov 3.
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Roku will not increase prices on its players
Supply chain disruptions are impacting businesses across the economy, from Procter & Gamble to Peloton to Roku. Each company must decide how it plans to deal with one byproduct of these disruptions -- rising costs -- and Roku has made its choice. Here's what management had to say about pricing in its second-quarter earnings release: "Tight component supply conditions and shipping constraints continued to increase costs faster than expected across all consumer electronics categories. In Q2, we insulated consumers from increased costs for Roku players, which resulted in player gross margin turning negative in the quarter."
In other words, instead of passing higher costs onto consumers, Roku decided to absorb them. Customers are paying the same prices for Roku's streaming hardware, and the company has temporarily accepted lower profit margins as its costs rise in the hopes of sustaining player sales, which increased just 1% year over year in the second quarter.
While the player segment encompasses the devices customers connect to their TVs (and licensing deals with TV manufacturers for Roku TVs), the platform segment includes revenue Roku generates by showing ads to viewers and a percentage of user spending on its platform. Roku earns the vast majority of its profits from the platform segment. In its most recent quarter, platform gross profit totaled $345 million, while the player business reported a loss of $7 million. For that reason, management has strategically chosen to sell players, even at a slight loss, to bring as many viewers onto its platform as possible.
This dynamic is likely to become even more apparent when Roku reports third-quarter earnings. Management previously said they expect supply chain challenges and higher component costs to hurt gross profit in the player segment through the remainder of this year.
Near-term headwinds causing Roku stock to fall
Analysts on Wall Street expect Roku to report revenue of $684 million for the third quarter and earnings per share of $0.06. If the company hits that revenue estimate, it would represent a 51% increase from the same quarter of 2020. Reopening economies may mean reduced engagement for the company, but it's also creating rebounding demand from advertisers as they seek to reconnect with consumers.
Roku stock is down over 30% in the last three months due to a combination of the factors I outlined here and also the broad sell-off of many of the market's biggest winners during the pandemic.
Still, shares of Roku are not cheap, trading at a forward price-to-sales ratio of 15. The next few quarters may be difficult for Roku, but the company still has excellent long-term prospects as it supports the ongoing migration of audiences -- and advertisers -- from linear television to connected TV.
