What happened

Shares of Wayfair (W -1.94%) were down 15% as of 2:30 p.m. ET on Friday as analysts continued to process the third-quarter earnings report released on Thursday.

Jefferies analyst Jonathan Matuszewski noted that the declining demand for home furnishings is putting Wayfair's turnaround effort in a difficult spot. The analyst maintained a hold rating on the stock, despite the stock being down 83% year to date.

So what

Wayfair's revenue has fallen nearly 13% year over year through the first nine months of 2022. This is a business that grew revenue by 55% in 2020. One of the few positives from the earnings report was that revenue didn't decline as much as the previous quarter, down 9% year over year compared with a 15% decrease in the second quarter.  But that's not much of a consolation.

To management's credit, it's focusing on what it can control, which is bringing costs in line with lower demand. CEO Niraj Shah said on the earnings call that the highest priority is to return to breakeven in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2023 "before targeting positive free cash flow shortly thereafter." 

However, Wayfair is in an awkward spot. Matuszewski noted that the company is working to reduce expenses while at the same time needing to increase marketing to keep demand up. Marketing expense totaled 12.4% of revenue in the quarter, above management's guidance. This is while the company's profit margin dipped to negative 10%, a slight improvement from negative 11% in the second quarter. 

Now what

This upcoming holiday season is expected to be highly promotional with lots of discounting, which will be fueled by marketing. This doesn't bode well for retail profits.

The difficult balancing act of trying to hold sales volume up while lowering costs in other areas will require excellent execution. The uncertainty of Wayfair's turnaround effort explains why the stock is down big to end the week, despite trading at a cheap-looking valuation.