Lovesac's (LOVE 0.84%) modular couch concept has been a big hit with consumers, but you wouldn't know it by looking at the stock's performance. Shares of Lovesac are down 60% year to date, and trade at a cheap valuation of less than 10 times this year's earnings estimates.
The underperformance reflects the market's anticipation that the weak economy will eventually become a drag on sales. But here are four reasons why the stock could be a surprise winner in the new year.
1. Mastering the supply chain
In September, the company reported a 45% year-over-year sales increase for the second quarter, which ended in July. Next quarter's results will be announced on Dec. 7 before the markets open, and Wall Street analysts anticipate sales decelerating to a 25% growth rate. But that's still very impressive in this challenging retail environment.
Lovesac's growth comes on top of a double-digit decline across the home goods industry, which means the brand is gaining significant market share. A key to these share gains has been the company's ability to maintain high inventory levels to satisfy demand -- something not even world-class retailers have managed to do this year.
Lovesac makes a simple product that is designed to last a lifetime. This allows the company to buy inventory without fear of having to discount out-of-season merchandise to sell it later.
2. Growing brand awareness
Sactionals are a very marketable product due to their modular design and technological features. The company is leveraging partnerships with major entertainment brands to build awareness.
Lovesac recently announced partnerships with Walt Disney and Microsoft's Xbox. The goal is to grow awareness for Lovesac's StealthTech audio, which creates an immersive experience when watching movies and playing games. Customers can even charge their mobile devices wirelessly from the embedded technology in the Sactional couch.
CEO Shawn Nelson believes the product has reached an important inflection point in growth, as he explained during the last earnings call:
Having only achieved between 1% and 2% market share so far in a highly fragmented couch category, we believe we are finally through that early adopter phase and on to the early majority phase of that classic product adoption curve.
As customer satisfaction increases, management believes the company's investments in services and infrastructure will lead to further brand strength.
3. Profitable growth
What's most impressive about Lovesac's robust sales growth is that the business is very profitable. Some companies can be so aggressive in driving growth that they reinvest all gross profits into marketing, wiping out the bottom line in the process. But Lovesac reported a net profit of $44 million on $591 million of revenue over the last four quarters.
Data by YCharts
Lovesac should be able to improve its profit margin over time. A third of Sactional sales are driven by word-of-mouth. If this trend continues, management could ease up on marketing expense to boost profit margin. This is a potential catalyst that the market is overlooking at these cheap share prices.
4. Low valuation
Lovesac is arguably the most underappreciated growth retail story right now. The stock trades at a low price-to-earnings ratio of 8 based on next year's earnings estimates. That is a massive discount to the S&P 500 average P/E of 21. Considering the company's momentum, growing brand awareness, and ability to invest in innovative products while staying profitable, Lovesac could be a surprise growth stock in 2023.
