It's said that not all that glitters is gold. Similarly, a low share price doesn't mean a stock is cheap. Shares of home goods e-commerce site Wayfair (W -8.36%) have fallen 90% from their high.
Many growth stocks have sharply fallen over the past two years, so that might not initially alarm investors. However, a closer look shows that Wayfair could be trending lower for good reasons. Here is why Wayfair could have some problems bubbling under the surface.
Collapsing profit margins
Wayfair is an e-commerce company focusing exclusively on the home goods market. It sells furniture, decor, appliances, lighting fixtures, and more. The company's revenue surpassed $12 billion in 2022, though it peaked in 2020 at $14 billion. Management estimates its addressable market at $800 billion, which could grow to $1 trillion by 2030.
But Wayfair isn't alone in the home goods space. Instead, it's competing with various retailers, including IKEA, Amazon, Walmart, Target, and more. E-commerce is essentially a game of efficiency; Wayfair's larger competitors have the sheer size and extensive fulfillment networks to operate at higher profit margins.
W Operating Margin (TTM) data by YCharts
The company's operating margins have collapsed since early 2021 due to pandemic-related supply chain woes and rising costs throughout the business due to inflation. But as you can see in the above chart, Wayfair hasn't been able to handle these circumstances as well as its larger competitors. Margins are trending lower into negative territory.
Burning cash creates a ticking clock
Wayfair's collapsing margins put management in a challenging position. It's hard to invest in growing the business when you're bleeding money. But Wayfair must grow larger to become profitable. It's the classic between-a-rock-and-a-hard-place scenario. Management has emphasized its efforts to bring the company to non-GAAP EBITDA profitability, but the real milestone will be free cash flow, since that impacts the balance sheet.
W Cash and Short Term Investments (Quarterly) data by YCharts
Wayfair has burned $1.1 billion over the past year, giving the company just over a year of funding left before it runs out of cash. It could last longer if Wayfair can meaningfully slow its cash losses. However, it already has $3.1 billion in debt, making future borrowing less practical, especially given higher interest rates.
The most likely bet would be issuing new shares to raise cash. But existing shareholders get diluted in these events because increasing outstanding shares makes each share worth a smaller piece of the business. It's like cutting a pie into more and more slices -- everyone gets less pie.
The stock isn't cheap, considering Wayfair's problems
Issuing shares to raise money is typical for growing companies, but timing plays an important role. Wayfair's stock has fallen 90% from its high, which means it would have to issue 10 times the number of shares to raise the same amount of cash it would have generated had it issued shares at the stock's peak.
Suppose Wayfair wants to raise $1 billion, matching its cash burn over the past year. At its current market capitalization of $3.5 billion, investors would see the portion of Wayfair their shares represent decrease by more than 25%. In other words, the share price could fall by somewhere near that amount.
Wayfair stock looks cheap on the surface -- its price-to-sales ratio (P/S) is at all-time lows of just 0.2. However, that's because of the reasons mentioned above. The company is sitting on a financial foundation of sand, and it could start crumbling if cash keeps leaving the balance sheet at this pace. The company's book value is negative $2.5 billion, meaning there are already more liabilities (what Wayfair owes) than assets (what Wayfair has).
In all, it's not a recipe for success, so investors should run far away from Wayfair stock until these dark clouds clear up -- if they ever do.
