"This was a strong quarter for Wayfair (W 5.52%)..." begins the online furniture retailer's first-quarter earnings report. A quick look at the numbers says otherwise.
Wayfair enjoyed booming demand for home goods during the first part of the pandemic. Revenue soared 55% in 2020, and the chronically unprofitable company even managed to produce a positive net income. But that demand soon evaporated. Revenue dipped 3.1% in 2021, followed by a larger 10.9% decline in 2022.
Wayfair's first quarter of 2023 was not much better. Revenue sank 7.3% year over year to $2.8 billion, the number of active customers tumbled 14.6%, and net loss widened to $355 million. Free cash flow was a loss of $234 million, which chipped away at the cash on the company's balance sheet.
A long road to real profitability
The only time Wayfair was able to turn a quarterly net profit based on generally accepted accounting principles (GAAP) as a publicly traded company, which goes back to late 2013, was during the first two years of the pandemic. That's it. It took the absolute best demand environment imaginable, fueled by people stuck in their homes with stimulus cash to burn, for Wayfair to stop printing red ink.
W Net Income (Quarterly) data by YCharts
Despite these chronic losses, Wayfair CEO Niraj Shah said this in the first-quarter earnings release: "We have always known, and now we are clearly demonstrating that the Wayfair model is inherently profitable and that there is considerable opportunity in front of us to rapidly drive further margin expansion."
What Shah is referring to when he talks about profits is adjusted earnings before interest, taxes, depreciation, and amortization, or adjusted EBITDA. Wayfair posted a small adjusted EBITDA loss of $14 million in the first quarter, and it expects this metric to turn positive in the second quarter.
The problem with adjusted EBITDA is that it backs out a lot of real costs that should not be ignored. Interest and taxes aren't significant for Wayfair, but depreciation and amortization certainly are. Those two items totaled $104 million in the first quarter.
The "adjusted" part of adjusted EBITDA for most companies that tout this creative metric involves backing out stock-based compensation. As Warren Buffett puts it:
If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?
Wayfair's adjusted EBITDA calculation added back $151 million in stock-based compensation expenses and related taxes in the first quarter.
GAAP net income is not a perfect metric either. It's an accounting number, so it's not necessarily a good indication of underlying profitability. But what it doesn't do is ignore real costs. Free cash flow, which represents the actual amount of cash a company generates from operations minus any capital expenditures, is sometime a better measure. On both counts, Wayfair is nowhere near profitable.
Wayfair is far from the only company promising "profitability" by way of adjusted EBITDA. Online used car seller Carvana just did the same thing. Here's Buffett again: "People who use EBITDA are either trying to con you or they're conning themselves."
Stay away from Wayfair stock
No matter what Wayfair's management says, the company has yet to prove that its business model works outside of a once-in-a-century global pandemic. It wasn't profitable before the pandemic, it's not profitable now, and it won't be profitable in the second quarter, even if adjusted EBITDA turns positive.
Wayfair stock is down about 88% from its pandemic-era high, but it's no bargain. Slumping revenue, chronic losses, and a management team putting the focus on a dubious profitability metric are reasons enough to avoid the stock.
