Wayfair (W -1.94%) has been one of the most volatile e-commerce stocks over the last few years. The macroeconomic headwinds exposed some vulnerabilities in Wayfair's business, and the company's revenue has fallen -- customers don't have the appetite to spend money on their homes after their spending binge during the pandemic.
Still, Wayfair is a leading brand in the home goods market, and there are signs the company is on the verge of turning the corner. Here are three reasons the stock could be ready for a bull run.
1. More efficient operations
The era of artificial intelligence (AI) has arrived, and many companies are scrambling to invest in this revolutionary technology. Wayfair is already ahead of the game. The company has been investing in AI for several years.
One problem for Wayfair has been its weak profitability. The company's loss was $355 million in the first quarter, which is weighing on the stock. It needs to turn that around if the stock is going to rebound.
One way management is improving its cost structure is using machine learning, a form of AI, to optimize its logistics network. Wayfair uses this technology to curate products on search results pages that are closest to the customer. This helps shorten shipping distances and costs, while also improving the customer experience by reducing the rate of product damage during transit.
You can see evidence of Wayfair becoming more efficient. After a temporary dip earlier last year, gross margin has been trending up over the last few quarters.
W Gross Profit Margin data by YCharts
An improving gross margin for a retail business is excellent. If gross margin were trending down, it would indicate that the company was having to sell products at lower prices to compete, but Wayfair's gross margin remains much higher than before the pandemic. The company said it has continued to gain market share over the last year, positioning the business to emerge from this downturn in a stronger position to drive long-term growth.
2. Returning to revenue growth
Another reason to believe Wayfair is on the verge of a comeback is stabilizing revenue. In the first quarter, the top line fell 7.3%, but that was a lower rate of decline than 13.9% in the year-ago quarter.
Since the fourth of quarter of 2019, Wayfair's quarterly revenue is up 9.5%.
W Revenue (Quarterly) data by YCharts
During the first-quarter earnings call, management said it expects second-quarter revenue to increase just below 10% over the first quarter. This means the company could begin reporting year-over-year revenue growth in the second half of the year.
The main risk here would be a recession, which could weigh on revenue through the end of the year, but the stock already trades at a very cheap valuation that seems to account for this scenario. This brings us to the final reason why the stock could be ready to rebound.
3. Swinging to a profit is the biggest catalyst
The stock sells at a very low price-to-sales ratio of 0.32. This sets up the stock for significant upside as the business returns to a profit.
When Wayfair announced in January that it was on track to reach breakeven earlier than expected, the stock jumped more than 80% within a few weeks. It has since given back those gains, but that immediate reaction to the news shows that investors are more concerned about Wayfair's profitability than anything else right now.
Given the cost savings plan underway, management expects to deliver a small adjusted operating profit at an annual revenue level of $12.25 billion, and gross margin exceeding 30%.
The main risk would be the economy worsening in the near term, which is a possibility with the recent bank failures. The Federal Reserve has warned of a possible recession on the horizon. But turning a profit is more within management's control, and that could significantly lift the stock.
There are negatives for Wayfair, but I also don't believe it's realistic to expect the leading online home goods brand to report declining revenue forever. After all, this is a business that has grown annual revenue over 10-fold over the last 10 years.
At these lower share prices, investors should look at Wayfair as a contrarian investment with a potentially big payoff. By allocating a very small percentage of a diversified portfolio to Wayfair, you don't lose much if things go wrong, but you position yourself to win big if Wayfair continues to show progress at returning to revenue growth.
