Shares of e-retail marketplace eBay (NASDAQ:EBAY) dropped slightly after the company reported fourth quarter numbers which topped both revenue and earnings estimates. Despite the double beat, it was low-quality revenue beat with a down revenue guide for Q1 and fiscal 2019. Investors weren’t impressed. They sold eBay stock, on the heels of what was a near 30% rally over the past month into the Q4 print.
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This minor sell-off isn’t a big deal. In fact, it’s just an opportunity buy more eBay stock at a discount. In the big picture, eBay’s fourth quarter earnings report illustrated why this stock can rise 25% in 2019 to $40.
Top line trends are weakening. Gross merchandise value growth is slowing. Active buyer growth is slowing. Sold items growth is null. Revenue growth is falling. Indeed, next year, revenue growth is expected to be just a hair above zero.
But, against the backdrop of weakening top-line trends, bottom-line trends are improving. Namely, operating margins fell by less in Q4, than they have all year long. Margins are also expected to improve meaningfully in 2019, and EPS growth is expected at nearly 15%.
eBay stock trades at just 12X next year’s guided earnings. That multiple is just too low for a company growing profits at a 15% pace.
Overall, eBay’s fourth quarter report illustrated that margin improvements will more than offset revenue growth deceleration in 2019, and that earnings will soar higher. eBay stock isn’t priced for earnings to soar higher, meaning that as profits rise throughout 2019, eBay stock will rise, too.
Revenue Trends Are Stable
At its core, eBay is an online garage sale that connects independent buyers with independent sellers. Demand for this forum of ecommerce is relatively niche. Most customers would rather just shop on Amazon (NASDAQ:AMZN) or on a company’s website. But, demand for an online garage sale is also stable. Some customers simply prefer searching for better prices, or enjoy buying from independent sellers.
Thus, while eBay isn’t a growth machine, it also isn’t going anywhere any time soon. This is a stable company with tepid revenue growth potential over the next several years thanks to ecommerce expansion.
Current revenue trends confirm this narrative. Active buyer growth came in at 4% in Q4, which is in-line with the average 4-5% growth rate over the past several quarters. U.S. GMV growth went negative to -1%, and it’s slowing from the 5-8% rate that was the norm several quarters ago.
International GMV growth is also following a similar slowing trajectory, but is still running around 5%. Sold items growth is flat, which is the same as the past three quarters. Organic FX-neutral revenue growth was 5%, continuing a multi-quarter slowdown from 7%.
Meanwhile, revenue growth next year is expected to be essentially flat.
Overall, the trend here is clear. Revenue growth and revenue growth related metrics are slowing. But, they aren’t falling apart. They are simply normalizing to more stable levels around 0-4%. This speaks to both the limited growth and staying power of the online garage sale model.
Margin Trends Are Improving
While revenue trends are normalizing lower, margin trends are meaningfully improving.
In each of the first three quarters of 2018, eBay’s operating margin dropped by 100 basis points or more year-over-year. In Q4, operating margins fell just 60 basis points, boosted by 20 basis points of gross margin improvement. Moreover, management is going to reduce largely unnecessary marketing spend in conjunction with cutting other unnecessary costs in 2019.
Net result? eBay is expecting two points of operating leverage in 2019, and for margins to expand by over 100 basis points to ~28.5%.
Overall, the trend here is clear, too. The company overspent for a long time trying to tap into customers that simply weren’t interested. Now, they are peeling back that unnecessary spend, and margins are rising.
$40 Seems Achievable in 2019
Fiscal 2019’s growth rates should turn into the new normal.
Over the next several years, due to limited marketing spend and niche appeal of the online garage sales model, eBay’s revenue growth should slow. But, inflation and global ecommerce expansion should add some firepower. Thus, revenue growth over the next few years should hover around 0-2%.
Meanwhile, margins will march higher. Marketing spend will decrease. Other costs will come out of the system as the company transitions away from trying to grow at all costs. As such, operating margins could realistically head back towards 30% or higher within the next five years.
Tepid revenue growth and steady margin expansion on top of buybacks should push EPS towards $3.60 by fiscal 2024. Based on a historically average 15 forward multiple, that equates to a fiscal 2023 price target of $54. Discounted back by 8% per year (shaving off 2% my normal 10% discount rate to account for the new dividend), that implies a 2019 price target of just under $40.
Bottom Line on EBAY Stock
eBay isn’t a growth machine. But, as the go-to online garage sale operator, the company is stable in the long run. In 2019, margins will start to move meaningfully higher, and that should spark a multi-year uptrend in profits. As profits go higher, eBay stock will rise, too, given the stock’s currently depressed valuation.
As of this writing, Luke Lango was long EBAY and AMZN.
