Social media company Snap (NYSE:SNAP) has been on fire in 2019, with shares up a whopping 125% year-to-date, and we are only a few days into April. But, this big rally is about to face its biggest test yet, and I’m not so sure that SNAP stock can make the grade.
Snap is set to report first quarter numbers at the end of the month. This will be the first time since early February that we’ll get numbers from management. The early February numbers were really good, and served as the primary catalyst for SNAP’s huge 2019 rally. All the buying and upgrades since those numbers strongly imply that everyone expects the March quarter’s numbers to be just as good, if not better. If they are, SNAP stock will stay in rally mode. If they aren’t, the stock could fall off a cliff.
Broadly speaking, then, Snap’s Q1 earnings will either confirm or negate the legitimacy of the 2019 rally in SNAP stock. Considering the size of the rally, that means there is a lot at stake when Snap reports earnings later this month.
How will things play out? Unfortunately, I don’t think they will play out great for SNAP stock. As such, I think the first-quarter earnings report could short-circuit this monster rally in SNAP.
Understanding the SNAP Stock Set-Up
One of the most important things to understand here is the set-up of SNAP stock heading into the Q1 earnings news. Broadly, the stock’s rally since the last results is unprecedented, and strongly implies that expectations may be too high heading into the Q1 announcement.
From the 4Q18 earnings report on Feb. 5 to now, SNAP stock has gained 75%. That is the largest earnings report-to-earnings report move the stock has had. Ever. By a long shot. The second-highest quarter-to-quarter move? Up 10%, back in mid-2017. The average quarter-to-quarter move? Negative. Thus, this isn’t just a big rally in SNAP stock. It’s an unprecedented and unrivaled rally for the shares.
Here’s the data, ranked from biggest gains to biggest losses:
- 4Q18 to 1Q19: +75%
- 2Q17 to 3Q17: +10%
- 3Q18 to 4Q18: +0.7%
- 4Q17 to 1Q18: +0.5%
- 3Q17 to 4Q17: -7%
- 1Q18 to 2Q18: -16%
- 1Q17 to 2Q17: -40%
- 2Q18 to 3Q18: – 46%
Further, from the above data, there’s really only one period that was substantially positive quarter-to-quarter (the 10% rally from 2Q17 to 3Q17). That period ended with an ugly third quarter 2017 earnings report, which sparked a 20% one day sell-off in SNAP stock.
All in all, history says that SNAP stock is out over its skis here, and needs really good numbers to justify its big rally since the last earnings report. Unfortunately, I don’t think that will happen, and believe this big rally will be short-circuited by underwhelming numbers, much like the mid-2017 rally was similarly short-circuited.
Numbers Could Be Worse Than Expected
From a numbers perspective, Snap needs to report three things at the end of April in order for the stock to hold onto its big year-to-date gains:
- Daily active user (DAU) growth
- Healthy average revenue per user (ARPU) growth
- Big margin expansion
Given the set-up into the report, Snap needs to check off all three of those boxes in order for the stock not to fall. Unfortunately, I think the company will only check off two of them.
ARPU growth and margin expansion should be good in the quarter. Both of these things have been fairly consistent for the entire life of Snap as a public company. Nothing implies that these trends reversed course in early 2019. Snap’s ARPU is still a fraction of peer ARPU levels, and should continue to move higher as advertisers build more trust in the platform. Meanwhile, margins are likewise far below peers levels, and should continue to improve with revenue scale.
But, when it comes to user growth, I think Snap will underwhelm, and that’s a big deal.
The most important thing from last quarter’s earnings report is that the user base stabilized, after several consecutive quarters of declines. Everyone expects this stabilization to turn into growth. I’m not convinced. My ground level observation is that Instagram continues to eat Snap’s lunch, and that consumers are increasingly flocking to Instagram at the expense of Snapchat. Google Trends and SimilarWeb data corroborate this ground-level observation.
Consequently, I’m unconvinced that Snap grew its user base through the first several months of the 2019. Without that user growth catalyst, Snapchat stock is subject to a big drop following the Q1 report.
Bottom Line on SNAP Stock
The fundamentals underlying SNAP stock are clearly improving, but not by enough to warrant a 125% rally through three months and a few days. The stock once again trades at a huge premium on forward-sales basis to Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR), and the Q1 earnings report will likely show that this premium is unwarranted.
As of this writing, Luke Lango was long FB and TWTR.
