Roku (NASDAQ:ROKU) has fallen along with the market, about $40 from its peak in January to $102. In fact, from its all-time-highs in late 2019, Roku stock is down 42%.
But maybe not all is lost. There is an invisible hand at work here. The seeds of a turnaround are at the heart of the reasons for the stock’s drop.
For example, Roku’s underlying fundamentals could benefit from the coronavirus outbreak. If people stream more while they stay at home as a result of the outbreak, Roku’s sales could rise. Subscription services, ad revenue and other types of income at Roku will rise as well.
Roku’s Sales Stoked By Streaming
Roku is now everywhere. Roku claimed in their latest 10-K report, filed on Feb. 13, 2020, that nearly one in three TVs sold in the U.S. in 2019 was a Roku smart TV.
Its operating system is becoming more prevalent in the streaming arena. In fact, Roku says Amazon (NASDAQ:AMZN), Best Buy (NYSE:BBY) and Walmart (NYSE:WMT) now account for 72% of their streaming player sales.
In the company’s 10-K annual report, Roku says that it believes all TV viewing in the near future will be by streaming. The days of cable TV, now called “linear TV” are numbered.
For example, over the last year, many of the biggest names in media and TV programming embraced the transition to streaming. New TV streaming services have launched like Disney+, which has attracted over 28 million subscribers in the matter of a few months. As TV streaming becomes mainstream, consumers are spending more time watching TV streaming services, with many leaving legacy pay-TV services entirely.
In effect, this spiked ROKU’s revenues in 2019. Total net revenue grew 52% YoY to $1,128.9 million. Moreover, Gross profit was up 49% YoY to $495.2 million. Lastly, Average Revenue Per User (ARPU) increased $5.19 YoY, up 28.9% to $23.14 (trailing 12-month basis).
Here’s the bottom line: ROKU is on an upward trajectory in revenues and profits.
Outlook for ROKU Stock
However, the company is still losing money on a net income basis. ROKU lost $59.9 million in after-tax income. In fact, the company is not even projecting net income profits for a while.
However, ROKU likes to measure its profitability on an Adjusted EBITDA basis. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It “adjusts” this measure by also adding back stock-based compensation expenses (SBC).
Last year ROKU made a positive Adjusted EBITDA profit of $35.8 million. But the problem, as I see it, is that for 2020 ROKU is claiming Adjusted EBITDA will only be between negative $10 million and positive $10 million.
The good news is that ROKU expects its sales to increase another 42% to over $1.6 billion. And, as I pointed out above, there is the possibility that the impact of the coronavirus may make people more sedentary and stream more. So it is possible the revenue estimate may be too conservative.
But somehow this translates into lower profitability for 2020. I don’t think that is going to push up ROKU stock. Investors are going to start to want to see significant profitability, or at least cash flow profitability.
Is ROKU Stock a Defensive Investment?
An analyst at Needham this week came out with a glowing report on ROKU stock, according to Seeking Alpha. Laura Martin wrote that if people stay home, it would boost ROKU’s hours viewed and available ad units above projections.
This would make ROKU stock a defensive investment. She has a “buy” rating and $200 price target, implying 71% upside.
Maybe. But there is a problem with that. The market would already have discounted this in the ROKU stock price by now. For example, ROKU stock is down significantly from its highs, since the Feb. 13 shareholder letter was issued.
Moreover, for a stock to be a “defensive” investment, it needs to have certain value characteristics. One of them is a margin of safety. Let’s look at that.
ROKU stock does have net cash of $415.8 million, even after its $100 million or so in debt. So the company is not going to need to raise cash any time soon. But that represents just 3.4% of its market value of $12.2 billion. Moreover, the cash burn in Q4 was $49.6 million in negative free cash flow. It can’t keep this up without using up a lot of the net cash over the next year.
Valuation of ROKU Stock
Moreover, the EV-to-EBITDA ratio of ROKU stock is still very high. If Roku makes $10 million in Adjusted EBITDA next year, as expected, the ratio is over 1,000 times.
However, the EV-t0-Sales ratio, based on $1.6 billion in revenue for 2020, is only 7.4 times. This is one of the lowest ratios so far that ROKU stock has had.
I suspect that investors and the company look at this ratio more than the EV-to-EBITDA ratio. This is because EBITDA is more volatile and harder to predict than sales.
I suspect that ROKU stock will tend to do well this year as it continues to report higher sales. If ROKU shows higher Adjusted EBITDA, lower cash burn and increased streaming viewership through the year, ROKU stock will light up.
Moreover, the coronavirus outbreak may turn out to be a mild catalyst to higher sales of its operating systems, TVs, and ads. This will also be a positive influence on ROKU stock.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers get a two-week free trial.