Wayfair (NYSE:W) posted phenomenal Q1 results on May 5, blasting the stock dramatically higher. By the end of the day, W stock had rocketed up almost 24% higher in one day. Moreover, in after-hours trading, the stock was even higher.
At first glance, some might be confused with the results. For example, adjusted EBITDA losses increased from negative $102 million in Q1 2019 to negative $127 million in Q1 2020.
What Caused the Blast Off in W Stock
But that is not what moved investors. First of all, the top-line revenue grew 19.8% year-over-year, to $2.33 billion in Q1. Moreover, the last 12 months’ (LTM) revenue was up 4.2% sequentially to $9.5 billion.
In the retailing world, this is a breath of fresh air. Companies like J. Crew are declaring bankruptcy. Barron’s says that JC Penney (NYSE:JCP) and four other retailers are close to going under as well.
Second, the company announced that it now has 29% more active users, at 21.1 million, from a year ago. Millennials are not only flocking to Wayfair to buy physical things online, but their order frequency is increasing. Its clients typically order LTM 1.86 times and Wayfair is appealing to the mass market with most of its products.
Wayfair said in its presentation to investors that the 80 million millennials aged between 20 and 37 are now entering the peak furniture ordering age of between 31 and 50 years old. In other words, Wayfair expects to pick up a larger market share of major purchases from this group.
That is why the market is excited. They expect Wayfair to benefit from its focus on this demographic group of buyers.
Wayfair’s Financials Are Not as Bad as It Might Seem
As I pointed out, adjusted EBITDA rose by 24.5% to $127 million from last year during Q1. But this is not exactly as bad as it might appear.
For one, the U.S. portion EBITDA performance actually improved. On page 38 of the investor presentation, Wayfair showed that the U.S adjusted EBITDA cash flow of negative $45.1 million. This was better than the Q4 figure of negative $88 million.
Moreover, the U.S. adjusted margin was negative at minus 2.3%. Keep in mind that the U.S. accounts for 85% of the total $2.33 billion in quarterly revenue. The international adjusted margin was negative at minus 23.7%.
So the market is excited that as sales grow, the U.S. portion of revenue should begin to turn EBITDA positive, based on the concepts of operating leverage and economies of scale.
Wayfair is counting on millennials entering into the peak furniture buying years in the next several years, taking a long-term view of financial performance. So far, the market has been willing to accommodate them.
W Stock Is an Anomaly That Might Work Out Fine
Wayfair now has a $12.65 billion market value. It does not seem to need any financing, and so the market is willing to believe the company’s story.
Cash at the end of the quarter was $891 million. Based on my analysis of their cash flow statement, I estimate the company is burning about $350 million or so per quarter. That means it must eventually get profitable within three quarters or so, or else increase their debt levels.
Alternatively, they could raise equity capital, but that would kill W stock for a while. It’s usually the last alternative for a company. The way that works is as follows: no one will invest in a company that is likely to go bankrupt. But if you have a good story and can explain your cash flow losses, you have the ability, like Wayfair, to raise equity capital.
Be careful with Wayfair. They need to start showing profits now that they are close to generating $1o billion in revenue. If not, cracks might start to develop in the stock “story.”
But at least you can understand how millennials will be their salvation. W stock may work out just fine if millennials keep buying Wayfair furniture around the world, but especially in the U.S.
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.
