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Why Red-Hot Wayfair Stock Could Rally Above $200

Wayfair (NYSE:W) stock is red-hot. From its March lows, Wayfair stock is up nearly 700%.

Why Red-Hot Wayfair Stock Could Rally Above $200
Source: Jonathan Weiss / Shutterstock.com

What’s behind the huge rally?

Ever since mid-March, investors have been bullish on the idea that commerce activity is migrating online amid the novel coronavirus pandemic. The market has consequently bid up all online retail stocks. See Wayfair, or Shopify (NYSE:SHOP), Etsy (NASDAQ:ETSY), Amazon (NASDAQ:AMZN) or eBay (NASDAQ:EBAY). All of those online retail stocks have soared since mid-March.

At the same time, investors have also grown increasingly bullish on the idea that, because consumers are stuck at home, they are allocating a greater share-of-wallet to home furnishings and decorations purchases.

Wayfair is at the intersection of these two tailwinds. That’s why Wayfair stock rose 550% from mid-March to early May.

Then, shares popped another 40% in early May after Wayfair reported first-quarter numbers that broadly confirmed the idea that this company is a Covid-19 winner.

Here’s the more important question than how Wayfair got here: where’s Wayfair stock going next?

Above $200. Here’s why.

Strong Earnings

Wayfair’s first-quarter earnings report was very good, and implied that this company is set to have a breakout 2020.

The Q1 numbers themselves were good. But not amazing. Across the broad, revenue growth trends slowed and margins failed to make meaningful upward progress. But, growth remained solidly above 20%, and margins didn’t compress. All in all, it was a solid — but not great — first quarter.

The “amazing” part of the earnings report came during the conference call, when management updated investors on second-quarter growth trends.

Quarter-to-date, revenues are up 90% year-over-year, driven by both a surge in new customers and repeat purchase activity from current customers. Because of this increased scale, gross margins are expected to rise meaningfully to 26%, and adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margins are expected to be positive.

In other words, the Wayfair growth narrative caught fire in April, and that fire has put Wayfair on track to report record-high and much better-than-expected second-quarter and full-year 2020 numbers.

Favorable Fundamentals

Zooming out, Q2 growth acceleration is more than just a near-term phenomena. In context, it represents an improvement in what was already a favorable fundamental backdrop for Wayfair stock.

That fundamental backdrop includes the fact that Wayfair is the right company, in the right market, with huge profit growth potential. Specifically:

  • The right market: The global furniture market is a steady low-single-digit growth market supported by stable demand drivers such as consumers moving into new homes and/or remodeling existing homes. Within that industry, we are now seeing a massive pivot toward the online channel. According to Wayfair numbers, e-commerce penetration in the U.S. home market has consistently increased. But, it’s still at just 13% today, versus  approximately 30% for apparel. Further, the new buyers in this industry are millennial first-time home buyers who want to buy things online. Thus, the runway for growth in the online home market is huge, and supported by strong demand tailwinds.
  • Early and consistent leadership: Within the e-retail furniture market, Wayfair has established itself as the unparalleled leader — the Amazon (NASDAQ:AMZN) of furniture, if you will. The company’s share of U.S. e-retail furniture sales has risen from just over 10% in 2015, to nearly 20% last year. Huge early 2020 growth puts Wayfair on track to continue to extend its leadership position this year.
  • Profit ramp potential: The big knock against Wayfair is that company runs steep losses. But, so did Amazon once upon a time. Now, Amazon’s profit margins are in the low to mid single-digit range, and expanding rapidly. This is the benefit of scale in the e-commerce world. Wayfair’s margins should follow a similar trajectory as Amazon. Gross margins are high enough (above 25%) that as revenue scale drives opex leverage, then operating margins will zoom into positive territory, and profits will soar.

Valuation Upside

In the big picture, I view the second-quarter growth surge from Wayfair as a seminal moment for this company, wherein Wayfair truly turns into the Amazon of furniture retail within the next few years.

From a numbers perspective, that means I see the U.S. furniture e-retail market climbing to 30%-plus penetration by the end of the decade, Wayfair inching its way towards 35%-plus market share (roughly where Amazon’s total e-commerce market share is in the U.S.) and the company’s international business scaling alongside the domestic one.

It also means that I see increased scale driving significant margin improvements at Wayfair. Long-term, mid-single-digit operating margins seem entirely doable for this company.

Assuming so, my modeling pegs Wayfair’s 2030 earnings-per-share potential at $25. Based on a 20-times forward earnings multiple — the medium-term average forward multiple for tech stocks — that implies a 2029 price target for Wayfair stock of $500.

Discounted back by 10% per year, that equates to a 2020 price target of over $200.

Bottom Line on Wayfair Stock

Wayfair stock is red hot. It’s easy to look at the stock’s 600%-plus gain over the past six weeks, and say the best of the rally has already happened.

Of course it has. The stock isn’t going to rise another 600% from here over the next six weeks. But this rally isn’t over, either. Instead, shares still have another 15%-plus upside potential over the next few months.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long SHOP.  

Article printed from InvestorPlace Media, https://investorplace.com/2020/05/wayfair-stock-could-rally-above-200/.

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