Roku (NASDAQ:ROKU) could face a growth rate slowdown in its second half as stay-at-home orders will be mostly gone by then. That is a conclusion the company made in its outlook statement in its first-quarter shareholder letter on May 6. As a result, ROKU stock could end up drifting lower from here, or at least not rise that much.
Roku makes most of its revenue from what it calls “platform” revenue, which is content distribution fees as well as advertising revenue. This accounted for 81% of total revenue, with the rest being its “player” revenue from its Roku peripherals and TV sets. The platform revenue is very profitable.
In Q1 Roku made 66.9% gross margins on that platform revenue, compared to 13.8% in player gross margins. The net result is that in Q1 ROKU made 56.9% gross margins and 21.9% adjusted EBITDA margins (earnings before interest, taxes, depreciation, and amortization). This can be seen on page 1 of the shareholder letter. More importantly, adjusted EBITDA margins grew from 17.5% to 21.9% from the prior quarter.
But growth is slowing, as people are not stuck indoors as much anymore. Here is the complicated way that ROKU described what it expects:
“… 2020 produced a spike in streaming hours per account in Q2 2020, and also resulted in elevated growth for Roku’s active account base … we expect the year-over-year growth rates of both metrics to be lower than those in 2020. However, we expect net adds of both active accounts and streaming hours to be above pre-COVID-19 levels. Furthermore, … we expect streaming hours per account to be higher in 2021 than in 2020.” (emphasis added)
Did you understand that? It is extremely garbled. The company seems to be saying that streaming hours and its “active account base” growth will be lower. But they will still be higher than apparently 2019 levels. And 2021 will be higher than 2020. They seem to be saying expect to see a deceleration in growth.
That already has started in Q1. For example, Roku’s active accounts rose from 51.2 million in Q4 2020 to 53.6 million in Q1 2021. That is a quarter-over-quarter (QoQ) growth rate of 4.7%. But in 2020, the number of accounts grew from Q3 to Q4 by 11.3%, from Q2 to Q3 by 6.98% and from Q1 to Q2 by 8%. So you can see the slowing rate of QoQ growth, although these numbers still lead to very high annual rates of growth.
Outlook For Q2 and the Rest of 2021
The company also made news in its Q1 letter by saying that it expects its EBITDA dollar value to fall a good deal. It will drop to $60 million to $70 million, from $125.9 million in Q1.
This is because the company expects to have significantly higher “opex” or operating expenditures. Roku slowed down its opex spending last year and it has to make up for that this year.
And don’t forget what the company said in the quote above about the slowing growth rate of its accounts going forward.
The net result is that profits will be lower, which could hurt ROKU stock.
What To Do With ROKU Stock
This likely leaves Roku’s investors somewhat bewildered. They know the company is in a growth industry and its revenue and profits are still growing. But the growth rates are now slowing. So what does this mean for its valuation?
Right now ROKU has a $43.8 billion market capitalization according to Seeking Alpha. Revenue is forecast to hit $2.74 billion this year and $3.75 billion next year. That puts it on a price-to-sales multiple (P/S) of 16 times and 11.7 times next year.
Moreover, the price-to-earnings (P/E) multiples are extremely high. Earnings per share (EPS) estimates are for 40 cents this year and $1.06 next year. That puts it P/E ratio astronomically high at 835 times and 367 times respectively.
Seeking Alpha EPS estimates are for $5.19 in 2024 and $10.57 in 2025. This implies huge growth rates. But as ROKU stock closed at $330.65 on May 21, it lowers the P/E multiple to 31 to 64 times, albeit 3.75 to 4.75 years in the future.
Using a 15% discount rate, the 2024 EPS falls to $3.19, raising its P/E ratio to 103.7. Moreover, the 2025 EPS estimate drops to $5.52 and raises the P/E ratio to 59.9 times. These are very high valuation estimates.
Given Roku’s high valuation and its slowing growth rates, ROKU stock is due for a correction or at least a treading water pattern for a while.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.