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This Just In: Snap Stock Upgraded

Rich Smith, The Motley Fool

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Snap (NYSE: SNAP) stock is back, baby!

After plunging from a high north of $20 a share in 2018 to a low below $5, hurt by a botched app redesign for Android users, the Snapchat operator's stock has enjoyed gains of over 165% in 2019. At a recent price just shy of $16 a share, it's not quite back to its former heights just yet -- but one analyst believes it could eventually get close.

Nine young people leaning against a wall outside while looking down at their smartphones

Image source: Getty Images.

Upgrading Snap stock

This morning, Goldman Sachs announced it's piling aboard the Snap train, upgrading the shares to buy and assigning an $18 price target.

Why? "[W]e believe product improvements and feature additions are driving positive trends in user growth and engagement," says the analyst, echoing a recent report in The Wall Street Journal that cites Sensor Tower data showing that a new "gender swap" feature on Snapchat "went viral" in May, helping to fuel record downloads of the app in the second quarter of 2019.

Combined with "the company's new Android app [and] the launch of Snap Games," Goldman believes that the "new viral lenses (e.g. gender/age lenses)" are fueling "user growth reacceleration," as the analyst explains in a note covered on StreetInsider.com.

Downloads of the app topped 41 million in May -- 37% better than the company's previous best month, which was recorded way back in 2016. This marks a "stark reversal" in the trend at Snap, says Goldman -- and potentially a big enough change to justify the stock's rapid rebound in share price.

The problem with profit

There is, however, one nagging problem with Snap: Profit.

Download trends notwithstanding, Snap has never had much of a problem growing its business. From 2015 to 2016, sales exploded sevenfold. Things have slowed a bit since then, but even so, data from S&P Global Market Intelligence confirms that from 2016 to 2018, revenue at Snap still managed to triple.

But Snap has never quite managed to make the leap from growing revenue to earning profits on that revenue. As revenue tripled from 2016 to 2018, for example, losses more than doubled to over $1.2 billion last year (with $810 million in negative free cash flow, besides).

A glimmer of hope

And yet, that could change -- indeed, it may already be changing. In its upgrade, Goldman makes the connection between app downloads and profitability, arguing that "along with monetization improvement from ad tech initiatives," the addition of new users providing new revenue for Snap "should drive upside to consensus estimates." And there's evidence in the company's numbers already to support this.

In Q1, for example, Snap did not make money. But the rate at which it lost money decreased. Losses as calculated according to generally accepted accounting principles (GAAP) declined to $310 million in Q1 2019, versus nearly $386 million in the prior-year period. Negative free cash flow was only $78 million, versus more than $268 million burned a year ago.

And while Goldman's write-up on StreetInsider doesn't say precisely what the analyst is looking to see happen in Q2, consensus estimates posted by S&P Global have analysts, on average, forecasting a further reduction in quarterly losses to $298 million. Free cash flow is expected to get a bit worse than what we saw in Q1 as Snap rolls out its latest improvements. But even then, it will be less than half Q2 2018's negative free cash flow of $234 million.

So while analysts still don't see Snap turning FCF positive before 2022, or generating GAAP profits before 2023 at the earliest, the trend does seem to be improving for the company.

We'll find out if that is good enough to keep the stock's momentum going when Snap reports Q2 earnings after close of trading on Tuesday, July 23.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.