In the stock market, a truth about volatility is that it always comes back. It’s sometimes easy to forget this when you’ve found a winning stock that’s firing on all cylinders. That winning stock could easily rise 50%, 75%, or even 100%-plus in a hurry, and do so in linear fashion. The another truth, though, is that even the best stocks don’t go up in straight lines forever. Even seemingly invincible stocks hit rough patches every once in a while, and when they do, the stocks will struggle to head higher.
Case in point: Wayfair (NYSE:W). The furniture e-retailer is firing on all cylinders, and has distinguished itself as the leader in the U.S. e-commerce furniture market. They are also seeing tremendous success internationally, and margins are making some progress toward their healthy long-term goals. As such, W stock has been absolutely on fire. Year-to-date, it’s up 65%.
But, this seems like a case of a winning stock heading into a rough patch.
To be sure, Wayfair stock has all the attributes of a long-term winner. The company has distinct advantages in a secular growth market powered by healthy demand tailwinds, and has established an early and consistent leadership position on that secular landscape. Margins also have a pathway to head meaningfully higher in the long run. Wayfair looks like a big revenue and profit grower for the next several years, the sum of which will drive W stock higher.
Having said that, Wayfair stock has come very far, very fast, and the valuation is now fundamentally challenged. As such, I think patience is key here. Don’t chase the rally. But, be prepared to buy the dip.
Wayfair is a Long-Term Winner
In the big picture, Wayfair is a long-term winner for three big reasons. Those three big reasons are as follows:
- 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, and according to Wayfair numbers, e-commerce penetration in the U.S. home market has consistently increased. But, it’s still at just 13%, versus ~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 leader. The company’s share of U.S. e-retail furniture sales has risen from just over 10% in 2015, to more than 15% last year. Further, of the $4.8 billion in new online furniture sales generated in 2018, roughly a third was from Wayfair. So, this company has an early leadership in the secular growth online furniture market, and is rapidly expanding that leadership position.
- Profit ramp potential: The big knock against Wayfair is that company runs steep losses. But, so did Amazon (NASDAQ:AMZN) once (or twice, or…) 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 24%) that as revenue scale drives opex leverage, then margins will zoom into positive territory, and profits will soar.
All in all, Wayfair has all the right attributes to support a healthy long term growth narrative. As such, so long as management continues to execute, Wayfair stock should stay on a long term uptrend.
Beware Near-Term Turbulence
The problem with Wayfair stock here is that current levels don’t seem sustainable in the near to medium term.
Namely, the valuation is rich. When it comes to W stock, you can’t really look at the current multiples and say anything about the valuation. Instead, you have to look at potential profits down the road, and see how the current valuation stacks up against those profits. When you do that, it becomes pretty clear that Wayfair stock is pushing the limits of its present day valuation.
At scale, I have a bullish outlook on Wayfair’s growth trajectory. I think:
The U.S. home market will continue to grow at a steady low to mid single-growth rate for the foreseeable future. E-retail share in the U.S. e-commerce market will hit nearly 50% by 2030. Wayfair will grow e-retail U.S. market share to 30%-plus by 2030. The international retail business can continue to grow at a robust rate and hit 10% penetration of its $300 billion addressable market by 2030. Gross margins will run towards 25%, while the opex rate will drop towards 20%.
Even under those bullish assumptions, I still think Wayfair stock is fundamentally stretched here. Earnings per share of $20 seems doable by fiscal 2030. Based on a growth average 20x forward multiple, that implies a reasonable fiscal 2029 price target for W stock of $400. Discounted back by 10% per year, that equates to a fiscal 2019 price target roughly $155.
That’s about where the stock trades today. As such, long-term fundamentals say Wayfair stock is fully valued here.
Bottom Line on W Stock
Wayfair stock is a long-term winner that sprinted ahead of the fundamentals in the near term. As such, the next few months should be defined by sideways trading and not much sustainable upward progress in the stock.
As of this writing, Luke Lango was long AMZN.
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