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Zacks Industry Outlook Highlights Dropbox and DoorDash

For Immediate Release

Chicago, IL – May 11, 2023 – Today, Zacks Equity Research discusses Dropbox, Inc. DBX and DoorDash, Inc. DASH.

Industry: Internet Services

Link: https://www.zacks.com/commentary/2093719/2-great-stocks-to-play-the-internet-services-industry

Macro factors currently driving the economy, such as inflation, rate hikes, supply chain issues (though minimal right now and in pockets), the relative strength in labor and so forth have a varied impact on players in the extremely diverse Internet – Services industry.
 
However, since this is a capital-intensive industry with high fixed cost of operation and the fairly constant need to expand capacity, a high interest rate just isn't very positive for it. Nor is the impending recession, or at least slowdown, since the industry tends to do better when the overall economy does well. These factors, along with the still-elevated inflation are weighing on stocks. Valuations continue to drop, creating some opportunities.

About the Industry

Internet - Services companies are primarily those that rely on huge software and hardware infrastructure, referred to as their properties, to deliver various services to consumers. People can avail the services by accessing these properties with their personal connected devices from almost anywhere in the world.

Companies in the sector generally operate two models: an ad-based model where the service is offered free and an ad-free model where they charge for the service. Alphabet, Baidu and Akamai are some of the larger players while Dropbox, Etsy, Shopify, Uber, Lyft and Trivago are some of the emerging players.

Because of the diversity of services offered, it is difficult to identify industrywide factors that could affect all players. Macro factors such as inflation, rate hikes, supply chain issues and so forth affect different players differe

Factors Shaping the Industry

  • It goes without saying that increased digitization of different aspects of daily life is a driver for the entire industry because digitization essentially transfers work online, which is where Internet service providers are required. To that extent, the pandemic has proved course-altering for the industry because of the huge volume of transactions that moved online. And people are not giving up all of these conveniences to go back to their old ways. The expansion of the installed base of connected devices beyond PCs and smartphones to IoT, automotive and more is creating additional opportunities for targeting. The ownership of multiple devices automatically drives people to use these services more as they increasingly automate routine chores.

  • Being a capital-intensive industry, there is the need to raise funds to build out costly infrastructure. Funds are also needed to maintain this infrastructure. Companies have scaled back capital spending in view of rising rates and the impending recession, which if it happens in late 2023 or 2024, will impact revenue growth and therefore, cost absorption. Therefore, while the cutback in spending should be viewed positively in terms of cost control, it also implies softening demand, which isn't so positive. Notably, Alphabet, which is big enough to skew averages, has not cut back spending.

  • Debt levels were stable through 2022, but should come down slightly in 2023, as Alphabet's debt levels are slightly lowered in the March quarter. Two things typically trigger major increases in debt levels (and the two are not mutually exclusive), i.e. fixed asset investment and acquisitions. To that extent, the reduction in capital spending in December (compiled March numbers pending) could be indicative of a trend and will keep debt levels stable. The appetite for acquisitions could also come down, especially for smaller players given the soft demand outlook, despite the fact that acquiring new competencies is essential to stay ahead of some of the stiff competition in the space. In 2022, Alphabet alone acquired 257 organizations.

  • Traffic acquisition is one of the most important drivers of revenue, so companies invest in advertising or building communities that can draw more users to their online properties and get them to spend more time there, much like a store owner would try to keep a prospective buyer within the store. Some large players, including those providing infrastructure services, grow by tying up with other such large players for access to their customers. Since the personal touch is absent in an online store, many rely on cookies and other technologies to track users, collect data on them and profile them in order to better understand their needs.

  • As these companies have grown over time, some of them have collected such a wealth of information on their users that the data itself is now helping them build artificial intelligence (AI) to generate revenues from new technologies and services and also lower the cost of operation. Ad-based services are no longer considered free. The EU's GDPR for example requires service providers to acquire explicit permission from users before collecting their data. While not all businesses are built on the same scale or have the same customer reach, AI tools are increasingly helping organizations of every size. They are tremendously increasing operational efficiency and the scope for growth.

Zacks Industry Rank Indicates Slow Recovery

The Zacks Internet - Services industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #95, which places it among the top 38% of more than 250 Zacks-classified industries.

The group's Zacks Industry Rank, which is basically the average rank of all the member stocks, indicates that there are likely to be a few opportunities in the space although the diverse range of companies makes stock selection tricky.

Looking at the aggregate earnings estimate revisions over the past year, we see that while estimates have dropped over the past year, the bottom seems to have been in January, with trend reversing since then. Overall, the industry's earnings estimate for 2023 is down 19.3% from May 2022. The average earnings estimate for 2024 is down 21.1%.

Historically, the top 50% of Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. So the industry's positioning in the top 50% of the Zacks-ranked industries should be considered a positive, even if a recession, albeit a shallow one appears to be around the corner.

Before we present a few stocks that you may want to consider for your portfolio, let's take a look at the industry's recent stock-market performance and valuation picture.

Industry Lags on Stock Market Performance

While initially trading more or less in line with the broader Technology sector and the S&P 500, since November, it has been trading at a discount to both.

The industry has lost 4.1% of its value over this period compared to the S&P 500 index's gain of 2.7% and broader sector's gain of 3.3%.

Industry's Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing technology companies, we see that the industry is currently trading at a 20.33X multiple, which is its median value over the past year. However, this is a premium to the S&P 500's 18.27X although a discount to the sector's 22.78X, suggesting that valuation has gotten more attractive in the past few months.

2 Solid Bets

Dropbox, Inc.: San Francisco, California-based Dropbox provides a content collaboration platform worldwide. The company's platform facilitates collaboration between individuals, families, teams and organizations (professional services, technology, media, education, industrial, consumer and retail, and financial services industries). The free sign-up through its website or app offers limited features and is supplemented with a paid subscription tier for premium features.

Management has said that the economic backdrop remains tough for its existing businesses. And this can be seen in the very high operating expenses as a percentage of revenue. Overall. the gross margin remains at the low-end of the long-term targeted range while the operating margin has a really long way to go before it gets within the targeted range. Management is seeing "huge opportunity to apply AI/ML" to its products "to transform knowledge work" and is "committed to ensuring Dropbox is at the forefront of this era". They also promise to "bring more AI-powered products to market".

The company beat earnings estimates in the last quarter by 20% despite significantly negative FX impact, and the 2023 estimate is up 8 cents (4.8%) in the last 30 days. The 2024 estimate is also up 9 cents (4.6%). Analysts currently expect 2023 revenue and earnings growth of 6.7% and 11.4%, respectively. For 2024, they're expecting 4.9% revenue growth and 15.6% earnings growth.

The shares of this Zacks Rank #1 (Strong Buy) stock are up 3.3% over the past year.

DoorDash, Inc.: San Francisco, California-based DoorDash's logistics platform connects merchants, consumers and delivery personnel (dashers) in the U.S. and internationally. Its DoorDash and Wolt marketplaces offer merchants the tools for customer acquisition, delivery, insights and analytics, merchandising, payment processing and customer support; The DashPass and Wolt+ are membership products, and DoorDash Drive and Wolt Drive white-label delivery fulfillment services. It also offers merchants DoorDash Storefront for e-commerce and Bbot for digital ordering and payment solutions (for both in-store and online sales).

DoorDash is benefiting from strong growth in the core restaurant business and even stronger growth in the grocery delivery business, and management believes that the company is taking share in both segments. The international business is also much stronger than the domestic and a major driver of its results. The company is also improving operating efficiency in many areas of its business, including through disciplined expense management.

DoorDash reported March quarter results, which beat estimates by 26.8%. In the last seven days, analysts have taken their 2023 per share loss estimates down 38 cents (17.7%) and their 2024 loss estimate down 39 cents (27.5%). Both the top and bottom lines are expected to improve materially in both years. For 2023, the expectation is for revenue growth of 24.3% and loss improvement of 31.7%. For 2024 growth is expected to be 17.8% and 41.8%, respectively.

In the past year, there is no net change in the share price of this #2 (Buy)-ranked company.

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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Zacks Investment Research does not engage in investment banking, market making or asset management activities of any securities. These returns are from hypothetical portfolios consisting of stocks with Zacks Rank = 1 that were rebalanced monthly with zero transaction costs. These are not the returns of actual portfolios of stocks. The S&P 500 is an unmanaged index. Visit https://www.zacks.com/performance  for information about the performance numbers displayed in this press release.

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