Wednesday 29th June, 2022
Wayfair’s stock has been hit from multiple angles.
The home goods industry in which it operates is set for further contraction as rising food and energy costs divert consumer spending away from discretionary categories like furniture and home furnishings.
The industry has also seen sales shrink as consumers redirected their dollars to services like travel starting in late 2020, reversing their above trend spend on goods, induced by the lockdowns.
In step with the goods-to-services shift, the reopening of brick-and-mortar competitors has resulted in online players giving back the market share gains they made when non-essential stores were barred from opening.
Alongside these economic factors, the likelihood of further interest rates hikes has led to a wholesale derating of high-growth stocks, whose promise of large free cash-flows in the future now look less likely and are being discounted at higher rates.
Together, from March 2021 highs, these factors have sent Wayfair’s shares down 85%, to near March 2020 lows. Short-sellers, representing over 30% of Wayfair’s freely tradable stock, are having their day in the sun.
While momentum forces may continue to benefit these short-term-focussed bears, Wayfair’s prospects for expanding market share and margins present a business worth multiple times the current $5bn market value.
The home goods industry is dominated by intermediaries that connect suppliers with customers. About 80% of sales still go through high-street shops, which constrained by inventory storage costs, concentrate their volumes across a limited number of SKUs to strengthen their bargaining power over suppliers. This forces them to focus on specific customer groups.
Suppliers, which manufacture sofas, beds, gazebos, etc. don’t benefit from brands and hence rely on these intermediaries to reach customers.
Customers in turn select goods based on price and their personal style, and select an intermediary that can provide these two with efficient delivery and returns.
Wayfair, an intermediary, was founded in 2002 with the premise that it is quicker and cheaper for customers to find home goods online, rather than travelling to shops. Wayfair’s customers can view products that its suppliers own, and that Wayfair can deliver to them. As such, unlike high-street shops, Wayfair doesn’t incur upfront costs to buy and/or store inventory, enabling it to sell products targeting a far broader spectrum of tastes and income-brackets, all while freeing up cash and avoiding inventory obsolescence risk.
Together this has facilitated Wayfair’s rapid growth to become the largest online seller of home goods in the US and UK, the first two markets it entered, as well as gaining share in its other markets of Canada and Germany.
Overall growth has been supported by home goods consumers shifting their spend online – category penetration grew from c. 5% in 2011 to c.20% in 2021, a 15% CAGR.
But Wayfair’s market beating sales CAGR of 40% since FY ‘14 is indicative of its superior offering for suppliers to sell their products online, and for customers to buy from. When paired with the fact that FY ’21 sales of $14bn represents c.2% share of the growing furniture, home furnishings, appliances and garden equipment market it targets, this suggests a major portion of Wayfair’s growth lies ahead.
For suppliers, Wayfair provides access to huge customer traffic – 4bn site visits in 2021- plus end-to-end delivery of their goods, for no fee.
In return, suppliers offer their products to Wayfair at wholesale prices, with Wayfair incorporating its costs to acquire, retain and deliver to customers in setting the retail price.
Suppliers can thus boost sales in a low-risk way; outsourcing the costs of website development, maintenance, advertising and delivery. This has incentivized more suppliers to sell more items through Wayfair.
Specifically, Wayfair has grown from having 7,000 suppliers each offering 1,000 SKUs on average in FY ‘14 to 23,000 offering 1,400 in FY ‘21 – creating an enormous assortment of 31M SKUs for customers. By comparison IKEA only offers 9,500 SKUs.
This broad selection benefits customers of all tastes and income brackets, who also benefit from Wayfair’s reinvestments into its proprietary logistics capabilities, which reduce delivery times and the retail prices Wayfair can offer. Increasing numbers of new and higher-spending, repeat customers, further incentivizes more suppliers to join thus further increasing selection, positively reinforcing the virtuous cycle.
To emphasise the power of this platform, its worth noting that the 10x growth since FY ‘14 in sales and active customers (27M FY ’21) has not been on the back of lax promotional or advertising spend.
Between FY ‘14 and FY ‘21, gross margins have actually expanded from 24% to 28% while advertising expenses as a percent of sales have gone down from 15% to 10%.
Through higher utilization of its logistics network plus growth in higher margin supplier services such as merchandising and advertising, future sales growth will likely be paired with gross margins expanding to c.30%. Advertising spend will likely continue falling to 7% of sales through brand-development and a larger share of cheaper, repeat business.
College room-mates and co-founders, Niraj Shah and Steve Conine remain in charge and the largest shareholders – each owning 13%.
While strong competitors such as Amazon and Walmart are also developing their 3P online home offerings, they sit alongside Wayfair as platforms consolidating assortments and benefitting from the consumer transition online. By investing to boost supplier sales and customer experience, these platforms are raising supplier switching costs and industry requirements to compete.
Wayfair’s current valuation prices a 2008-style contraction in its existing markets, continued shift in spend online, but no market share gains for Wayfair within online.
Planned expansions into adjacent European markets of Ireland and Austria and potentially more, will expand Wayfair’s TAM, as could sales of its 3D digital furniture images in the Metaverse.
Wayfair’s strengths over its weakest competitors should enable its market share to grow from 2% to 8% by 2030 –sales growing from $14bn to $56bn in 8yrs, at a 19% CAGR. Expanding margins should boost free cash flow yields from 1% to 5%.
A business producing $3bn in FCF in 2030, with room to grow, might well have a market value $40bn or more – that’s 8-times the current $5bn price in 8 years, presenting investors 30% CAGR potential over the period.
If Shah and Conine hit their $100bn 2030 sales target, the upside is doubled, Short-sellers should savour the short-term, as falling prices appear to be attributing ever smaller amounts to Wayfair’s long-term growth prospects.
The Equity Analyst 