Wayfair: Excessive Stock-Based Compensation Amid Financial Deterioration

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The mass closure and "pseudo-bankruptcy" (or mass-dilution) of Bed Bath & Beyond (BBBY) is causing ripple effects crossed nan home merchandise unit industry. Given its higher overhead operating costs, Bed Bath & Beyond has struggled to compete against online brands. Conversely, its largest online competitors, specified arsenic Wayfair (NYSE:W), are astir arsenic as unprofitable. Wayfair's little prices person allowed it to hamper in-store competitors significantly, but nan institution is trading astatine prices acold excessively debased to stay a "going concern."

The banal mislaid astir a 4th of its worth connected Thursday aft announcing its Q4 net results. The institution posted a -$1.71 EPS nett nonaccomplishment and $3.1B successful sales. Its income was somewhat beneath expectations, while its income were marginally higher. However, nan largest reddish emblem was nan company's continued equilibrium expanse deterioration and excessively precocious operating costs to sales. The firm's moving superior is now negative, indicating a displacement toward greater financial liquidity consequence arsenic its antecedently beardown rate buffer dwindles. The patient besides continues to dilute shareholders done excessive stock-based compensation, contempt its anemic capacity and astir 90% peak-to-trough devaluation.

Wayfair has very precocious short liking astatine astir 35% of shares outstanding. The banal is overmuch cheaper than successful 2021, and nan institution antecedently had beardown income growth, truthful that investors whitethorn beryllium willing successful it arsenic a rebound opportunity. Despite monolithic advertizing spending, Wayfair's income are declining, and its equilibrium expanse is deteriorating. Most larger home equipment are besides very ostentation delicate and exposed to economical cycles. While nan macroeconomic situation is not needfully declining, it remains anemic and does not bode good for Wayfair. Overall, I judge these factors could yet jeopardize Wayfair's equity, chiefly owed to its untenable business model.

Does Wayfair's Business Model Work?

Online shopping is simply a powerful business exemplary for medium-sized items pinch debased return aliases defect rates. The champion examples are Amazon's "bread and butter," specified arsenic books, electronics, and akin items. Larger, higher-cost furnishings items are acold little competitory successful nan online sphere. Most of Wayfair's products are dense and bulky, causing very precocious shipping costs - acold supra nan value customers salary (likely $25 to $80 for astir of its domestically-sold items). Physical stores person a important competitory advantage since they do not request to walk other shipping to homes, and immoderate usage their ain freight. These costs are multiplied erstwhile products person defects aliases are returned. Online shopping besides requires much important operating expenses, peculiarly advertising, which consumes ~%13.1 of Wayfair's sales.

Of course, dissimilar Bed Bath & Beyond, Wayfair does not salary nan precocious overhead costs of operating beingness stores. Ultimately, Wayfair and Bed Bath & Beyond salary akin operating expenses compared to full sales. However, Wayfair has dramatically underpriced Bed Bath & Beyond done little gross margins, forcing Bed Bath & Beyond to trim gross margins accordingly. See below:

Data by YCharts

Despite their vastly different operating structures, Wayfair and Bed Bath & Beyond person very akin operational costs. The benefits of nan online footprint look mostly offset by different added costs and vice versa. The captious quality is that Wayfair utilized to waste its products astatine a overmuch little gross profit margin, apt to beforehand maturation astatine nan disbursal of beingness competitors. That strategy has mostly worked astatine causing Wayfair to turn and has hampered its competitors. However, Wayfair's gross margins are still not precocious capable for nan institution to beryllium adjacent to profitable.

Is Wayfair's business exemplary wholly untenable? Probably not, but it is simply a very challenging prospect. Various inflationary factors and little family request person caused some Wayfair and Bed Bath & Beyond's operating costs to emergence disproportionately. These macroeconomic issues person besides seemingly made it difficult for Wayfair to raise its prices to nan basal levels, arsenic seen successful its gross margins. If it were not for these macroeconomic factors, Wayfair might beryllium profitable today. It did make a profit earlier and could do truthful again if nan system becomes much supportive aliases its competitory pressures fade.

What is Wayfair Worth?

The institution earned a profit astir nan precocious 2020 to 2021 period, but that was a "goldilocks" situation of perfect conditions. At that time, family request was precocious owed to very precocious individual savings levels and much group astatine location looking to walk connected upgrades. Fewer group wanted to shop in-store, greatly benefiting Wayfair complete its competitors. Inflation was besides not a monolithic rumor from 2020 to mid-2021. See below:

Data by YCharts

Wayfair's business exemplary only appears to activity successful nan absolute champion conditions. The company's TTM nett income peaked astatine astir $500M. At a ~2.5% separator astatine Wayfair's 2022 income of $12.2B, this would astir apt beryllium person to $300M today. Hypothetically, nether perfect economical conditions, Wayfair could apt gain a profit of astir $200M to $400M. However, its "P/E" valuation would beryllium a spot precocious astatine ~14X, aliases a scope of 10X to 21X. Obviously, we must usage an extended EPS scope since it remains uncertain what Wayfair's perfect profit separator could be. However, I judge nan banal is comparatively expensive, fixed it would not beryllium inexpensive nether nan champion economical assumptions.

The reality is that Wayfair's macroeconomic support is apt still waning. Although galore captious inflationary forces person faded, nan economical request outlook appears to beryllium weakening. The "new orders" scale is peculiarly applicable for Wayfair since it's a unit business. The emergence and autumn successful Wayfair's income and inventory level are intimately correlated to nan macroeconomic "New Orders" index. See below:

Data by YCharts

Wayfair's quarterly income successful Q4 were somewhat higher astatine $3.1B, and its inventory fell somewhat; however, that is chiefly owed to seasonal factors, and they continued to diminution connected a TTM basis. Wayfair's astir important contiguous situation is nan weakening macroeconomic environment. Rising costs remain an issue, and family request for durable equipment appears to beryllium falling. Savings levels stay low, and though existent wages whitethorn not beryllium falling, nan US whitethorn already beryllium successful a recession.

As discussed in caller articles, nan existent world economical situation appears to beryllium a prolonged stagnation that challenges anemic firms alternatively of a "normal" sharp but short-lived recession that challenges astir each firms. Wayfair falls into nan "at risk" class owed to its unproven business exemplary and highly cyclical (and inflation-exposed) industry. The institution did extremity Q4 pinch slightly improved rate but antagonistic working capital. Retailers often person antagonistic moving capital, which is an rumor fixed its precocious yearly rate pain rate. I judge Wayfair's equilibrium expanse is not truthful bad that nan institution appears astatine contiguous bankruptcy risk. However, nan patient will request to make important changes to past done 2024 and cannot trust connected perfect economical conditions returning.

The Bottom Line

Problematically, Wayfair continues to dilute shareholders done excessive maturation successful stock-based compensation. The institution reported $513M successful stock-based compensation successful 2022, up substantially from $344M successful 2021. That would not beryllium a important rumor if nan patient traded astatine a higher marketplace capitalization than successful 2021. However, nan existent stock-based compensation level will dilute nan institution by astir 12-13% per twelvemonth astatine its existent marketplace capitalization. In my view, that is simply a important figure, peculiarly considering its lackluster business and banal performance.

Overall, I americium bearish connected Wayfair and judge nan banal is overvalued and apt to proceed to deteriorate successful value. However, my position depends connected nan presumption that nan macroeconomic scenery will proceed to weaken. Hypothetically, if nan macroeconomic situation improves, Wayfair could gain a precocious capable profit that its valuation coming would beryllium sensible (though not needfully attractive). Further, it is imaginable that macroeconomic weakness could yet beryllium suitable for Wayfair if it continues to unit its in-store competitors to close, specified arsenic Bed Bath & Beyond. Wayfair is apt a benefactor of Bed Bath & Beyond's failure. In my view, these possibilities are not important capable to warrant a bullish stance connected W but are decent capable that I would not short nan banal - peculiarly considering its precocious short liking level today.

Harrison is simply a financial expert who has been penning connected Seeking Alpha since 2018 and has intimately followed nan marketplace for complete a decade. He has master acquisition successful nan backstage equity, existent estate, and economical investigation industry. Harrison besides has an world inheritance successful financial econometrics, economical forecasting, and world monetary economics.