Why Wayfair Inc Shares Could Fall 50% From Current Levels

Once the digital retailer and wayfair Inc. (US:f) was one of the hottest stocks in the market. This time it was not too long ago. In 2017, the stock W went up 130% to $80. Until the beginning of 2018, the stock of W increased by 25% to pass 100 dollars for the first time in the history of the company.

But the stock came crashing down in the last few weeks. Superior technology and estimation problems weighed on stock tremendously (this is almost 2 times sales, despite the launch of huge losses).

Plus, the threat of universal tax digital sales are only growing as the Supreme court to hear arguments on the issue later this month. And of course there’s the day of judgment calls is widely followed short-seller citron research.

Put it all together, and you had a red-hot stock with great grades, who came under significant pressure. The net result? And wayfair shares fell 30% in a hurry.

What’s next?

It’s hard to say. Wayfair is an online retailer with great top-line growth potential. But the competition is very high, profitability remains a question mark, and legislation can provide a serious headwind.

All in all, I think the risk-reward profile on the stock W is offset to the downside at these levels. Here’s why.

The bull Case for wayfair warehouse

There is a case at the warehouse W to head significantly higher from current levels. This thesis, however, relies on a rather large assumptions.

Namely, the increase is not to purposefully continue to decline over the past few years (70% in fiscal year 2015 to 50% in fiscal 2016, to 40% in fiscal 2017).

The company will be able to achieve Amazon.com ink. (Nasdaq:weekly) level North American retail profitability over the next 3-5 years (Amazon’s North America retail operating profit margin was 4.5% last quarter).

And the Supreme Court decides in favor of and wayfair to the tax argument digital sales, and digital tax will not be headwind for the foreseeable future.

If all this is true, and wayfair should be able to grow revenues 25% per year over the next five years. Operating margin is expected to hit 5%. This combination produces 14.4 billion dollars in five years 720 million dollars of operating profit. Take out the 21% taxes and divide by allegedly 95 million shares outstanding and you get about 6 $in profit per share.

A simple 20 times forward that gets you to the target price in four years for$ 120. Discounting that by 10% a year, you will arrive in a gift totaling just over 80 $(roughly 20% upside).

Case Bear for wayfair warehouse

Things are in the warehouse W, although it seems to hold more water than best.

Top-line growth was significantly slowed over the past few years. In addition, the net profit per client has been smooth over the past few years. Same with orders for a single customer.

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Thus, the driving force behind the growth of income should be the growth of the client. But that fell meaningfully, too (67% in the 2015 financial year, 54% in financial 2016, and 33% in fiscal 2017). Plus, competition from Amazon and others, only heating up.

Thus, the most likely outcome over the next few years, is a continuation of the slowing revenue growth trend.

More likely, the margin will not come roaring higher in the near future. Amazon operates on 5% margins in retail sales, because they are the titanium industry. And wayfair’s not even close to the scale of Amazon, and because of this the profit of the company Amazon must remain substantially higher than profits and wayfair.

Meanwhile, digital tax headwind is very unpredictable, and assuming that in any case this seems too risky.

All together, a more likely outcome for wayfair is that the company is growing revenues at 15-20% a year over the next five years, and margins to work up to 2-3%. In the mid-that will bring in $10.6 billion in revenues and $264 million in operating profit in five years. Take out the 21% taxes and share on 95 million diluted shares and you get about 2.20 $profit per share.

At 20 times forward multiple on that gets you to the target price in four years, 44$. Discounting that by 10% a year, you will arrive in a gift in the amount of slightly more than $30(50% down).

The bottom line on the stock W

At current levels, I see 20% upside for the stock rail on the bullish scenario and 50% scenario minus the bear. Scenario bear also looks more likely than the bullish scenario.

Therefore, I think the risk-reward asymmetry and wayfair shares shifted to the downside at current levels.

At the time of this writing, Luke Lango not to take a position in any of the above securities.

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