Walmart results expected to show improved margins, online sales By Reuters


© Reuters. FILE PHOTO: The entrance to a Walmart store is seen in Bradford, Pennsylvania

By Aishwarya Venugopal and Melissa Fares

(Reuters) – Walmart Inc’s (N:) margins and online sales are expected to benefit in the second quarter as the largest U.S. retailer cashed in on shoppers using government stimulus checks to buy higher-priced products like sneakers and toys along with daily essentials.

The majority of stimulus money went to housing, savings and grocery bills, according to an IRI consumer survey. Retailers including Walmart also experienced a surge in sales of items like electronics and clothes in the second quarter. Those bigger-ticket items are expected to help Walmart’s margins.

“Unlike other retailers, we believe Walmart took most of the pain in Q1, limiting the Q2 impact,” Credit Suisse (SIX:) analyst Seth Sigman said in a note last week. One question is how well it will perform compared to big-box competitors like Costco Wholesale Corp (O:) and Target (N:) that have gained momentum since the start of the pandemic.

Visits to Costco the weeks of July 6th, July 20th, and July 27th all show year-over-year growth, according to Placer.ai, a firm that tracks foot traffic.

Dollar General (N:) also saw foot traffic increase the same week unemployment benefits largely expired, on July 31, according to Placer.ai.

Even so, investors give Walmart the edge.

“The way we see consumers right now is they’re spending on what they need to spend on – a lot less dining, a lot more eating at home. All of those trends favor Walmart,” said Randy Hare, portfolio manager at Huntington Private Bank.

Hare highlighted Walmart’s investments in areas such as grocery pickup and same-day delivery that helped meet surging demand seen during the lockdowns.

“Walmart has done a lot right in recent years. It’s improved execution & successfully changed the narrative of its story from that of a mature brick & mortar retailer to being a viable No. 2 in e-commerce,” UBS equities analyst Michael Lasser said.

For an interactive graphic: (https://graphics.reuters.com/WALMART-RESULTS/PREVIEW/gjnvwxndwpw/index.html)

The company is due to report earnings on Tuesday. Analysts expect same-store sales growth of 5.02%, according to IBES data from Refinitiv.

Graphic: Walmart set for another quarter of strong sales on lockdown boost Walmart set for another quarter of strong sales on lockdown boost https://graphics.reuters.com/WALMART-RESULTS/PREVIEW/jznpnkraevl/chart.png

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QuinStreet: Poised To Grow Margins With QRP Catalyst (NASDAQ:QNST)


Company Overview

QuinStreet (QNST) lays claim to the term ‘pioneer’ of performance marketing. With a history of over 20 years, the company specializes in delivering clicks, leads, inquiries, calls, applications, or customers to its clients. This performance marketing strategy is attractive to QuinStreet’s clients, who pay solely based on tangible execution. QuinStreet operates in financial services, education and home services. M&A is a big part of the business model: the company has acquired three companies since 2018 (AmOne, CCM, and MBT) primarily to increase its number of customer relationships. Although digital ad spend has been down during the pandemic, the macro-shift toward online advertising is resolute. QuinStreet is well-positioned to profit from this transition as long as management can successfully increase margins.

Business Model

QuinStreet’s business model is fairly simple. The company is paid a commission for its marketing performance on a per-quote basis. The variable model runs very few fixed costs as the cost of revenue is largely media-based. When revenue drops, so too does the company’s largest cost. Unfortunately, this low-risk model returns less than favorable margins. The company has TTM gross margins of 11%. Management plans to increase these margins by divesting its unprofitable businesses and rolling out SaaS-like products. Additionally, the company plans to continue its heavy emphasis on growth-oriented acquisitions. On the 2Q 2020 Earnings Call, CEO Doug Valenti remarked:

We plan to narrow our focus to a smaller number of our best-performing businesses and market opportunities and to restructure to align resources and efforts with those areas…We also expect faster margin expansion from top-line leverage on a smaller cost base and a heavier mix of businesses with SaaS-like margins

These plans will need to be monitored by investors over the next few months as the changes begin to be recognized. If the plan is followed through successfully, QuinStreet will prove to be undervalued at its current price.

Financial Highlights

The last few years have been rocky for QuinStreet. After increasing revenue by 35% YoY in 2018, the top line grew just 13% in 2019 and is expected to grow just 7% at the end of the fiscal year in July. This volatility in top-line growth has led to a wavering stock price, as shown below:

Zimlon Insurance Company Analysis

As shown in the graph, QuinStreet’s earnings have been up and down and it is reflected in the steep declines in price. Breaking down its revenue, financial services represented 77% of total revenue in Q3 FY2020. The majority of other revenue comes from the education vertical, representing ~12% of revenue. Financial services grew 15% YoY in the most recent period, while education showed meager 4% growth. The company has struggled to gain ground in education since 2019 when it lost Dream Center Education Holdings, which represented upwards of 20% of revenue. Client diversification remains a risk for QuinStreet as Progressive Corporation (PGR) represents 22% of net revenue. One strong positive for QuinStreet is its balance sheet. The company has upwards of $97 million in cash on hand, representing 17% of its market cap. This gives management a cushion if ad-spend falls off temporarily due to coronavirus. It also may allow management to pursue acquisitions or develop new products to increase margin.

Catalyst

Although the company hasn’t grown its top line favorably over the last few years, it has an exciting catalyst which management expects to grow margins. The QuinStreet Rating Platform (QRP) is an enhanced workflow system designed to vastly improve the sales efficiency of carrier partners and their agents. Carrier partners will get much better workflow management and control, ultimately allowing them to reduce costs. CEO Doug Valenti cited on the Q3 2020 Earnings call that QuinStreet has the most end-to-end integrations with the biggest carriers, allowing them to provide agents with accurate and timely quotes. Although the product has not been completely rolled out, Valenti said the pilot company realized upwards of 40% lift in productivity.

The most exciting part of this catalyst is the SaaS-like margins. Management expects QRP to have 80% gross margins and rise steadily with use. Valenti also noted that the pipeline for the product is extremely deep. In the Q3 2020 Earnings Call, he had this to say regarding QRP:

Launched QRP clients already represent over $6 million dollars in estimated annual revenue opportunity once fully ramped. Signed and near-signed clients (not yet launched) represent $12 million of additional estimated annual revenue opportunity. The balance of clients in the advanced pipeline (not yet at signing stage) represents $36 million more of estimated annual revenue opportunity. That means we believe we already have line-of-sight to over $50 million of estimated annual QRP revenue. We believe the full pipeline and market represent an estimated revenue opportunity of well over $100 million per year.

The excitement for this catalyst is evident in the management’s rhetoric. The company has yet to recognize revenue for the product, but expect to do so sometime in the next few months. Until then, investors can rely on the testimonial of Tom Lyons, Chief Operations Officer of Plymouth Rock Management Company of New Jersey:

QRP will help us improve response time to client inquiries while preparing the most competitive insurance quotes possible. We view QRP as a mission-critical enterprise workflow management application that should significantly drive our business value to customers and help us expand sales.

It should be clear to investors that QRP is a great opportunity for QuinStreet in the near future. The product offers great reward to carriers and their agents, and will allow QuinStreet to improve upon its poor margins. Management expects to see 8-digit revenue from QRP in FY2021 which is just shy of 15 months from now.

Risk

Aside from the bright future surrounding QRP, the company has a few risks. As mentioned earlier, 22% of its revenue is derived from Progressive Corporation. Although no other companies represent more than 10% of revenue, this heavy reliance on a single company could be reason to worry. Progressive currently has a strong balance sheet, but further virus implications could force the company to reduce ad-spend. Doing some simple math, a 50% reduction in ad-spend would wipe more than 10% of QuinStreet’s revenue. This is a very real risk and deserves to be recognized in any financial projections.

Another risk lies in the company’s business model. Management has promised to continue to pursue acquisitions. While the company certainly has enough cash to do so, the underlying principle is cause for concern. One bad acquisition could prove costly to a growth company like QuinStreet. Investors will be putting their trust in management, relying on them to choose the right acquisitions at the right cost.

Valuation

Given the risk of decreased ad-spend from Progressive and/or other carriers, any valuation deserves two scenarios. A DCF model captured both scenarios. The following table shows the inputs and assumptions of the model:

5-Year CAGR

QRP Revenue Growth

50%

Other Revenue Growth

10%

QRP Gross Profit Margin

80%

Other Gross Profit Margin

11%

Operating Expenses (% of Revenue)

10%

Tax Rate

20%

Growth rate in perpetuity

2%

WACC

7%

Beta

1.25

Risk-free Rate

2%

Market return

6%

The above assumptions were present in both scenarios. In the first scenario, FY2021 revenue (consisting of Financial services/Education/Other) decreased by 10% from FY2020. The effect of the loss on earnings is somewhat diminished by QRP revenue which represented $10M in 2021, in line with management guidance. Discounting the 2025 value back to present, the model returns a price target of $12.25. This should be viewed as a baseline price target.

In scenario 2, FY2021 revenue has no growth, followed by 10% growth in subsequent periods. This results in a price target of $13.83, representing 35% upside from the current price. It should be noted that both models incorporated QRP revenue as management guided, forecasting for 8-digit revenue in FY2021. QRP revenue tops out around $50M in 2025 in the model, although management foresees revenue reaching $100M in the future. As seen in the chart below, profit margins will steadily increase as QRP gains ground in the market.

Zimlon Insurance Company Analysis

As the company becomes more profitable with QRP and other SaaS-like products, the stock price is sure to follow. Both of these scenarios were relatively conservative and thus clearly exhibit a considerable margin of upside for investors.

Conclusion

To sum up, QuinStreet is an undervalued company with room to grow. Revenue growth has been up and down in recent years, but the impending QRP product will rejuvenate the company’s earnings. Keen investors will notice QuinStreet trading at an absurd 38 P/E ratio. Normally this high of a ratio would be cause for concern. However, QRP promises to lift earnings over the next few years and management remains focused on growth-oriented acquisitions. The successful combination of these two will result in a profitable business worth more than 35% of its current share price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.





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Chewy: Sales Okay, Margins Not So Great (NYSE:CHWY)


One of the darlings in the market during the Covid-19 crisis has been Chewy (CHWY) as investors like this e-commerce play even more given today’s circumstances, on top of the already solid growth roadmap which the company has on its own.

In April, I praised the company for great growth performance but worried that it might not be enough. While there is no question that this is a dominant and growing online franchise with real potential, I believe that valuations are too rich even as sales multiples look modest. I simply feared and continue to fear that margin potential is simply very limited for such a name.

The Business

It is very hard to not like Chewy as a company as it quickly has become a household name in e-commerce of animal products, in part driven by the integrity of the business. Furthermore, animal care and food are a solidly growing business given the demographic and social trends, with consumers willing to spend more on pets.

Quality, integrity and fair pricing, in combination with a very savvy reordering autoship program, have driven the success, exemplified in high Net Promoter Scores.

Founded in 2011, the company has quickly grown to $3.5 billion in sales in 2018, in what is a target market which approaches $100 billion. This growth is nothing short of amazing, although accompanied by a $268 million loss in 2018. Amidst the Covid-19 crisis, the company reported 2019 results with revenues up 40% for the year and adjusted EBITDA losses narrowing from $229 million to $81 million. This looks very promising, yet at the same time, stock-based compensation expenses ten-folded to $136 million last year, resulting still in an economic loss of nearly a quarter of a billion on $4.85 billion in sales.

While much of the losses do not involve cash outflows as they are largely incurred through stock-based compensation, valuations look quite rich. The 401 million shares outstanding already represented a $14 billion valuation in April, nearly 3 times the sales numbers. Share price momentum in April was driven by the comment that first-quarter sales were seen up 35-37% to around $1.5 billion, driven by the Covid-19 crisis.

While I had no doubts that the company could grow sales towards $10 billion by 2025, it has to deliver on real margins to live up to expectations. If the company could report operating margins around 10%, which would be an incredible achievement, it could earn $800 million after taxes, coming down to earnings of around $2 per share. That requires flawless execution and only in that case shares trade at market multiples based on potential performance five years ahead in time. This led me to conclude that the risk-reward simply was not very good.

This is certainly the case as fourth-quarter realistic losses came in at $60 million, equal to 2% of sales for that quarter. Shares have seen a big boost as a result of Covid-19, while the impact on the business was relatively modest (at least based on the guidance provided alongside the 2019 results being released). Hence, a 40% return for the year (in April), while the market was still facing large losses, made me very cautious to consider shares at the time.

The Actual Numbers

First-quarter sales did come in far ahead of estimates and the guidance, up 46% to $1.62 billion. Important to realize is that this was for the quarter which ended on May 3, as results basically “benefited” from Covid-19 for approximately one and a half months.

Further positive to see was a 50-basis point improvement in gross margins to 23.4% of sales, although the combination of this spectacular growth and margin expansion was not seen on the bottom line.

Adjusted EBITDA did improve 160 basis points to 0.2% of sales and in dollar terms came in at $3 million and change. The problem is that net losses increased from nearly $30 million to $48 million. The gap between EBITDA and net earnings of $51 million is largely explained by $7 million in depreciation expense and a large and real $42 million stock-based compensation expense. Hence, net earnings do paint a realistic picture here and losses on this metric are stable at 3% of sales as operating leverage has gone entirely to pay employees with more stock.

Furthermore, note that the company has grown to quite a size already with more than 15 million customers as two-third of revenues are generated from the autoship program. The company gained 1.6 million new customers during the quarter, roughly double the numbers seen in recent quarters, very encouraging signs.

Based on the current trajectory the company is already reporting sales at a run rate of $6.5 billion this year, which might leave real upside compared to the $10 billion potential revenue mark in 2025, yet on the margin front, no real progress is made just yet. Nonetheless, investors keep bidding up the stock, currently trading around the $50 mark which now supports a $20-billion valuation. This remains equal to about 3 times sales, yet the question remains what actual earnings can look like over time.

Final Thoughts

Key features such as Net Promoter Scores, being a 100% online play, and a high renewal rate (autoship) are key drivers for the stock, certainly in this Covid-19 environment. The shares furthermore benefit from low sales multiples, but this business is not transformative enough to support high single-digit or even double-digit operating margins in all likelihood within any reasonable period of time.

So while momentum on the sales front remains very impressive, driven by the circumstances, the margin performance is not – as the question is what sustainable levels of stock-based compensation look like. For now this remains an easy avoid, yet at the same time is a dangerous short as well with momentum plays pushed far these days, certainly in combination with limited floats.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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Livongo Health: Continued Momentum, Margins A Bit Soft – Livongo Health, Inc. (NASDAQ:LVGO)


Livongo Health (LVGO) is a name which I have been covering extensively since it went public. My last take on the company was halfway through November when the company posted satisfactory third-quarter results. Fourth-quarter sales momentum remains very strong as the company has outlined a great sales guidance for 2020, although I am far from impressed with the margin guidance for the upcoming year.

The Thesis

I have been attracted to Livongo since it went public as it aims to “treat” chronic diseases through improvements in both technology and data science. The combination of progress on both these fronts results in personalised solutions and treatments, resulting in better health results for the patients. This is very compelling as real improvements can be delivered at relatively low costs in a healthcare system which can be categorised as both expensive and at least at some points as ineffective.

The potential for the company and its solutions is very large, with over half of the US population suffering from chronic health issues, while continued care options are still very limited. Rather than monitoring, patients suffering from chronic conditions typically require guidance and real-time feedback with medical expertise. High net promoter scores, innovative solutions and market potential are what attracted me to the company.

The potential for the company was already priced into the shares when it went public at $28 in July of last year which worked down to a $2.5 billion equity valuation with 89 million shares outstanding, although the valuation fell to $2.2 billion after factoring in the net cash position.

To put this valuation into perspective: the company generated just $31 million in sales in 2017 on which it lost $17 million. Sales growth of 121% was spectacular in 2018, with revenues totalling $68 million although losses doubled to $35 million. By no means these numbers could justify a $2.2 billion valuation.

Nonetheless, there were some green shoots as first-quarter sales growth for 2019 came in at 157% with revenues totalling more than $32 million, accompanied by a near $17 million operating loss. Revenues grew to nearly $41 million in the second quarter and came in at nearly $47 million in the third quarter as the company reported very strong book-to-bill ratio in terms of contract wins. Based on the third-quarter results, the company was more or less guiding for fourth-quarter revenues of $49 million, suggesting that it has already achieved the $200 million run rate per annum.

Based on these results, shares recovered to $26 in November for a $2.0 billion enterprise valuation and thus less than 10 times forward sales multiple. This looks compelling given that growth rates are still above 100%, the target market is huge, and while the company loses money, these losses are not immediately threatening the business. Furthermore, losses are rapidly coming down as well.

Bases on those conditions, I was a happy holder of shares in the mid-20s.

Momentum Continues

At the start of March, the company announced strong fourth-quarter results with revenues up 137% year-over-year, actually surpassing the fifty-million mark at $50.4 million. The company furthermore reported an estimated value of agreements of about 1.5 times, indicating that continued growth should be expected. Comforting is that reported operating losses narrowed from $13.1 million to about $7.7 million, marking continued progress towards the flat line.

With net cash approaching the $400 million mark, that burn is not that significant nor worrying, as the 94 million outstanding shares have been holding steady around $26 per share. This values the enterprise at $2.0 billion as the company outlined a strong guidance for 2020, with sales seen at $285 million, plus or minus $5 million.

Despite the continued revenue improvements, the company still sees adjusted EBITDA losses in the region of $20-$22 million. That in itself is quite disappointing as the company actually reported an adjusted EBITDA profit of $1.5 million in the final quarter of 2019. In the fourth quarter the company reported an annualised depreciation and stock-based compensation expense of around $32 million, suggesting economic losses at around $50 million in the year to come. While this is not worrying given the net cash position, it is quite large, although the appeal arguably comes from the 7 times forward sales multiple.

What Now?

Do not get me wrong, I am pleased with the sales momentum and the outlook for 2020 in terms of sales, acknowledging that management has been conservative since it went public. Disappointing is the adjusted EBITDA guidance for next year, suggesting no operating leverage. That said, growth has priority given the rapidly evolving marketplace, as the net cash position is quite strong.

The key issue is to judge how competitive the business is in the long run as strong growth could spur takeover interest, which could be a good (short term) outcome. Alternative routes is years of strong organic growth in order to become a dominant player, yet in an adverse scenario, competition might limit the potential of Livongo. Of course, it is crucial to know which scenario becomes reality in the long run, yet that is very hard or impossible to judge at this moment.

Hence I am happy to hold onto a current position, yet see no active reason to add to the current position. While I do see the appeal of rapidly shrinking forward sales multiples, the margin numbers for 2020 are a bit underwhelming to me quite frankly.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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