2 stocks on my Growth watchlist
... and why
In this paid segment I aim to share with you some of the top stocks on my growth portfolio watch-list and the reasoning behind their appearance. This is not extensive research, but more of an initial sift based on potential. The aim here is to generate ideas and spark your own research.
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September has been a less than fun month for many growth investors. However, with any draw-down comes potential opportunities.
Here are two stocks I believe present attractive opportunities within the context of the current market (29th September 2021).
Before we start, here are some key features i’m looking for in my growth companies:
Evidence of historic growth
Potential for future growth driven by strong tailwinds.
Significant competitive advantage which can be maintained over time.
Evidence of good capital allocation and potential opportunities to reinvest capital
Competent management
Both of these companies may not tick every aspect, but are strong in many departments.
The first company on my watchlist is Portuguese-British luxury clothing marketplace, Farfetch.
1. Farfetch ($FTCH)
*everything in this short summary is drawn from the company’s 2021Q2 report*
Why Farfetch?
On the surface, Farfetch seems like a fairly simple e-commerce marketplace with an emphasis on ‘premium’, however when you dig deeper to explore the intricacies of the business you find a compelling company with a strong value proposition for all parties, high potential for strong return on capital employed, a good management team/founder and a long runway for future growth.
All of this combined with a reasonable price gives Farfetch the right to be near the top of my growth watchlist.
Top level - what do they do?
Farfetch operates a two-sided global marketplace specialising in luxury goods. The marketplace facilitates the buying and selling of luxury items from top worldwide brands.
For some idea of scale:
It has ~ 3.3 million active customers in over 200 countries, as well as 1.3k+ sellers/brands.
Farfetch is the biggest and fastest growing online destination for luxury in the world.
Here’s a thread by @Invesquotes on twitter who gives some good background on the company.
What’s their edge?
Farfetch have created a non-zero-sum game by creating value for all parties involved, i.e. the buyer, the seller and Farfetch themselves.
Buyer: Has access to a high quality and wide-ranging selection of luxury clothing at a relatively reasonable cost. Due to the platform being global, the selection is much better and more unique than your typical high-street.
Seller: The seller has direct access to over 3 million customers across the world. They have control over their pricing and presentation. They have use of Farfetch’s ‘Global Logistics Solutions’, their marketing services, the ability to create global presence online without too much resource and the ability to analyse data.
Farfetch: Farfetch is the only fully-scaled pure-play marketplace for luxury goods. They have a direct relationship with retailers. As the worldwide market for luxury good continues to grow (driven by China), Farfetch’s current market positioning should see the company benefit. Difficult for other similar marketplaces to spend their budget (~$2B each year). As with most other marketplace businesses, they are building substantial network effects.
Investing for growth
As mentioned above, Farfetch spend some fairly hefty sums of money each year on investments back into the business infrastructure such as the fulfilment centers, platform and technology. This number is somewhat tricky to pinpoint, however it looks to be somewhere between $1.3B and $2B.
This level of investment will be hard for competitors to match - therefore reinforcing their economic moat.
The downside, obviously, is the lack of profitability (with a TTM gross loss of ~$1B) along with negative cash flow. However, this looks to be close to changing.
Additionally, the $1.2Billion (and growing) Cash and Cash Equivalents on the balance sheet should be enough to continue to fuel growth in the short-to-medium term.
More investigation will be needed on their methods of financing.
Strong management
Jose Neves is the founder and CEO.
Having launched the business in 2008, the company is at a TTM GMV (Gross Merchandising Value) of ~$3.7B GMV. GMV is the total dollar value of orders processed. The Q2 GMV exceeds $1B, which is up 40% y/y and more than double compared to Q2 2019.
It’s hard to estimate how much of the business’s success is down to management at this stage.
However it is apparent that management are good capital allocators. For example, it is fairly typical within the e-commerce landscape to spend aggressively on flash sales and aggressive marketing. The result is usually lower-value customers and a lower return on the customer acquisition cost.
Going agains the grain somewhat, Farfetch intentionally chose to invest in the platform, the technology, the logistics etc. in order to attract higher value customers with a longer LTV (Lifetime Value).
This builds the strength in their network effects.
Market Opportunity
Farfetch operates in the worldwide luxury goods market. The worldwide aspect here is key, as it opens up so many opportunities in the future.
The current TAM is ~$310 Billion which is down since the pandemic. However we could see an increase over the coming years, with some estimates leaning towards $380 Billion - $400 Billion.
In addition, predictions are leaning towards online becoming a significant driver of the delivery of this industry at ~30%, which would give Farfetch a serviceable addressable market of about $115 Billion within the next several years (roughly 60X current rev).
Farfetch is the most established player within this industry as it stands, however this market is not without competition.
China
Short but important point on China.
China is “a perfect ground for new brands… like New York on steroids. The consumers are younger, millennials and Gen Z are buying [luxury], and it is much more digital and trendy. That means the acceleration of their behavior is stronger there than it is in New York.”
The Chinese luxury market is predicted to grow significantly over the coming decade, which is one potential huge tailwind for Farfetch if they can execute correctly.
Competition
This leads nicely onto competition.
There will likely be, and already is, with large online retailers such as Asos looking likely to get into the space. The upside for Farfetch is the fact that they specialize in the luxury space, whereas the competitors do not. This enhances the luxury ‘experience’ when shopping on the platform.
The CEO believes competition shouldn’t be an issue as long as they can continue to execute, mainly due to the belief that this will be a winner takes all online marketplace. The breadth of selection, overall scale and quality of listings really sets farfetch apart from the rest.
Valuation/Financials
In terms of the valuation and financial aspect, I haven’t had a chance to delve into the numbers in the detail I would like just yet. However, @Invesquotes and @buyandhold have just released an extensive deep-dive which gives some real clarity.
Some key takeaways:
Likely to continue growing revenues at 40%-50% for the next few years at least (5 year CAGR is 60%).
Main drivers of continued revenue growth will be China, customer growth and increasing GMV.
Financials don’t look great at this stage, but not to say it can’t be improved.
Questions for future research
Can they post positive FCF in the near future?
Will scale lead to better unit economics?
What role will China play in the future success of the company?
Second on my list is a company I have covered in great depth once before on the blog, so I won’t be going over it fully here like I have with Farfetch. Check out the previous deep-dive on Roku which goes into significant detail on the strategy and financials.
2. Roku ($ROKU)
What has changed since the last deep-dive?
Recent international expansion of Canadian advertising business with their OneView ad platform.
Roku partners with Shopify in order to bring connected TV advertising to Shopify merchants (this one is huge, imo).
Competition in the streaming wars is hotting up ($AMZN & $GOOG stepping up their game).
Price has contracted (probably mainly due to the previous point).
My short thesis
We are seeing a mass switch over from traditional TV to streaming. With that change comes a new, dynamic, advertising model where advertisers are seeing a much better ROI. Therefore, all (and I mean all) traditional TV eyeballs will move over to streaming at some point in the future.
Roku looks to be one of the best placed companies to capitalize on this opportunity with their extensive hardware and OS distribution.
Their current market lead makes for strong network effects and adds fuel to the flywheel. Both of these things are difficult to compete with.
Bull case
Roku continues to operate from a leading position.
Only 30% of the population has shifted full attention to streaming. As that number continues to increase, more and more advertising dollars will be spent there.
The trend of convergence to one of two main operating systems seems to be in Roku’s favour.
The future of TV will be app-driven.
Roku powers the operating system of most TV’s.
Roku’s ARPU is very strong compared to its counterparts.
Data is a strong tailwind - “For AI and machine learning algorithms, there is no better consumer viewing data than Roku’s ‘walled garden’ data, and it’s data lead grows every day”, Needham.
3 revenue streams - “Roku has hardware plus AVOD plus SVOD revenue streams. Whereas other CTV (Connected TV) ecosystem competitors have typically chosen a single source of revenue, which increases risk”, Needham.
Roku channel growing.
International expansion favours Roku’s business model. Roku are one of the only providers out there making it easy to install apps and TV channels from the local area. Conversely, streaming and content services like Netflix and Disney will need to create all new content or adapt existing content to new users.
Bear case
Competition is heating up. Amazon has been on a recent push. But, to counter, Amazon and Google have been up against Roku for a long time now. I don’t think much has changed.
Roku’s market share has been declining over the past few years (E.g. the picture above states 46% market share, however the year prior saw Roku at 59% - a significant decrease).
Can Roku ultimately compete with big companies with deep pockets willing to sell at negative margins in order to expand market share? Time will tell.
International expansion will be hard to execute. They need to gain new users, build new relationships, and sell hardware in brand new markets.
Compared to recent years, there is a higher concentration of smart TV penetration in the international markets that ROKU are targeting.
Fair value estimate
This is a basic estimate at a fair value for the stock. Note that for growth companies, this is hard to do accurately. Spreadsheet linked.
Assumptions:
Due to nature of compounding historical growth - I have estimated several more years of 50% growth followed by a slowdown towards 35%.
Net profitability assumed to be 15%-20% by 2025 (difficult, but do-able).
Terminal Value of 35 due to high potential runway for growth in the future.
From the above rough assumptions, my model is showing Roku to be about 20% overvalued, with a fair price to be around $260.
In order for the current price to be fair, we would need to assume a 2025 profit margin of between 20% and 25% which could be difficult to achieve if we’re being realistic.
As a massive caveat, these are rough calculations with some pretty sweeping assumptions which may turn out to be drastically wrong. Nevertheless, it’s a good exercise to carry out so we can set some expectations in place with what to look for moving forwards.
Final thoughts
Roku has, for some time, had a large amount of good news and optimism priced into the stock. Our job is to ask the question of whether we think there is any additional value in this stock given the current price. Also, will they be able to outperform current expectations?
My opinion, and the reason it’s on my watch-list rather than my buy-list, is that Roku is a great company at a steep price. I will be keeping this one close to the top of my watchlist for the time being as the $ROKU price looks to be falling substantially without any significant change in the fundamentals.
Questions to ask yourself
Can Roku become a consistent profit producing company? When will this happen and how far can they push margins?
What is the realistic cap on growth? And how much longer can Roku keep up their impressive growth?
Can Roku keep their competitive edge with competition heating up in the market? Can Roku’s business model be easily copied?
I enjoyed doing this light-touch analysis on my watchlist companies. I have a bunch of really exciting companies I’m watching which would be good to cover in this level of detail, so this segment may become more regular.
Cheers,
Innovestor