Summary
Snapchat has finally joined the tech rally.
But the same competitive and macro headwinds pressuring the stock have not disappeared.
The stock is not egregiously overvalued, but near-term catalysts are limited.
I am downgrading the stock due to the poor performance relative to Meta Platforms.
Jerod Harris/Getty Images Entertainment
Snapchat $Snap Inc(SNAP)$ crashed after its last earnings report and I immediately came to its defense due to the overly pessimistic valuation. I did not anticipate the stock to recover so quickly - to the tune of 50% in less than a quarter’s time. While valuations are not necessarily bubbly, especially if we assume an eventual recovery, I am of the view that there is now a mismatch between investor sentiment and the actual company fundamentals. SNAP has yet to show real evidence of a turnaround, and I suspect that near term fundamentals may show more pain than upside surprise. SNAP stock may be rising alongside other lower quality tech stocks and I fear that such a rally is unsustainable in the near term. I am downgrading my rating from buy to neutral.
SNAP Stock Price
SNAP had been left out of the broader tech rally, but has recently joined in.
Data by YCharts
I last covered SNAP in April after the stock crashed post-earnings. The stock is up a staggering 51% since then but I am doubtful that the fundamentals will follow.
SNAP Stock Key Metrics
To recap the company’s latest results, SNAP had crashed in large part due to seeing a 7% YOY decline in revenue, during a quarter in which larger peer Meta Platforms $Meta Platforms, Inc.(META)$ generated some growth.
2023 Q1 Presentation
The disappointing top-line results in turn led the company to see adjusted EBITDA finally turn negative.
2023 Q1 Presentation
The one bright spot in the quarter was the incessant growth in daily active users (‘DAUs’) but the stark underperformance relative to META has spooked many investors (including yours truly) about the company’s ability to compete with TikTok (and of course META).
2023 Q1 Presentation
My takeaway from the earnings report was that investors could only hope for an easing of the tough macro environment or an outright ban of TikTok before a comeback becomes feasible - two conditions not in the company’s control.
Why Is SNAP Rising?
Yet the stock is rising anyway, ahead of the next earnings report. There are several potential reasons. The state of Montana banned TikTok starting next year, perhaps raising hopes that other states will follow. Such a result would undoubtedly help SNAP by reducing a viral competitor, but is unlikely in my opinion as it feels “un-American” (but my prognosis of politics in our country has not always been accurate). SNAP management mentioned gaining four million paid subscribers for Snapchat+ in its first year, but advertising revenues continue to be the more important driver of profitability here. The company recently opened up its AI chatbot to all users, with management citing the potential benefit for ad quality, and I suppose that could raise hopes that the company can move past the data privacy changes from Apple $Apple(AAPL)$.
But in my view, the real reason why the stock is rising is much simpler than any of that: all low quality tech stocks seem to be flying, as seen in the charts of names like Carvana $Carvana Co.(CVNA)$ and others.
Data by YCharts
As a fundamentals-based investor, such reasoning frightens me, as I find it impossible to accurately predict the future state of such momentum.
After the rally, SNAP found itself trading just under 5x sales.
Seeking Alpha
If one can believe that SNAP sustains double-digit top-line growth and achieves a 21% net margin by 2028, then the stock is trading at 11x 2028 earnings estimates.
Seeking Alpha
These valuations are not crazy, especially compared to some of the lower quality names shared above, but with there being little evidence of a tangible turnaround in motion, I view the current setup as being quite risky. Assuming between 10% and 25% forward revenue growth, 25% long term net margins, and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see the stock trading anywhere from 3.75x sales to 9.4x sales. Yes, the stock trades near the lower end of that, but the probabilities of 15% to 25% revenue growth appear far lower than that of 10% revenue growth. The company does still maintain a respectable balance sheet with $400 million of net cash, but I expect cash flow to remain negative for several quarters at least. This is a case where the main catalysts (easing of a tough macro environment, TikTok ban, etc.) are far from imminent, but with revenue growth tame and no earnings to be seen, it is difficult to see solid forward returns. Yes, inflation continues to abate, but investors should be concerned that SNAP is seeing strikingly different fundamental results than META in spite of being dealt the same hand of cards. TikTok initially was a big driver of the stock price plunge, but META has fully recovered from its own TikTok plunge. META may be the reason why SNAP stock struggles from here - I recommend waiting for signs of a turnaround to emerge before returning to this name. I am downgrading the stock to neutral due to the lack of visible catalysts.
Source: Seeking Alpha
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