Snap: Risks Are Rising But Stock Is Cheap (NYSE:SNAP)

Snapchat (NYSE:SNAP) investors may have been hoping for some reprieve after a very tough 2022. That hasn’t happened in 2023 and the macro picture no longer appears to be the main culprit. In a period in which cost discipline and profit margins reign king, SNAP has struggled to find its footing. The company is struggling with competitive threats from TikTok and investors have lost confidence in the long-term thesis. That is a difficult place to be considering that its largest competitor in Meta Platforms (META) seems to have finally stoked some love from Wall Street. While SNAP remains too cheap at current levels, my bullishness wanes.

SNAP’s Stock Price

One can be forgiven for forgetting that SNAP at one point traded 7x higher than current levels.

I last covered SNAP in January where I rated the stock a buy in spite of a difficult third quarter earnings report. The following earnings report was even more brutal and seemed to suggest that it may be a while before the stock is truly out of the woods.

SNAP Stock Key Metrics

In its most recent quarter, revenue came to a standstill, growing only 0.1% YOY marked by a 6% decline in North America.

That marked the sixth consecutive quarter of decelerating revenue growth – the company had been a 57% grower YOY as recently as the third quarter of 2021.

The problem wasn’t user growth, as daily active users grew by an impressive 17% on a global basis in the quarter.

Instead, the problem was average revenue per user (‘ARPU’), which declined by 15% in the quarter.

While the market is typically understanding of such misses especially considering the macro environment, the problem is that, unlike META, SNAP has been unable to offset disappointing news on growth with positive news on profitability. Adjusted EBITDA margins contracted by 700 bps YOY and the company is still not yet profitable on a GAAP basis.

It is interesting to note that the company continued its share repurchase program. That said, given the lack of GAAP profitability, I would not count on the share repurchase program being meaningful enough to move the needle.

SNAP ended the quarter with $3.9 billion cash versus $3.7 billion in convertible notes. While that represents a slim net cash balance sheet, all of the convertible notes mature on or after 2026 and carry minimal interest rates around 1% or less. SNAP may not have to deal with the issues with refinancing debt maturities in a rising interest rate environment at least for several years.

On the conference call, management gave guidance for DAUs of between 382 and 384 million in the next quarter and declined to give official guidance for revenue. Management did state that revenue had declined by approximately 7% in the quarter through January and that their internal forecasts assume up to 10% declines in revenue for the full quarter. On the bright side, management believes that they may be able to achieve breakeven adjusted EBITDA in the quarter.

What is the main issue at play here? TikTok is the most reasonable answer, as management discussed “Spotlight,” their answer to TikTok 25 times on the call.

Management noted that they delayed in releasing a major overhaul to the app UI until the first quarter, but I am doubtful that such an update would make an impact in addressing such competitive threats. Management did tout their improvements to their in-app Web View performance and user ID graph, which they believe will lead to “higher dwell times, higher non-bounce rates, and higher third-party match rates.” For now, though, the stock has quickly shifted from high-growth high-flyer to being a no-growth, “show me” story in perhaps the toughest environment the company has ever had to work through.

Is SNAP’s Stock A Buy, Sell, or Hold?

SNAP touts reaching “75% of 13- to 34-year-olds in more than 20 countries.” Yet in spite of that reach, Wall Street seems to retain the same doubts regarding its business model as it did many years ago. After all, SNAP finds its stock trading around 60% lower than it did six years ago, in spite of growing revenues by more than 5x. The problem isn’t so hard to understand: TikTok looks very similar to SNAP (at least to an outsider) and is clearly resonating with Gen-Z.

After many disappointing quarters, I doubt that many investors are still projecting a quick return to 50% growth rates, if ever. Yet the stock is still trading reasonably at around 3.5x sales. Consensus estimates call for a return to mid-teens growth starting next year.

That acceleration might come from an improving economy as well as internal improvements. At its 2023 Investor Day, management touted their two million Snapchat+ subscribers as being a key medium term growth catalyst, as well as their long term positioning in augmented reality. SNAP announced just today its augmented reality shopping product – we shall see how effective this proves in boosting retailer sales.

Again, I am admittedly an outsider to the appeal of Snapchat services, but at these valuations, there’s enough to retain hope. I can see SNAP sustaining at least 25% net margins over the long term. Based on a return to 15% growth and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see SNAP trading at 5.6x sales, representing a stock price of $17 per share over the next 12 months.

What are the key risks? A tough economy is an easily touted risk, as it is likely playing a big role in the decelerating growth rates. But the more pressing risk is that of irrelevance – whereas META appears to be taking TikTok competitive threats in stride, I am not yet comfortable with saying that SNAP has adequately addressed those threats themselves. While investors may be justified in showing patience with tough revenue growth rates amidst a tough economy, slowing user growth may not be as easily justifiable as it may be instead a sign of increasing irrelevance. SNAP stock may have a run-up due to hopes of a TikTok ban in the United States, but my personal view is that one should not be so optimistic for such an outcome. Due to the company’s heavy reliance on online advertising, I do not expect the company to be able to offset poor growth rates with improvements in profit margins – the opposite appears to be taking place. As discussed with subscribers to Best of Breed Growth Stocks, I view a portfolio of undervalued tech stocks as being an ideal strategy to position ahead of a tech recovery. SNAP can fit right in with such a portfolio, though I note my preference for the more profitable META.