Snap Inc NYSE: SNAP got some analyst love prior to their outstanding second quarter. The company might well deserve more love than they are getting. A quick review of SNAP’s financial statements shows a company that could be closer to profitability than Wall Street expects.
To his credit, Aegis Capital analyst Victor Anthony upgraded SNAP to a Buy and raised his price target to $17 before the company’s second quarter earnings announcement. Anthony said the company’s advertisers are happy with the return-on-investments (ROI)m which is strong with the 13 to 24-year-old “coveted” demographic. He says that should help the company as things “have changed dramatically for the company in the last six-months.”
Stifel Analyst John Egbert also got on the pre-earning train, changing his recommendation to buy from hold and increasing his price target to $17. Like Anthony, Egbert says he is “optimistic about Snap’s growth prospects in 2H:19 and beyond.”
They were both right as the stock rose 18.43% the day after pummeling Wall Street’s earnings and revenue forecasts. Year-over-year sales increased 48% to $388 million, smashing the $360.5 million consensus. Meanwhile, the chat service lost $0.06 per-share versus an anticipated loss of a dime.
Since the earnings beatdown, Anthony once again upped his price target $19 along with many other Johnny Comelatelys.
Diving a little into SNAP second quarter financial reveals a better quarter than all the new enthusiasm and stock pop indicates. Sales grew at a much faster rate than costs. You know what that means? Fatter margins, although the company continues to spend more than it makes. Hence the $0.06 loss. Nonetheless, cutting costs as a percentage of sales will help SNAP find profitability faster.
During the second quarter, the top line jumped 48%, as we already highlighted. At the same time, year-over-year cost of sales grew by just 12%, to $215.492 million from $191.165 million. While still too high at 56% of sales, it’s down from 73% in the first quarter.
Management also continues to spend a big chunk of dough on Research and Development (R&D). SNAP invested $236.119 million in R&D for the three-months ending June 30, 2019. That’s more than the first quarter’s $203.246 million, but just 61% of revenue compared to 77% in the first three-months of the year. Research and Development spending is fine with us as new technology and apps drive new user growth, which is the heartbeat of SNAP’s future.
Another investment in tomorrow is Sales and Marketing. Management put $111.504 million towards client acquisition in the quarter, about $10 million more than they spent in the last quarter. Despite spending more, the line item fell to 29% of sales compared to 39% in Q1.
The last Income Statement metric for our quality of earnings check is General and Administrative costs; rent, payroll, utility bills, and that sort of stuff. Here is where you want management to show restraint. From January through the end of March, G&A accounted for 47% of revenue, whereas it fell to 33% in the last 90-days.
Costs sliding all the way down the Income Statement is a healthy sign. If the trend continues into the second half and beyond, SNAP could become profitable before expectations.
It’s also a good sign that Accounts Receivables dropped in the second quarter versus the first. That means SNAP customers are paying their invoices in a timely manner. One point of concern in the Balance Sheet is Cash, and Cash Equivalents dipped to $335.774 million from $387.149 million a year ago.
Of course, SNAP will have to dip into the bank account while the company continues to lose money. If they don’t start to put positive numbers on the bottom-line, it’s likely they will need to return to the market and raise capital, most likely from a secondary offering of stock. It would not be surprising to see an announcement on that front sooner than later on the heels of a strong quarter or two. However, it would increase the number of shares outstanding and extend the calendar to profitability.
As for the stock price, shares broke out on the uber-bullish earning report, but are borderline overbought on a Relative Strength basis. Some profit taking could come in the near-term with a decent amount of support at $14, then $12, then $10.
On the upside, $20 might invite sellers. It’s a round price and it’s where the stock stopped rising and reversed course already. If SNAP can get to the better side of $21ish, then it could have a legitimate shot at challenging its all-time closing high of $27.09, maybe the intra-day high of $29.44.