Shutterfly (NASDAQ:SFLY), declared its second quarter results last week. The company beat its own expectations and reported a significant growth in revenues, gross margins and operating margins despite a dip in net income. The announcement was greeted with much enthusiasm by the market as a result of which the company’s prices jumped almost 10% over the past week.
The company is primarily an online photo sharing, storage and printing service which enables users to create customized products using their images. It competes directly with services like HP’s (NYSE:HPQ) Snapfish, American Greetings’ Photoworks and Webshots brands, and even Apple (NASDAQ:AAPL).
We maintain our $47.03 price estimate for Shutterfly’s stock which is about 40% higher than the current market price. We believe that the difference can largely be attributed to the fact that the key gift giving season of the year, the principle business period for the company is in Q4 and that the enterprise business which has exhibited strong growth is expected to further grow.
The primary business quarter for the company is Q4
The company reported a positive adjusted EBITDA of $3.6 million for the second quarter. This was backed by improved efficiencies in material, labor and shipping costs. Higher revenues were supported by better than expected average selling prices, along with delays in expenditures associated with the Kodak migration and holiday preparations which will occur in the third quarter.
The company reported an average consumer order value of $31.70 for the second quarter, an increase of 5% year-over-year. These figures are inclusive of the Treat.com service the company started offering in April 2012. With the primary business quarter being Q4, the revenues we expect to exhibit high growth on the back of strong performance in non primary business quarters.
The ‘Consumer’ base expected to grow faster
The customer base in the consumer category grew 14% year over year on a pro-forma basis. Also, the company recently completed the acquisition of Kodak gallery’s accounts and customers. Existing customers of Kodak were given the opportunity to migrate to Shutterfly systems or opt out. The company is currently in the process of migrating the customer across the systems and expects to complete the same in the third quarter.
Also, the company started offering a new service ‘Treat.com’ in April 2012. The service allows customers to customize and send across personalized greeting cards. The company estimates to corner a major segment of the offline greeting cards market using this service. With additional customers from the new service and migration of Kodak’s customers, we expect the customer base to expand aggressively.
The ‘Enterprise’ base continues to exhibit aggressive growth
The company reported a net revenue of $4.6 million from its enterprise category. The revenues from the category grew almost 70% on a year over year basis. This growth was backed by trust from existing customers as well as the addition of new customers. The company expects the category’s performance to improve as it outgrows its early stage nature. The enterprise category currently accounts for 5% of its total revenues. This is an increase of a single percentage point over last year second quarter performance.
Key Risks: Infrastructure Costs Soar, Off-cycle business may be slower than expected
One of the primary risks to our price estimate is increase in infrastructure costs associated with aggressive user base expansion. With a high growth rate, the company will have to invest in new storage space and manufacturing facilities to meet the demand.
Also, the current quarter is an off-cycle quarter for the company. The business this quarter can be slower than expected on the backs of international events like the as the London Olympics, the upcoming presidential election, the challenges in the Euro zone and the U.S.’s upcoming fiscal cliff, which may occupy consumers’ mind share.
Furthermore, if competition from Apple and HP intensifies, there could be an impact on the growth in customer base across both the categories. This in turn, may make the operating costs and the costs associated with recent acquisitions, service launches seem formidable which will impact the margins. This could lead to a slowdown in the company’s expansion in the U.S. market.