Roku Stock Can Rise To $70 As Cash Flows Surge

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ROKU: Roku logo
ROKU
Roku

Roku (NASDAQ:ROKU) has had a tough year so far, falling by about 43% year-to-date, underperforming the Nasdaq-100, which gained over 20% over the same period. The decline comes amid heightened competition in the advertising markets, as well as expectations of slower sales growth from the high-margin platform business. However, we think the sell-off is overdone and value Roku stock at about $70 per share, which is about 33% ahead of the current market price.  See our analysis on Roku Valuation: Expensive or Cheap for more details on what’s driving our price estimate for the stock. So what has contributed to the sell-off in Roku stock, and how are things likely to pan out going forward?

There are a couple of things that have weighed Roku stock down this year.  Roku’s streaming service distribution business, which facilitates the subscription process for streaming services and earns commissions for the same, is seeing some headwinds as more streaming services, including Netflix, focus on selling more affordable, ad-supported plans as customers look for better value in a mixed economic environment.  Moreover, Roku has to increasingly compete for advertising-related revenue with big technology players including Netflix, Meta, and Alphabet in the video market. Roku’s per-user revenue growth for its platform business appears to be easing. ARPU stood at $40.60 for the last quarter, roughly flat compared to last year. This is partly due to a higher mix of net adds coming from international markets, where per-user revenue is lower.

Looking at a longer period, ROKU stock has suffered a sharp decline of 85% from $330 in early January 2021 to around $55 now, vs. an increase of about 45% for the S&P 500 over this roughly 3-year period. However, the decrease in ROKU stock has been far from consistent. Returns for the stock were -31% in 2021, -82% in 2022, and 125% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that ROKU underperformed the S&P in 2021 and 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Communication Services sector including GOOG, META, and NFLX, and even for the mega-cap stars TSLA, MSFT, and AMZN.

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In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could ROKU face a similar situation as it did in 2021 and 2022 and underperform the S&P over the next 12 months – or will it see a recovery?

Overall, we believe that the risk-to-reward trade-off for Roku stock remains very positive at the current market price of about $52 per share. The stock trades at under 2x forward revenue, which is considerably below levels of over 30x that it traded at its peak in 2021. The secular trend of ad dollars shifting away from linear television to digital video formats is likely to benefit Roku in the long run.  For Q1 2024, Roku’s revenue rose 19% to $881 million, and gross profit rose 18% year-over-year to $394.4 million. Growth was driven in part by a higher number of active users on the company’s platform. Roku had 81.6 million active accounts globally as of the end of the quarter, up from 71.6 million at the end of Q1 2023.  Engagement rates on Roku’s platforms have also been on the rise. The company saw total streaming hours rise by 23% year-over-year during the most recent quarter, outpacing growth in total accounts.  The Roku channel saw hours streamed rise by 66% year-over-year. This could help the company drive higher-margin advertising revenue in the long run. Roku has made some progress in managing costs in recent quarters. For example, in Q1 the company saw total operating expenses fall by 16% year-over-year, driven by workforce and office space reductions carried out in 2023. Roku is also generating more cash. Free cash flow stood at $426.7 million for the quarter, up from $175 million in the previous quarter and from negative levels in the year-ago quarter.  We value Roku stock at about $70, which is 33% ahead of the current market price.

 Returns Jun 2024
MTD [1]
2024
YTD [1]
2017-24
Total [2]
 ROKU Return -8% -43% 1%
 S&P 500 Return 4% 15% 144%
 Trefis Reinforced Value Portfolio 4% 8% 666%

[1] Returns as of 6/20/2024
[2] Cumulative total returns since the end of 2016

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