Shutterfly Can Flutter To $40 As Half Of Sales Come From Fourth Quarter

Shutterfly (NASDAQ:SFLY) has been battling negative market sentiments which have seen its stock prices dip by close to 20% after its Q3 earnings release on November 1. We believe that the company is well positioned to improve its sales performance vis a vis last year after a recent survey reported that a majority of the respondents will be send across similar or more number of greetings this holiday season when compared to last year. ^[1] The company has historically derived with almost half of its revenues from its consumer business in the fourth quarter and is well positioned to do so again as a result of the improving consumer sentiments this holiday season. However, it will also be dealing with rising operational and capital expenses as it triples it east coast production facility’s capacity and integrates new users and products into its portfolio.

Shutterfly competes primarily with services like HP’s (NYSE:HPQ) Snapfish, American Greetings’ Photoworks and Webshots brands, and even Apple’s (NASDAQ:AAPL) Cards app on iOS.

Check out our complete analysis of Shutterfly

User base and orders continue to grow

The company’s primary consumer business, which includes four brands: Shutterfly, Tiny Prints, Wedding Paper Divas, and Treat, derives revenues from the sale of photo-based products, such as photo-books, stationery and greeting cards, other photo-based merchandise, photo prints, and the related shipping revenues. The segment accounts for almost 95% of the company’s overall revenues.

In the third quarter the company’s user base grew to 2.2 million unique customers on the acquisition of Kodak Gallery customers, a 40% increase from the prior year same period. We expect the growth to continue with the acquisition of Fuji’s SeeHere customers in the fourth quarter. The company is also aggressively promoting its services on television and social networks and we believe these will bring in additional customers.

The company looks poised for a healthy fourth quarter as it can market its products to its newly acquired customers. This would be inline with the trend in Q3 when the total number of orders generated were 3.6 million, a 40% y-o-y increase similar to the increase in the number of unique customers.

Expansion takes a toll on margins and average order value

The average order value went down to $25 during the third quarter as a result on the company’s expanding product portfolio adding more lower priced products. Consequently, the sales growth has not been at par with the growth in user base and could be the reason for market’s bearish sentiments. Going forward, we expect the lower priced products to drive order volumes and the higher priced orders to maintain their growth trajectory.

The segment’s gross profit margin declined as a result of the higher customer service costs owing to the Kodak Gallery migration and a lease termination fee related to the pending move of the East Coast production facility. It has also been promoting its services on television and social networks which has result in a 34% growth in its marketing expenses during the first nine months of the fiscal year. We expect the margin to improve but still be lower during the fourth and coming quarters as it accounts for customer acquisition costs from Fuji’s SeeHere migration.

We believe that the market has been unfairly bearish on the company. It has a diversified product portfolio and its recent acquisition Photoccino will help differentiate it from its competitors. The past quarter saw it launch an iPhone app for its Treat brand as its mobile business grew to 620,000 active monthly users. We expect the company to successfully monetize and grow its mobile presence as it integrates recently acquired Penguin Digital’s MoPho app to the existing Shutterfly app.

We have a revised $40 Trefis price estimate for Shutterfly, down 15% from our initial $47 estimate for the company in view of its rising capital and marketing expenses. However, we remain positive about the company’s growth prospects.

1. Make Your Holiday More Merry With Shutterfly Holiday Cards, MarketWatch, November 2012 [↩]