Stock Analysis & Ideas

Roku’s Bear Case is Stronger Following Its Dismal Q2 Results

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ROKU stock fell off a cliff after reporting its dismal second-quarter results last week. The drop in advertising spending remains a concern that has weighed on its bottom line while its stock trades at a lofty valuation.

Shares of streaming TV-device maker Roku (ROKU) had a horrible day on July 29, tanking 26% following a miserable second-quarter earnings report. Consequently, Wall Street analysts significantly cut their price targets for the stock. Though there are positives with Roku, especially with its position in streaming, its lofty valuation and penchant for losing money make it a Sell, in our opinion. Therefore, we are bearish on ROKU stock.

It’s tough to sugarcoat Roku’s positioning at this point. In the past 12 months, the stock has been hammered while its underlying business continues to disappoint.

The competition in the space and current market headwinds have proven to be remarkably challenging for the business. Its losses are staggering, and its second-quarter report added more fuel to the fire. ROKU seems attractive on the speculative front, but its weakening metrics suggest that it’s far from being an attractive bet.

Interestingly, however, ROKU has a 5 out of 10 Smart Score rating on TipRanks. This metric indicates that the stock is likely to perform in line with the broader market, going forward.

Recapping Roku’s Terrible Earnings

Roku delivered a disastrous earnings report during the second quarter, which missed estimates on both lines by a healthy margin. It missed sales estimates by a substantial $40.2 million and reported a wider-than-expected loss for the quarter, at -$0.82 per share. Additionally, it missed estimates on the earnings front by $0.13.

Though its revenues grew by 18.5% from the prior-year period, the sluggishness of its bottom-line growth remains a massive concern. However, to rub more salt in its investor’s wounds, Roku said it expects to grow sales by just 3% in the third quarter.

The current economic environment is remarkably challenging for advertisers. With rising inflation rates, many advertisers are looking to pause their spending. However, this is horrible for companies such as Roku, which rely heavily on advertisement income.

If we dig deeper into its advertising metrics, we see that its streaming hours of 20.7 billion were down sequentially by 0.2 billion hours.

The company management believes that elevated inflation rates and recessionary fears have caused advertisers to significantly reduce spending and consumers to limit discretionary spending. The double whammy weighed down its results significantly, and though ad revenues were up 26% on a year-over-year basis, they were far below market expectations.

Consequently, Roku’s margins took a haircut, as its second-quarter gross margin of 46.5% was down from the 52.4% margin in the previous year’s quarter. Additionally, the Player segment’s gross margin was -24%.

Roku’s Valuation is Unappealing

Even if you’re as bullish as Cathie Wood is on ROKU stock, its valuation is tough to justify at this point. It trades at almost 3x forward sales while trading at more than 142x its operating cash flow for the trailing twelve months (TTM).

To be fair, these metrics are more attractive than they were during the height of the pandemic. The surge in the streaming space and its relatively robust operating performance helped ROKU rack up some strong gains.

From January 1, 2020, to December 31, 2021, ROKU stock gained a massive 150% in value. However, most of these gains have faded, and the stock trades are at multi-year lows. Does that mean you should pick up the stock at current levels? Probably not, in our opinion.

After its troubling second-quarter report, ROKU stock has been downgraded by multiple Wall Street firms. Expect the stock to tumble and underperform again in Q3.

Wall Street’s Take on Roku Stock

Turning to Wall Street, ROKU stock maintains a Moderate Buy consensus rating. Out of 22 total analyst ratings, 12 Buys, six Holds, and four Sell ratings were assigned over the past three months.

The average ROKU price target is $84.67, implying 7.2% upside potential. Analyst price targets range from a low of $55 per share to a high of $130 per share.

Conclusion: Poor Earnings and Valuation, but There are Positives

Roku had a terrible Q2, and its stock fell substantially. It forecasts its Q3 to be even worse, leaving investors worried. Moreover, its valuation is still unattractive despite the substantial correction over the past several months. It’s not all gloom with Roku, though. Digital TV consumption will likely continue at a healthy pace for the foreseeable future. Advertising numbers have dipped, but they are likely to improve in the long run.

Despite the long-term positives, it’s tough to feel upbeat about a company that has been losing money in four of the past five years. Some analysts believe that the stock won’t be profitable for at least three to four years. With such a negative update, placing your bets on a risky proposition such as ROKU stock is tough. Therefore, it’s likely best to be on the sidelines.

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