Can You Picture Profits With This Company?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When a company becomes synonymous with an activity that is usually a good sign. Phrases like, “hand me a Kleenex”, or “will you Google that for me” show that a brand has become imbedded into our culture. When it comes to making greeting cards, calendars and photo prints, we may hear, “can you Shutterfly (NASDAQ: SFLY) that for me” someday. The company has become near synonymous with online printing of anything photo related. The company's strategy is very simple, offer ridiculously good deals and hope that the customer sticks around long enough to spend real money. The strategy seems to be working.
Shutterfly came to my house much like it did to others, through an offer of something for virtually nothing. The company's offer on their main web page right now is, join today and get 50 free 4X6 prints. You have to pay for shipping and handling and taxes of course, but who can resist something for virtually nothing? While the world has moved from physical pictures to digital images, there are still many times a year the standard customer can use Shutterfly's services. From printing a calendar to give to relatives, making a personalized coffee mug, or greeting card, there are many possibilities. In addition, as great as digital photos are, there are still millions of people who want a physical picture that they can put into a scrapbook.
In their last quarterly report, the company shows they just reported their 44th consecutive quarter of year-over-year growth. This is a remarkable achievement when you consider the changes in the Internet over the last 11 years. Shutterfly operates 3 basic divisions, personalized products and services, prints, and commercial printing. Of the three, personalized products and services is the largest division and showed growth of 71% year-over-year in the last quarter. Prints is the lowest growth and most difficult business, as there are hundreds of competitors offering cheap photo prints. Among others, you can go online to Walgreens (NYSE: WAG) or Walmart (NYSE: WMT) and not only order photo prints, but you can also create cards and other gifts. With over 7,800 and over 10,000 stores respectively, these two companies offer a convenience of picking up your prints that Shutterfly can't match. Commercial print is a small part of Shutterfly, but seems to have a lot of promise. The size and scope of Shutterfly's printing capabilities is a competitive advantage that businesses could take advantage of. With growth of 165% in the last quarter, Shutterfly is beginning to gain traction in this opportunity filled field.
So you might be wondering, all of this sounds pretty good, so what is the catch? The catch is, at today's prices Shutterfly sells for about 105 times forward earnings. With forward growth of 20% expected this seems like a rich valuation. There are a few positives about Shutterfly's earnings that could make this valuation more palpable. First, the forward P/E is actually 37% less than the highest P/E the stock has traded at in the last 5 years. Second, the company has a history of beating earnings estimates. In the last four quarters, Shutterfly beat estimates 3 of the 4 by an average of 26.98%. Third, Shutterfly's customers are very loyal. In 2010 total orders were comprised of 72% repeat orders from existing customers. In 2011 total orders grew substantially, and 74% of these orders were from existing customers. It's not hard to imagine that with free unlimited lifetime storage of your photos, customers would keep coming back. After all, who wants to have to re-upload all of those photos to another site?
If there is one big concern for Shutterfly investors it has to be the company's gross margins. Clearly this is a business where size matters. The more orders are placed, the better the margin on these orders. Look at what has happened with gross margin over the last three years (plus the Dec. 2011 quarter):
You can see that as sales grow (which they have for the last 3 years), that margin improves. Think about this, in 2009 the company had $246 million in sales and a gross margin of 54.69%. In just the last quarter of 2011, the company had $264 million in sales and a gross margin of 58.87%. In the last quarter, Shutterfly grew customers by 23% and orders by 24%. However, the average order value declined by 3% during this same timeframe, largely due to this discounting landscape that Shutterfly had to contend with.
If you are a long term Shutterfly shareholder, what are you to do? With the stock selling for 105 times 2012 earnings, the trends to watch are: new customers, repeat orders, and gross margin. The company can't afford to miss earnings after beating for three straight quarters with this high of a P/E ratio. If the company were to miss estimates, look out below. To me Shutterfly also is a potential buyout target. With no long term debt, $180 million in cash and a market cap of just over $1 billion this would be an easy target for part of Google's (NASDAQ: GOOG) nearly $50 billion in cash and investments. With the existing Picasa photo editing software, the company could combine the two and instantly become a leader in online photo printing. This is a risky stock at current levels, but as both a potential takeover target and an independent business, the company has some attractive qualities. Let me know what you think in the comments section below.
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