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Snap: victim of a profitless stock market disappointment, but for how long?

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It’s one thing to lower the guide; it’s another to be barely profitable or downright unprofitable and less profitable. Of course, it’s already been hard enough being a tech stock on either side of this market environment, but as some companies have discovered, Snap (NYSE: SNAP) now included, stock drawdowns can be massive when both are accomplished. But with the worst, can Snap start working on business fundamentals and stock price recovery? The short answer is yes, but it may not be until Q3 as further downgrades are likely to occur.

The story begins with Snap’s Q1 earnings call, where it framed, covered, and gave an otherwise painful color to its Q2 guidance. He detailed how uncertain the macroeconomic environment is and how uncertain management is about what will happen in the quarter. This is quite rare even in good market conditions and truly unheard of in volatile market conditions like the one we find ourselves in. Most companies have given up on publishing forecasts when they find themselves at this level of uncertainty. But seeing the comment in its entirety is necessary to do it justice:

On the revenue side, forward-looking visibility is as difficult today or perhaps more difficult than at any time in recent history. While the 116% revenue growth we experienced in the second quarter of last year makes comparisons more difficult this quarter, we believe the biggest challenge to forward-looking visibility is the uncertain operating environment. The macro headwinds we saw in the first quarterincluding supply chain disruptions, labor shortages, inflationary pressures and the impact of rising interest rates on the overall economic environment, remains a challenge as we enter the second quarter. We believe that the impact of the war in Ukraine on input costs, marketing budgets and overall economic confidence has been significant and it is difficult to predict its impact on a forward-looking basis.

Given the uncertainty caused by these difficult circumstances, we have chose to share which our Rate of growth so far in the second quarter is around 30% year-over-year or just below the growth rate of around 32% that we saw after the invasion of Ukraine in the first quarter. That said, we fear that the operating environment ahead will be even more challenging, leading to further campaign interruptions or advertiser budget cuts. As I noted earlier, our comparisons to the prior year are more difficult in Q2 than in Q1.

Given this, we estimate that the revenue forecast for 20%-25% year-over-year revenue growth in the second quarter is reasonable.

-Derek Andersen, CFO, Snap Q1 Earnings Call

The company was throwing investors a bone, severely hedging the 20%-25% Q2 earnings guide. Again, that’s right; it is a difficult environment. But what didn’t help was throwing it out the window a month later when CEO Evan Spiegel attended JPMorgan’s 50th annual global technology, media and communications conference on May 23. There he was asked about the macro environment and shared this:

Well the the macroeconomic environment has definitely deteriorated more and faster than expected when we released our guidance for the second quarter. So even though our revenue continues to grow year-over-year in the second quarter, revenue and EBITDA are likely to be below the bottom of our guidance range.

This is not good news to be announced casually at a conference. As a result, this update has undoubtedly reset expectations for the stock as the stock fell around 34% following the forecast update.

Chart
Data by Y-Charts

The question now is, is this bottom line for Snap, or is there more pain to come?

With macroenvironmental fog at its peak, there is no clear view of when it will lift. Companies will need hard evidence that world events, inflation, and global uncertainty will improve before committing new dollars to marketing. I expect macro conditions to last into Q3 as the social media advertising industry will continue to struggle, disproportionately affecting Snap as it is a tier advertiser lower compared to Google (GOOG) (GOOGL) and Meta (FB). This means it will take longer for advertising dollars to flow back to Snap, even after a more structured recovery in the industry.

With that in mind, I’ve built estimates for the rest of the year and Q3 is the lowest. This is due to the headwinds mentioned above having a longer tail beyond Q2.

Snap's estimated Q4 22 revenue and revenue growth chart

Snap Estimated Q4 22 Revenue and Revenue Growth (Chart mine, data from Seeking Alpha revenue tab)

The estimates for the next three quarters that I created are below consensus at $1.15 billion, $1.28 billion, and $1.61 billion, respectively. I expect more downgrades in the coming weeks from analysts, which could add to the stock’s troubles, especially when the third and fourth quarters are downgraded.

Snap Q2-Q4 2022 Revenue Consensus

Snap revenue consensus in Q2-Q4 2022 (Looking for Alpha)

Snap’s ability to handle iOS privacy changes better than its competitors is an advantage, which shortens the ad curve a bit. Still, the bottom line is that Snap isn’t a first step for most midsize and large businesses. And since the company’s bottom line is insignificant and, in most cases, negative, the market won’t give it any multiple expansion for a few quarters. This is why the stock has fallen dramatically on news revenue which will drop from $1.2 billion at the initial 22.5% midpoint to $1.13 billion at my new 15% growth estimate. – a mere difference of $73 million. This market does not like non-profit stocks – first and foremost – and punishes stocks that show significant growth downgrades when they are already unprofitable.

The balanced strategy would be to start buying once earnings estimates stop falling. It may take until the Q2 earnings call is resolved, but keep an eye on the consensus until the call and see if it gets as low or lower than my estimates.

Now if the market stabilizes in the coming weeks or months, I can consider the chart moving sideways or turning around as a good indicator that the market valuation floor will be higher than it has been. , bringing with it the risk floor. This would signal that the falling knife has stopped and future bearish news is priced in. But, for now, I recommend being cautious playing with a high-risk asset like Snap after its misguided guide from just four weeks earlier. It might be the bottom, but the risk profile just doubled. A nibble here and there can work if you’re looking to initiate a position, but I’d be cautious to double down on stock for now.