Updated: Apr 3, 2021
Matthew Chapter 20 verses 17-19 state, "Now Jesus was going up to Jerusalem. On the way, he took the Twelve aside and said to them, we are going up to Jerusalem, and the Son of Man will be delivered over to the chief priests and the teachers of the law. They will condemn him to death and will hand him over to the Gentiles to be mocked and flogged and crucified. On the third day he will be raised to life!"
Today is Good Friday, so I hope this day finds you well. For me, it is a time for reflection on what God has done for me, for the simple reason that He loves me. This love is not solely for me as a Christian, but to all who are God's creation. The life, death, and resurrection of Jesus Christ is the key to unlock my hope and my relationship with Him. No other "religion" places God in the same position as humanity, let alone, has humanity kill Him. This is illustrative of my natural nature to sin, and do wrong, and God's forgiveness and love for me.
For investing, I tend to be very competitive and critical of my performance. This can very quickly turn into too much focus on a short duration of time, versus the big picture and long-term prize. The Bible always equates the life of a Christian as a race that is run over time. For investing, this illustration is the same. I cannot win at any given moment of time, but rather I must continue to endure and succeed.
This week's earnings review includes Chewy, Hut 8 Mining, and SoFi. I was out towards the end of last week, so I'm providing updates on Hut 8 Mining and SoFi. SoFi reported a couple weeks ago on March 17th, and I missed the fact that all of the company's 10-K information was updated. Chewy reported earlier in the week, so these three make up the last earnings report for the Q4 2020 cycle.
I've also updated all my financial models including more robust peer competitor information so this earnings report will highlight some new tools and assessments, so let's get to it.
Chewy, Inc. (CHWY) had a very strong fiscal year ending January 31, 2021. Overall Revenue grew 47% from the previous year to $7.2 billion. Autoship Customer Sales grew nearly the same to $4.9 billion reflecting 68% of the total. This is important because Autoship Customers are the most "sticky" and recurring buyers of products and services through Chewy. Overall Active Customers grew by 43% to just over 19 million, and sales per customer grew by a little over 3% to $372. The sales per customer growth rate declined by about 50% or so from the past three-year average.
Consumables were the slowest growth segment at 38% to $5 billion, while Hardgoods grew at 63% to $1.2 billion, and the Other Revenue category grew at 88% to just over $1 billion. Chewy's Other Revenue category includes pharmacy treatments and conditions, pet medications, and health services, as well as shipping fees. This has clearly been the fastest growing segment since 2017 when it first began, only generating a little over $4 million in sales.
Chewy's Cash Flow performance has continued to improve as the company witnessed further inflection during its fiscal year 2021. The current OCF margin stands at 2%, and I am modeling Chewy to head towards a 7.5% margin over the mid-term, which is 2026 per the company's fiscal year operations. The way that Chewy is going to achieve this growth in OCF margin, is by continuing to penetrate its addressable market through converting consumers to buying online, while at the same time, continuing to diversity its product offerings, at higher margins.
From a competitive peer perspective, based on the next couple of years, Chewy remains a leader per Revenue growth expectations. Chewy's nearly 50% growth projection through fiscal year 2023 is double or higher that of the majority of peers. Notable exceptions are only within 5-8% of Chewy's Revenue estimates, meaning that scalability is not necessarily an easy accomplishment. Aside from Amazon's mixed e-commerce business, Chewy is the largest company by Revenue over the next two years, for the pet-related industry.
When it comes to Chewy's potential to achieve these growth estimates, the key drivers include Active Customers and corresponding Net Sales per Active Customer. Looking further to the mid-term, I am modeling Chewy to see annualized Active Customer growth of around 15% to 39 million by fiscal year 2026. At the same time, I am only assuming a much lower growth rate for Net Sales per Active Customer of 2.5% per year towards $420.
Here are some quick pet-related highlights for the U.S. per Spots.com as of this past February, for investors to consider as to Chewy's potential to continue to penetrate its markets:
85 million or 67% of American homes include a pet.
95% of American pet owners consider their pets to be family members.
Freshwater aquarium fish are the most popular pet, with 139.3 million of them nationwide.
Generation X and Millennials make up more than two thirds of all pet owners in the United States.
Americans spend $1 billion each year on pet insurance.
Chewy holds a 22% market share of the 85 million U.S. pet owners today (assuming that one household would have one account). As pet ownership continues to rise as indicated from younger generation trends, Chewy's number to hit over the next five years to generate the growth leading to strong investment returns is around a 35-40% market share. I feel that my average customer spend is very conservative and could potentially allow for further Revenue generation upside.
Aside from Amazon, there is a pretty strong correlation with valuation of Chewy's peers related to OCF margin. The higher OCF margin, the higher premium for EV/Revenue multiples. This is why it is highly important for Chewy to witness sustained Cash Flow expansion in order to justify a strong return on investment.
I am modeling Chewy conservatively to see modest OCF margin expansion towards 3% over the next two years with Revenue increasing towards $11 billion, all while keeping EV/Revenue constant at 4.5 times. Assuming an OCF per share multiple at 150 times, my PT for Chewy through 2023 is just below $115 per share reflecting a 38% premium from today's price.
Over the mid-term, I am remaining conservative only giving Chewy a peak EV/Revenue multiple at 5 times, while assuming an OCF per share multiple at 70 times, with the OCF margin inflecting towards 7.5%. Based on these estimates, over the next five years, investors could expect to potentially achieve an annualized return on investment of around 18%, with Chewy's PT heading towards $200 by fiscal year 2026. My average cost basis for the Chewy position in the portfolio is at $54.50, and I will be looking to accumulate 46% of the current position at around $75 per share to bring my average cost basis up to $59.60. A SP at $75 affords any investor with no exposure to Chewy currently, to also potentially witness an annualized return near 22% over the mid-term.
Financial Metrics on a Last Twelve-Month, LTM, Basis
Net Cash Position: $563 million
Revenues: $7.2 billion
Gross Margin, GM: 25.5%
Operating Cash Flow, OCF / Margin: $133 million / 2%
Free Cash Flow, FCF / Margin: $25 million / 0.3%
Shares Outstanding: 415 million
Active Customers: 19.2 million
Net Sales per Active Customer: $372
Autoship Customer Sales: $4.9 Billion
Autoship Customer Sales Percentage: 68.4%
Consumables Rev: $5 billion
Hardgoods Rev: $1.2 billion
Other Rev: $1 billion
Enterprise Value, EV: $33.8 billion
EV/Revenues: 4.7 times
Net Debt/OCF: N/A
Stock Price, SP/OCF per Share: 259 times
Hut 8 Mining
Hut 8 Mining (HUTMF) has become a very intriguing investment opportunity. The company's financial performance for all of 2020 is not necessarily reflective of what the future potential holds. Hut 8 Mining is a Bitcoin miner. The process to mine Bitcoin involves the need to purchase mining equipment in order to increase the hash mining rate. Simply put, investing in equipment leads to a number of Bitcoin that can be mined per day. If anyone hasn't noticed yet, one Bitcoin is worth nearly $60,000 today.
Hut 8 Mining only generated approximately $32 million in Revenue during 2020, meaning that the company mined Bitcoin to achieve this amount. As a part of the computational effort required to mine Bitcoin, Bitcoin halving occurred in May of 2020, meaning that the effort and difficulty required increased, impacting all Bitcoin miners accordingly.
There are multiple Bitcoin and other Cryptocurrency miners looking to increase their hash rates and ability to maximize mining opportunities. As part of this, the term "Hodling" has become more of a mainstay as companies are looking to own Bitcoin as a digital asset. Companies like Tesla, Inc. (TSLA) and MicroStrategy Inc. (MSTR), Square, Inc. (SQ) among many others have even begun buying Bitcoin last year as a cash and investments addition. Hut 8 Mining currently holds 3,233 Bitcoins valued today at more than $190 million, all of which have been mined and not purchased.
The company has been executing well on very innovative approaches to ensure that it can continue to be a mining leader, while at the same time diversify its Revenue streams. This has included:
Management of site operations transferred to Hut 8 from Bitfury.
Hut 8 established a yield account with Genesis capital where it is earning 4% in interest per annum on 1,000 bitcoin.
Hut 8 fully repaid its US$20m Genesis Global Capital loan with all bitcoin collateral returned to Hut 8.
Announced that it has entered into exclusive partnership discussions with Validus Power Corp. to secure new revenue streams and energy solutions for its bitcoin mining operations.
Hut 8 Mining Corp. (TSX: HUT) (“Hut 8”) has executed on a purchase of $30 million USD of NVIDIA CMPs, which will be delivered starting in May 2021, with full deployment expected to be completed this summer.
Hut 8 Mining Corp. (TSX: HUT), one of North America’s oldest, largest and most innovative bitcoin miners, and Foundry Digital LLC, a wholly-owned subsidiary of Digital Currency Group (DCG) focused on digital asset mining and staking, jointly announced that Hut 8 is now mining on Foundry USA Pool.
Hut 8 Mining Corp. (TSX: HUT), one of North America’s, largest, and most innovative bitcoin mining pioneers, and Luxor Technology Corporation (“Luxor”) a Seattle-based hashrate manager, jointly announced that Hut 8 is now working with Luxor on hashrate best-price execution. Hut 8 has allocated a portion of its SHA-256 hashrate to Luxor to advance its recently announced expansion into Ethereum mining.
Moving forward, the key inputs to attempt to model Hut 8 Mining's performance is the number of Bitcoin the company will mine, versus other Revenue streams. The partnership with Validus Power Corp., and expansion into other Cryptocurrencies is not as clear today, so focusing on Bitcoin and interest is a conservative way to gauge the future, with additional Revenue streams to come on line serving as upside potential.
There is a very distinct difference with how Bitcoin and Cryptocurrency miners are being valued across the competitive landscape. Today, no one is more than the $32 million generated in Revenue by Hut 8 Mining. However, looking out the next couple of years, expectations are for a substantial increase in Revenue results. Interestingly, on an EV/Revenue multiple, Canadian miners (Hut 8 Mining, Bitfarms, and HIVE) are trading much lower than their U.S.-listed counterparts.
2021 and 2022 are going to be very exciting and interesting years for two reasons with respect to Hut 8 Mining. First, with no debt and continued growth in mining Bitcoin, the company will be generated stored value of Bitcoin, while at the same time generating Fiat Currency off of its agreed upon 4% interest from the 1,000 Bitcoins. On the other hand, the diversified partnerships and strategies will become more transparent as time progresses, further allowing for financial modeling.
While the fundamentals of the business are taking more shape, which is highly attestable to Jaime Leverton's leadership role, there continues to be an expectation that Hut 8 Mining is considering an up-listing to the NASDAQ. This would be a clear potential catalyst for a significant multiple expansion towards U.S. valued peers. While the speculation continues to swirl, it is best to remain wedded to Hut 8 Mining's fundamentals and prospects irrespective of this.
I just want to caveat here before talking about Hut 8 Mining's valuation, that visibility is not certain, to the point above, so financial model estimates and valuation is much more subjective today. I am looking at Hut 8 Mining's Bitcoins mined potential over the next couple of years in the 3,000 to 4,500 range. The upper end may be a little aggressive, but it is what it is. The 4% return on the 1,000 Bitcoins is straight forward, and a much lower proportion of overall Revenue potential. The key here is the value of Bitcoin. Assuming that it can remain above the $50,000 level, and OCF margins could expand towards 20-35%. Assuming Revenue growth towards $250 million or so from this, and Hut 8 Mining could be approaching $40 per share with an EV/Revenue multiple at 15 times, and OCF per share at around 45 times. These type of valuations allow for 400% upside from today's SP.
Looking out to the mid-term is less clear but the potential from Financial and Energy sectors is exponential. If Hut 8 Mining can evolve into a company scaling towards the $500 million to $1 billion level, investor returns could end up being highly robust, equating towards an annualized 80% return out to 2025. My average cost basis for Hut 8 Mining is at $7.40 and is entirely invested within the warrants. I am looking to accumulate more warrants in the event the warrant price drops below $5, increasing the current position by 45%.
Financial Metrics on a Last Twelve-Month, LTM, Basis
Net Cash Position: $62 million
Revenues: $32 million
Gross Margin, GM: (50%)
Operating Cash Flow, OCF / Margin: ($1) million / (3%)
Free Cash Flow, FCF / Margin: ($0.1) million / (0.3%)
Shares Outstanding: 94 million
Enterprise Value, EV: $680 million
EV/Revenues: 21 times
Net Debt/OCF: N/A
Stock Price, SP/OCF per Share: N/A
SoFi is still expected to merge with Social Capital Hedosophia Holdings Corp. V (IPOE) in Q2 2021. As part of the Amended S-4 filing, SoFi disclosed all of its key operating and financial information. Since the company is engaged in loans, financial services, and a technology platform, there's quite a bit to unpack. Since the company is new, I'll try to give the high-level review of these operating segments first.
SoFi's lending segment includes student loan refinancing, in-school loans, personal loans and home loans. Total origination volume was $9.7 billion in 2020 with 51% being student loan-related, including just below 600,000 loans with a balance. The weighted average origination FICO score is above 765, equating to high quality loans. The financial services segment includes SoFi Money (cash management account), SoFi Invest (digital brokerage service), SoFi Credit Card, SoFi Relay (tracking of financial accounts in one place), and SoFi Protect (third-party insurance products). The technology platform segment is driven by Galileo Financial Technologies, which was acquired in May 2020. Galileo has significantly grown its client base over the past few years and provides services to a large percentage of financial technology and financial services companies.
Through these segments, SoFi's key metrics for performance include Net Revenue which was up 28% to $566 million and Members which was up 89% to 1.9 million in 2020. Total Products increased by nearly 115% to 2.5 million, and the addition of Galileo has added 59 million Technology Platform Accounts. Noninterest Income reflected nearly 69% of Net Revenue at $388 million up nearly 245% in 2020. Net Interest Income was down 46% in 2020, as loan origination volume was down 13.5%. The financial services segment was a key driver for Noninterest Income growing to $106 million in 2020 from $4 million largely benefitting from Galileo. Net Interest Income was weighed down mostly by interest income from loans as the combination of lower loan originations and interest rate earned impacted results.
Valuing SoFi is slightly complicated, as relying on OCF is misleading due to the company's loan segment, which includes line items from investing and financing activities. For this reason, it's better to value the company based on FCF. At the same time, SoFi's loan business also muddies the Enterprise Value, EV, as the B/S includes loans and debt that are connected as evidenced by the Cash Flow statement. Nonetheless, SoFi continues to see lumpy FCF performance making it difficult to project how the mid-term will unfold. FCF margin has ebbed from positive to negative, and positive performance has ranged from 21% to 52%.
SoFi like newer entrants including Affirm Holdings, Bakkt, and soon to be going public Coinbase Global, are all targeting the Financial Sector. Aside from some of the newer success stories like PayPal Holdings and Square, SoFi, like Affirm Holdings, Bakkt, and Coinbase Global are expecting to be leading future growth over the foreseeable future.
From a valuation perspective, SoFi is trading more closely with PayPal Holdings and Square for both EV/Revenue and OCF per share, assuming the company is able to achieve its growth targets. SoFi is predominantly exposed to the loan side of the business today. But the company is expecting a substantial increase in newer segments leading to further diversified growth drivers.
Management has guided 2021 Net Revenue at nearly $1 billion which is consistent with the merger announcement guidance. I am modeling SoFi to generate $1.5 billion in Net Revenue for 2022 in-line with management's guidance. Based on this, I have set a PT at $28 per share over the next 18-month period assuming 16 times EV/Revenue and 90 times FCF per share. I am assuming a premium FCF per share multiple above the current level, as I'm modeling a more conservative FCF margin at 20%.
Fintech is an area that I am keen on building further within the portfolio. Similar to other legacy/incumbent sectors and industries, I want to find the next wave of growth over the coming decades. There's a reason why companies like Visa, Mastercard, PayPal Holdings, Square, and newer Fintech entrants are trading at substantial premiums to traditional banking and payment peers. Like many other legacy industries, incumbents do not have the culture to innovate, and nor the desire or fortitude to change quick enough.
I own both common shares and warrants with SoFi with an average cost basis around $15.50 assuming warrant parity per and $11.50 exercise price. I am looking to increase my cost basis by nearly 130% if SoFi were to fall towards $14 or lower. I am only going to purchase common shares from this point forward, and look to realize gains from the warrants at the right time.
Over the mid-term, I am modeling SoFi to generate Net Revenue towards $4 billion by 2025, with a 30% FCF margin. Based on this, I am valuing SoFi to attain an EV/Revenue at 15 times, and OCF per share at 55 times equating to a mid-term PT at $57 per share. This reflects a potential annualized return of 27% over the next five years.
Financial Metrics on a Last Twelve-Month, LTM, Basis
Net Cash Position: $1.3 billion
Revenues: $566 million
Gross Margin, GM: 68%
Operating Cash Flow, OCF / Margin: ($479) million / (85%)
Free Cash Flow, FCF / Margin: $293 million / 52%
Shares Outstanding: 865 million
Members: 1.9 million
Total Products: 2.5 million
Technology Platform Accounts: 59 million
Net Interest Income Rev: $178 million
Total Noninterest Income Rev: $388 million
Enterprise Value, EV: $13.6 billion
EV/Revenues: 24 times
Net Debt/OCF: N/A
Stock Price, SP/FCF per Share: 51 times