Often lumped with some of the biggest retail beneficiaries since the onset of COVID-19, shareholders of both Temple & Webster Group Ltd (ASX: TPW) and Redbubble Ltd (ASX: RBL) have been handsomely rewarded, with shares returning roughly 485% and 860%, respectively, over the last 12 months.
Given how hard both have rallied, I think it’s worth investigating how their valuations stack up today in order to get a rough sense of value. I will use a comparative valuation method for both companies.
Temple & Webster
At first glance, TPW’s shares look fairly expensive on a trailing Price/Earnings (P/E) ratio of 79x. Meaning, its market capitalisation is 79x larger than its annual net profit reported in FY20.
However, it’s important to note that TPW has only recently reached an inflection point on a net profit basis within the last couple of years, so as such, it’s quite understandable why the P/E is relatively high.
Being in a growth phase, TPW’s main priority is continuing to drive revenue growth by investing in private label inventories as well as further building the brand through higher marketing spend. Over time, these costs will normalise, margins will hopefully expand and its net profit figure will hopefully also trend upwards resulting in P/E that will most likely revert to a slightly more normal level.
I’ll use Nick Scali Limited (ASX: NCK) as a comparison company, because it’s also an Australian retailer with a capital-light business model, but also because it’s more mature and has had consistent margins for years now. Nick Scali typically achieves a net profit margin of roughly 16%, much higher than TPW’s net profit margin of 7.9% for FY20.
Based on analyst consensus estimates, it looks like TPW is on track to achieve FY21 revenue of $325 million. I’ll assume hypothetically that at some point in the future TPW might also be able to achieve the same 16% net profit margin, giving a net profit of $52 million. I’ll apply the average retail P/E multiple of 20x to arrive at a market capitalisation of just over $1 billion, implying a fair value of roughly $8.30 per share.
Therefore, based on TPW’s current revenue-generating capacity, the valuation seems pretty fair in my view, but it does assume margins are much larger than they currently are and as such, I’d want to see TPW’s shares slightly lower than where they are today for them to be a potential buy.
Redbubble
I’ve taken a look at ETSY Inc (NASDAQ: ETSY) in order to get a rough sense of the value of Redbubble, but it’s worth noting some important difference between the two.
Etsy is extremely capital-light in comparison. Its cost of goods sold (COGS) primarily consists of interchange and other fees for credit card processing services, as well as the back end cloud-based infrastructure. Gross margins in FY20 were 73%, and its net income margin was 20%.
Compare this with Redbubble, where it’s also responsible for fronting the fulfilment costs involved in the order. Things like product printing, shipping, and transaction costs really seem to add up, and typically accounts for 60% of its marketplace revenue. Its gross margin was 38% in FY20.
Given that Etsy is achieving a net profit margin of 20% without all the fulfilment costs involved, I don’t think it’s likely that Redbubble is going to achieve a similar margin any time soon. I’m going to arbitrarily say that Redbubble can achieve a 10% net income margin instead.
Analyst consensus estimates indicate that Redbubble’s revenue could be around $566 million in FY21, giving a net profit of $56.6 million, assuming the 10% margin which could be achieved at some point.
Applying the same P/E of 20x, results in a fair market capitalisation of $1.1 billion, implying a fair price of roughly $4 per share.
It’s important to remember some assumptions and limitations of a valuation method such as this, also apply to TPW. Firstly, I’m using its current revenue-generating ability and not accounting for future growth. Secondly, the net income margin is an estimate, so it might be completely off the mark in the future. Thirdly, it assumes the market will be willing to pay 20x for each $1 of earnings, which again, might be higher or lower.
Redbubble’s business model isn’t as capital-light as I originally thought. Ideally, as the business grows, it can achieve some economies of scale and fulfilment costs will come down as a proportion of revenue. At the current valuation and where margins currently are, shares don’t appear to be in bargain territory.
Which is the better pick?
Redbubble’s valuation might not make complete sense today, but I like the idea behind the company slightly more than TPW. While COVID-19 is still ongoing, this is a nice little tailwind in its overseas markets, and I also think it could maintain a lot of that momentum once the world is allowed to go outside again.
TPW’s valuation seems fairly justified, but its operations are limited within Australia (for now), so its only chance of growing its addressable market is by expanding its product offering, which it is actually doing, and as such, I think TPW will continue to perform well over the long-term as well.
