Summary in seconds
I continue to rate Spotify Technology SA (NYSE:SPOT) as a buy. My previous article for SPOT was written on January 18, 2022, and was about “the company’s competition with TikTok and Resso”. I’ll spend time on Spotify’s historical stock price performance, Q1 2022 guidance, and its five-year mid-term outlook in my last post.
I expect Spotify to hit the lower end of the company’s long-term gross profit target (30%) in five years. This should be the main catalyst for the revaluation of SPOT shares, which only trade at a multiple of enterprise value to single-digit earnings. As such, I believe SPOT’s stock is currently undervalued and deserving of a Buy rating.
How has Spotify Stock fared in 2021?
Spotify’s share price performance was poor in 2021 and things didn’t look up at the start of 2022. SPOT shares fell -24.8% for the full year of 2021 and again dropped -25% this year so far. Spotify also underperformed the S&P 500 significantly during these periods.
SPOT stock price performance in 2021
Spotify Share Price Performance in 2022 YTD
I think Spotify’s stock has done poorly in 2021 as it doesn’t appear to be nearing its long-term gross profit margin target in the 30% to 40% range. According to financial data from S&P Capital IQ, SPOT’s gross margin fell from 25.5% in the first quarter of 2021 to 28.4% in the second quarter of 2021, before contracting to 26.7% and 26.5% for the third quarter of 2021 and the fourth quarter of 2021, respectively.
During the company’s most recent Q4 2021 earnings call on February 2, 2022, Spotify appeared to have acknowledged that its gross profit margins over the past quarter had disappointed the market to some degree, noting that the focus on ” investments could slightly alter the progress we’ve seen in consolidated gross margin over the past 2 years.” But Spotify also stressed on the call that “it is exactly this progress that has given us the conviction to increase our investments in certain areas and gives us confidence that we are on the right path for the long term”.
In other words, Spotify is sacrificing near-term margin expansion by investing more to drive future growth, which has negatively impacted the company’s recent gross margin trends.
I also explain why SPOT stock price has been weak in 2022 year-to-date in the next two sections of the article.
Key Spotify Stock Metrics
Spotify has provided advice on a number of financial measures for the first quarter of 2022 as part of the company’s strategy. Announcement of fourth quarter 2021 results. The key metrics, which were part of SPOT’s first-quarter management guidelines that investors should take note of, are monthly active users or MAUs and total premium subscribers.
SPOT’s Q1 2022 MAU forecast of 418 million was -1% lower than the market consensus estimate of 422 million, while its expected number of premium subscribers for the first quarter of this year was 183 million, or -1% less than Wall Street analysts’ forecast of 185.3 million.
Spotify didn’t seem to care about what was perceived as lower-than-expected MAUs or premium subscribers by the market. SPOT pointed out during the recent Q4 2021 earnings briefing that “there are different seasonal trends and patterns every year”, and pointed out that “what we have seen over the past two years, it’s that the first quarter has become less and less important to us for year-over-year growth.” Nevertheless, SPOT will need to consider growth in MAU and premium subscriber metrics for the year 2022 and beyond to proving the detractors wrong.
Is Spotify a safe bet?
Risk assessment is an essential part of the evaluation process of any potential investment candidate. When deciding if Spotify is a safe bet, I basically try to consider the likelihood or impact of any major risk factors for the business.
One such risk factor that has recently come into the spotlight is the potential departure of content creators. January 31, 2022 Looking for Alpha The news article pointed out that “Neil Young, Joni Mitchell and Nils Lofgren have all removed their music from Spotify in response” to “a podcast episode featuring mRNA virologist Dr. Robert Malone in the ‘show from popular host Joe Rogan’. It’s also possible that Joe Rogan will also leave, although he recently rejected an offer from a competitor.
I agree with management’s view that this should be a short term issue that will eventually go away. Spotify mentioned during the company’s recent fourth quarter earnings briefing that “we’ve had controversies in the past, these are measured in months not days.”
Also, Spotify refers to itself as “the most popular audio streaming subscription service in the world” and it’s also “the #1 podcast platform” in the United States as I highlighted in my previous post on November 18, 2021 Unless a significant proportion of content creators leave the Spotify platform, a massive user exodus is unlikely.
In conclusion, I continue to think that Spotify is a safe bet in relation to the risk factor linked to the potential departure of content creators.
Where will Spotify Stock be in 5 years?
In determining Spotify’s five-year outlook, the most important factor is profitability and the key metric is gross profit margin. As I noted in an earlier section of this article, the underperformance of Spotify’s stock price is likely due to its inability to bring its gross margins closer to its long-term target of 30-40%.
Market consensus according to S&P Capital IQ data currently projects SPOT’s gross margin to gradually improve from 26.8% in fiscal 2021 to 27.5% in fiscal 2023, before improving to 29.5% in fiscal year 2025. I think Spotify should eventually reach the 30% gross margin level. in five years at the latest, which is aligned with the Wall Street consensus forecast.
Although Spotify is still in investment mode in 2022 as mentioned earlier in this article, SPOT should be in a good position to reap the rewards of its investments in the medium term. Notably, Spotify disclosed on its fourth quarter earnings call that it observed “revenue per hour listened to is growing at a faster rate than cost per hour listened to” and “leverage begins to appear” for certain content that is more than a year old. This suggests that Spotify could see an acceleration in margin expansion, when the company eventually slows the pace of its investments.
Is SPOT stock a buy, sell or hold?
Spotify remains a purchase. The market currently values SPOT at a very modest consensus over the next twelve months of the multiple of enterprise value to revenue of 2.3 times based on financial estimates obtained from S&P Capital IQ. Shares of Spotify are expected to see a substantial revaluation from current levels when it reaches its gross profit margin target in five years.