Roku Stock Falls 17% Due to Morgan Stanley Downgrade

Shares of high growth tech stock Roku (ROKU) have fallen close to 17% at the time of this writing. The stock is trading in the red. Morgan Stanley (MS) downgraded the stock from “equal-weight” to “underweight,” according to a report from The Fly.

Morgan Stanley analyst Benjamin Swinburne increased Roku’s target price from $100 to $110. Currently, the stock is trading at $133. Swinburne is concerned about the company’s valuation. He expects the growth to slow down in 2020.

Roku shares have been on an absolute tear in 2019. The shares have returned 300% year-to-date, after accounting for the decline today. Roku is valued at $16.56 billion or 15x forward sales.

Roku’s growth estimates

Analysts expect Roku’s sales to increase 49.4% year-over-year to $1.11 billion. The company’s sales will likely rise 42.3% to $1.58 billion in 2020 and 33.6% to $2.08 billion in 2021. Although the revenue growth is decelerating, it’s still strong enough to move the stock higher.

Swinburne expects the company’s growth to slow down “meaningfully” in 2020, which will lead to a sell-off. Over the last few quarters, Roku has mainly beat analysts’ revenue and earnings estimates.

The company beat the adjusted earnings estimates in the last four quarters. In the September quarter, Roku reported earnings of -$0.22, which were 18.5% above the consensus estimates of -$0.27.

Roku’s earnings were -$0.08 in the June quarter—63.6% above the estimates of -$0.22. In the March quarter, the company’s earnings of -$0.09 were 64% above the consensus estimates. In the fourth quarter of 2018, Roku reported earnings of $0.05, which were 66.7% above the estimates.

What’s next for Roku and investors?

Although Roku has reported strong growth metrics historically, it’s struggling with profitability. The company ended 2018 with adjusted earnings of -$0.08. Despite revenue growth of almost 50% in 2019, the company’s earnings will likely fall to -$0.52 this year. In the fourth quarter, analysts expect the adjusted EPS to decline to -$0.14 from $0.05 in the same quarter the previous year.

While Roku’s sales are estimated to grow 42.3% in 2020, the earnings will likely rise just 11.5% next year. The company will likely post an operating profit by the end of 2021. According to analysts’ estimates, the company will report an operating profit of $3.38 million, which indicates an operating margin of 0.16%.

Will Roku be able to beat the consensus estimates again during the holiday quarter? The holiday season is critical for most companies. Several companies bank on the December quarter to drive sales and rake in record sales. In the fourth quarter, analysts expect the company’s sales to rise 42% to $391.46 million.

The stock could touch record highs if Roku beats the consensus estimates and provides strong guidance.

Why is Roku a long-term play?

The cord-cutting phenomenon and global shift to streaming drive Roku. According to one eMarketer report, approximately 56 million households in the US will cancel satellite TV or cable TV subscriptions by 2023.

The company’s shareholder report said, “Approximately 1.7 million consumers cut the cord in Q3 alone. Our own research indicates that roughly 50% of U.S. cord cutters are Roku customers, and cord cutters who choose Roku products are highly satisfied with the decision and extremely unlikely to consider returning to a traditional pay TV subscription.”

The shift to online streaming will likely increase in emerging markets in India and Southeast Asia. Currently, Roku generates most of its sales from the US. The company could grow its revenues due to international expansion.

The company’s two primary businesses are its player and platform segments. While the player segment generates revenues from device sales, the platform segment generates sales from ads, subscriptions, and licensing.

Although Roku competes with Apple TV, Amazon Fire Stick, and Google Chrome in the player segment, the rapid growth of streaming players including Apple TV+, Disney+, and others will hold the company in good stead.

Roku also acquired Dataxu for $150 million. The acquisition will help the company plan and purchase video ad campaigns. Also, the acquisition will help the company gain traction in the programmatic ad space, which is valued at $60 billion in 2019.

Analysts’ target price estimate 

Due to Roku’s high valuation metrics, the stock will fall significantly if it doesn’t meet the consensus estimates. Fears about an upcoming recession might drive the stock to multiyear lows. We saw that the stock lost more than 35% in September due to the sell-off impacting high growth tech stocks.

Analysts are bullish on Roku stock. Among the 18 analysts tracking the stock, 12 recommend a “buy,” four recommend a “hold,” and two recommend a “sell.” Analysts have an average target price of $141 for the stock.