It’s almost never enough to just read the headline earnings from a company and ignore the rest of the information. I’m constantly amazed at the amount of information the average investor can glean from a quarterly earnings release. When looking at Groupon Inc (NASDAQ:GRPN)’s recent earnings, I found two issues that are standing in the way of the company’s earnings growth. The good news is, they are both 100% controllable by the company. The bad news is, neither issues is easy to fix.
Groupon Goods Should Scare Both Online And Traditional Retailers
Most people know Groupon Inc (NASDAQ:GRPN) for their daily e-mails with deals on all types of products and services. However, Groupon launched Groupon Goods within the last year, and this category is growing so fast, that it may soon take over as the company’s number one business.
In case you aren’t aware, Groupon Inc (NASDAQ:GRPN) Goods is the company’s exclusive pricing on retail goods. This offering is a real threat to retailers of all stripes. Part of what makes Amazon.com, Inc. (NASDAQ:AMZN) so successful is their relentless focus on price and convenience. However, what hurts Amazon.com, Inc. (NASDAQ:AMZN) sometimes is their massive selection.
Just as an example, Groupon is currently offering an Asus 14” laptop for $299.99. If you want to try and price compare through Amazon, you’ll have to look at 108 different Asus 14” laptops. Too many choices may cause customers to just assume that Groupon has the best deal. In addition, Groupon is beating Amazon on free shipping with orders of $15 versus Amazon.com, Inc. (NASDAQ:AMZN) requires a purchase of $25 or more.
Speaking of traditional retailers, Groupon Inc (NASDAQ:GRPN) Goods also poses a direct threat to two of the largest domestic retailers in Target Corporation (NYSE:TGT) and Wal-Mart Stores, Inc. (NYSE:WMT). Think about this, Wal-Mart and Target have convenience on their side, as they have over 1,700 and 4,000 domestic locations respectively. However, neither store offers free shipping on orders of $15 or more with no other qualifications. In addition, neither Target or Wal-Mart can match Groupon Goods prices.
Forget About Daily Deals, Goods Could Be A Category Killer
In the most recent quarter, Groupon’s traditional business saw revenue decline 13.66%, but Groupon Goods’ revenue increased 1,549%! When you consider that Groupon Goods launched about a year ago, for this category to make up more than 35% of revenue is astounding.
While Amazon is talked about for many things, over 60% of the company’s revenue is from general merchandise sales. While Amazon’s 28% increase in merchandise sales last quarter was impressive, it is nothing close to the 1,500%+ increase that Groupon Inc (NASDAQ:GRPN) Goods just turned in. Target and Wal-Mart are doing well, but analysts expect just a 3% increase in revenue at Target this year, and Wal-Mart is expected to see a 4.7% increase.
With 41 million active customers, and this count up 22% year-over-year, you can be sure some of these customers were hooked by a Groupon Goods offer.
But….There Are 2 Big Challenges
While the traditional Groupon business has massive margins due to the lack of inventory, the opposite is true of the Goods business. In fact, compared to Amazon.com, Inc. (NASDAQ:AMZN)’s gross margin of 24.13%, Target at 28.88%, and Wal-Mart at 26.56%, Groupon Goods’ gross margin was just 2.93% in the current quarter. That’s not a mistake; I said less than 3% was their gross margin.
One challenge Groupon faces is, they have to focus on price to make sure these deals can’t be outdone by Amazon, Target, Wal-Mart, or others. In addition, while the growth in this category is impressive, the company only sold $225 million of Goods in the current quarter. Compared to over $21.27 billion in sales at Amazon.com, Inc. (NASDAQ:AMZN), $22.73 billion in sales at Target, and $127.92 billion at Wal-Mart, Groupon Goods sales are not much more than a rounding error to their peers. The bottom line is, the company needs scale before they can gain better margins.
The second big issue is the amount Groupon Inc (NASDAQ:GRPN) is spending on selling, general, and administrative expenses. In the current quarter, Amazon.com, Inc. (NASDAQ:AMZN) spent 22.22% of revenue on SG&A, Target spent 19.19%, and Walmart spent 18.13%. By comparison, Groupon spent 48.19% of revenue on SG&A expenses.
What Happens If Groupon Goods Reaches Better Scale?
The average of Groupon’s peers in SG&A spending is 20%, Groupon in the last four quarters spent more than three times this percentage. If Groupon could lower their SG&A expenses to say 20% of sales, the company’s earnings per share would change significantly.
In the last four quarters, Groupon Inc (NASDAQ:GRPN) spent over $1.5 billion on SG&A expenses. Cutting this line item to 20%, would mean a cost savings of about $1.05 billion. With this adjustment, Groupon’s EPS in the last four quarters would have been $1.59 versus a loss of $0.10.
This is the crux of the Groupon story, if the company attains better scale and can improve margins and cut SG&A expenses, the stock would be ridiculously cheap. At current prices, the aforementioned $1.59 in EPS would give the stock a P/E of 3.6. I’m not saying this is going to happen overnight, or that it will happen at all.
However, if you believe in Groupon, it seems like there is a massive opportunity here. If you don’t believe in Groupon, check out their Groupon Goods and do some price comparisons of your own. When neither Amazon.com, Inc. (NASDAQ:AMZN), Target, or Wal-Mart can beat their prices, think about whether Groupon is a real threat or not. Groupon Inc (NASDAQ:GRPN) faces some real challenges to grow this business, but if they can make it work, the price of Groupon stock could be the best deal of all.
The article 2 Roadblocks To This Company’s Growth originally appeared on Fool.com and is written by Chad Henage.
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