Roku Stock Looks Attractive After a Meaningful Correction
Roku (NASDAQ:ROKU) stock surged to highs of $490 in July 2021. However, the company’s second-quarter results didn’t impress the markets. A sharp correction ensued, and ROKU stock closed yesterday at $316.
At its current levels, Roku appears to be attractive. There are positive catalysts for its sector even as the space gets more competitive. Therefore, the company can grow in the coming years.
My view is backed by a recent note from Citigroup. Even after factoring in the slowdown of Roku’s user growth last quarter, the bank has a price target of $410 to $450 for the stock. If it reaches the midpoint of that range, ROKU stock can climb more than 30%.
The Positive Aspects of Roku’s Q2 Results
As of the end of Q2, Roku reported that its active accounts had jumped 28% year-over-year to 55.1 million. However, compared with the previous quarter, its active user count rose by only 1.5 million.
But there were some positive aspects of the company’s Q2 results.
First and foremost, Roku reported that its average revenue per user had jumped 46% YOY to $36.46. It’s worth noting that its ARPU has been climbing on a quarter-over-quarter basis this year as well.
Furthermore, for Q2, the company reported that its platform revenue had soared 117% YOY to $532.3 million. The company’s revenue from its players climbed just 1% to $112.8 million. However, Roku’s platform revenue, which is generated from advertising, distribution fee and subscriptions, is the cash flow driver for the company.
The key point to note is that the platform segment’s gross margin was 64.8%. On a YOY basis, its gross margin expanded by 8.2 percentage points. So the growth of Roku’s core business and its margin expansion have been strong.
Positive Sector Catalysts
Within the platform segment, a key revenue driver was advertising. According to estimates, the global demand for smart TVs came in at 268.9 million units in 2020. Importantly, the demand for the devices is expected to climb at a compound annual growth rate of 20.8% through 2028.
Another estimate suggests that the global smart TV market is likely to rise by over 293 million units between 2020 and 2024.
Therefore, Roku has multi-year growth catalysts. The increase in the number of connected TVs is likely to have a positive impact on the company’s advertising revenue.
An important point to note is that Roku doesn’t produce original content. The company is, however, in the business of content distribution and licensing.
In March 2021, Roku acquired This Old House and Ask This Old House. They were the two top-rated home improvement TV shows in the U.S. in 2020. With the company acquiring more quality licensed content, its growth is likely to be robust going forward.
It’s also worth noting that the the global connected TV installed base is significantly fragmented. At the end of 2020, the market share of the Roku TV OS was 6.4%. while Samsung (OTCMKTS:SSNLF) was the leader with a global market share of 12.7%. In the U.S., Roku had a market share of 22%.
In the coming years, the market will consolidate. One of Roku’s advantages is that it spends more on research and development than its competitors.
In Q2, the company’s R&D spending jumped 34% YOY to $113.3 million. The company’s hardware innovations might provide Roku with an edge in a highly competitive and fragmented market.
Roku ended last quarter with cash and equivalents of $2.1 billion. I would not be surprised if it pursues acquisitions to boost its market share. The company’s financial flexibility also gives it the ability to obtain more quality content.
The Final Verdict on Roku Stock
ROKU stock looks interesting after it fell sharply from its highs. It seems that the markets might have overreacted to the recent deceleration of its subscriber growth.
Given the positive catalysts of Roku’s sector and the strong growth of its platform revenue, the stock is attractive. As the adoption of smart TVs continues to increase, the company’s advertising revenue will remain a key driver of its cash flow.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.