Spotify Stock (NYSE:SPOT)
After a successful fiscal year-end, we’ve decided to upgrade Spotify (NYSE:SPOT) to a hold. We had previously written on Spotify with a sell recommendation because we believed the firm would be unable to turn a profit in light of the current macroeconomic environment. After seeing a 20% YoY gain in monthly active users (MAU) and cost-cutting efforts, we have a more positive outlook on Spotify. However, we still think Spotify is under pressure soon on two fronts: finding out how to navigate the macroeconomic obstacles and regaining epidemic growth levels. We anticipate that the challenging macroeconomic climate, including the softening ad expenditure and growing operational costs, will continue to pressure Spotify’s financials soon. Spotify’s ad-supported income and podcast services are significant growth drivers in the medium to long term. Still, it is likely to contribute little to Spotify’s growth soon. We still think the stock has further to go before it soon offers an attractive risk-reward ratio.
Still Navigating Short-term Obstacles
The 4Q22 earnings report gave Spotify investors reason to be optimistic about the fiscal year 2023, but we anticipate that the firm will face macroeconomic challenges soon. Even though we anticipate Spotify’s user base to expand healthily, the company’s profit margins will take a lot of work to expand. Although Spotify’s gross margin in 4Q22 was better than expected at 25.3%, the business expects a lower 1Q23 margin of 24.9%. As we approach 1H23, we anticipate a further normalization of gross margins.
We also think it’s noteworthy to draw attention to Spotify’s operational expenditures, which increased by 44% year over year. In our opinion, the increased operational expenses directly result from the company’s increasing employee costs and advertising expenditures. Spotify’s operational costs have been increasing at a higher pace than the company’s revenue as of the most recent quarter. The hold rating was increased because we anticipate a gradual but steady transition to total revenue growth outpacing operating expenditures. However, we anticipate this to occur in less than 1H23.
Getting Closer but Not Quite There
With its unexpected increase in users and newfound efficiency, Spotify seems to be heading in the right direction. The corporation has previously indicated that it would slash 6% of its workforce in January, following the trend of layoffs in the IT industry. The market responded positively to Spotify’s layoffs, sending the stock up roughly 4% in Monday’s pre-market trading. Spotify’s ad-supported and podcast income is likely to rise at a faster rate than its other sources of income. We are pessimistic because we don’t think either will enjoy significant tailwinds in the foreseeable future. Below, we discuss the two factors we see as crucial to Spotify’s future expansion:
- Earnings from Ads:
Even though Spotify’s premium income is rising at a healthy 18% year over year, we anticipate that the firm will have difficulty expanding its ad-supported revenue, which rose at a more modest 14% year over year. We anticipate that the macroeconomic challenges will pressure the company’s ad-supported revenue due to lower pricing. We anticipate that Spotify will need more time to fully insulate its ad-supported income from the current softer spending environment. A decrease in ad expenditure growth is anticipated for 2023 due to the macroeconomic challenges and economic slowdown. Magna, a division of Interpublic Group (IPG), predicts that ad revenue will increase by 4.8% this year, down from the 6.3% rise predicted for 2023 in June. As a result of the slowing rise in ad expenditure, we anticipate a decline in Spotify’s ad revenues for the first half of fiscal year 23.
- Growing its presence as an “audio company”:
With podcast revenue expanding in the mid-30% range Y/Y, we think Spotify is countering the macro challenges by investing in its Podcast services. We see a bright future for Spotify as it expands its offerings beyond just music and establishes itself as a leading audio streaming provider. We anticipate Spotify will be able to capitalize on the rapidly expanding podcasting business, which is expected to increase at a whopping CAGR of 31.2% between 2022 and 2030. But we still think that podcast revenue can’t make up for the economic headwinds that pressure the company’s profits in the short future.
Valuation
Despite Spotify’s low price, we don’t think it’s yet time for investors to jump on the weakness and purchase the company. Compared to its competitors, the stock sells at a lower multiple of 1.4x EV/C2024 Sales. We think Spotify is headed in the right direction and may reach epidemic growth levels, but we anticipate more decline in the short term due to the weaker spending environment.
News from Wall Street
The stock market is just as pessimistic about Spotify as we are. There are 32 analysts following the company; 14 recommend buying, 17 think you should hold, and the rest say you should sell. SPOT stock sells for about $125, close to the consensus price objective of $125. Meanwhile, analysts have set an average price objective of $127.
How To Proceed With Spotify Stock
We are changing our recommendation on Spotify stock from a sell to a hold. While the company’s new subscribers and cost-cutting initiatives are encouraging, we still believe Spotify faces challenges from macroeconomic headwinds that might lead to a poorer spending environment on the consumer and advertising fronts. In the medium to long term, we see hope for Spotify, but in 1H23, we expect the company to face more losses. With over 30% below its 52-week high of $178, Spotify stock has dropped about 29% over the last year. While we have a long-term optimistic outlook on Spotify, we do not think the stock price now represents a good opportunity to buy. While the decline over 1H23 has been included in expectations for Spotify’s 2H23 profits, we will continue to monitor the company’s performance.
Featured Image: Freepik @ ezphoto
