Investment overview
I give a sell rating for Cricut, Inc. (NASDAQ:CRCT), as I expect demand to continue staying weak in the near term given that the macro environment remains soft. As consumers’ discretionary spending stays pressured, I expect lesser demand for CRCT’s main product (the machine), which will have a direct impact on demand for platform services, accessories, and materials.
Business description
CRCT is in the business of providing computer-controlled cutting machines for home crafters so that they are able to better design and create products of their liking. I have attached a picture below so that you can get a better sense of what product CRCT is selling:
The primary business units (segments) are: product (60% of FY23 revenue), and platform (40% of FY23 revenue). For reference, previously, the business had three major segments: connected machines (26% of FY23 revenue), platforms (40% of FY23 revenue), and accessories & materials (34% of FY23 revenue).
In the latest quarter (1Q24), reported on 7th May, CRCT saw total revenue of $167.4 million, which was down 7.6% vs. 1Q23; a gross margin of 54.7%, a big improvement from 42.3% in 1Q23; an EBITDA margin of 20%, also a big step up from 10.9% in 1Q23; and a net margin of 11.7%, up 670bps vs 1Q23. At the EPS level, CRCT reported $0.09 EPS vs. $0.04 in 1Q23.
Negative business outlook
I have a very negative view of the business outlook over the near term (6 to 12 months). Although profitability was a very positive highlight in the latest performance, the fact of the matter is that the business continues to see negative growth, and I don’t see any catalysts that could drive positive growth in the near term.
Starting with the poor macro conditions, my view is that CRCT is going to continue feeling the pressure as consumers’ spending power remains pressured, with no near-term visibility to when this would end. The recent US inflation data shows that inflation remains very sticky, and on a 3-month rolling average basis, the economy is back to where it was in 3Q23. This is really negative for consumer spending because it implies two things:
- The impact of high interest rates is not showing up as much as it should, which means
- Interest rates are going to stay higher for longer, and the scary part is that the Fed did not rule out the possibility of more rate hikes.
The nature of the CRCT business is that it is heavily exposed to how much consumers are willing to spend on discretionary items. The entire sales model revolves around CRCT selling the main product (the machine). Consumers would then subscribe to CRCT for design patterns and purchase tools and accessories to facilitate their cutting processes. In my opinion, the weak macro conditions will cause a huge drop in demand for the main product. Note that these machines are not cheap items that cost <$50. According to CRCT’s website, these machines cost from $100 all the way up to >$1,000. The decline in demand has a direct impact on platform revenues as there are fewer customers (less product owners) added to the CRCT customer base, and CRCT’s financials already show this weakness.
There are also several other signs of demand weakness. For instance:
- The number of active users continues to slow down on both a sequential and annual basis
- User engagement over the trailing 90 days went down by 5% to 3.5 million
- Most importantly, paid subscriber annual growth decelerated for the 7th consecutive quarter, from 35% in 3Q22 to just 3% in the latest 1Q24
With all these data points, I believe they are sufficient to prove my point that demand is slowing and is at an inflection point where it could turn negative if the macro conditions continue to remain soft. Management comments about 2Q24 performance did not show any positive signs of recovery or stabilization, as they noted that retailers continue to be cautious about restocking and that they expect a continuation of soft consumer spending trends.
Aside from macro weakness, management also called out competition as a major headwind to its accessories & materials segment, and this is particularly worrisome. This segment is around 33% of the business, and it is one that has the least barrier to entry (there are thousands of art and craft shops that consumers can purchase from). I expect this segment to continue dragging down overall growth as it not only faces the impact of a weak macro backdrop (lower product sales impact the demand for accessories and materials) but also from competition.
Puzzled at the new capital return program
I am also very puzzled by the new capital return program, which includes a $50 million share repurchase authorization, a $0.40/share special dividend, and a new recurring semi-annual dividend of $0.10/share. This may sound good to shareholders, but my inference from this action is that management had no better alternatives to deploy this amount of cash. I would’ve expected them to reinvest in the business to figure out a way to revive growth (my worry is that there is no way for CRCT to regain growth even if they deploy capital).
Hence, even with this capital return program, until I see signs of demand stabilizing or recovering and underlying user metrics getting better, I am not going to turn positive.
Valuation
Based on my research and analysis, my expected target price for CRCT is $4.
- I am expecting revenue to continue declining for the rest of the year (FY24) at the same rate as 1Q24, as I do not see any catalyst to drive up growth in the near term. That said, I do think the FY25 macro backdrop should be better than FY24, and CRCT should see some form of recovery. For FY25, I assumed a decline of 2%, following the same y/y growth uplift of 600 bps (FY24 -8% growth was a 600 bps step up from FY23).
- On earnings margin expectation, I give management the benefit of doubt that they can achieve their FY24 guide and maintain that for FY25, given that they did show strong margin performance in 1Q24.
- CRCT trades near its historical average multiple of 24x today, which, I believe, is not accurately reflecting the continuous slowdown of the business. Just a few months ago, the stock was trading at 18x forward PE, and I believe that is the potential downside that CRCT could face. Assuming CRCT trades at 18x, it implies a share price of ~$4.
Risk
Given that subscription revenue and accessories & materials revenue growth trail connected machine sales, higher than expected connected machine sales would prove my topline estimates to be too conservative. In particular, Cricut recently launched in several new markets internationally that could drive faster than expected growth.
Conclusion
I give a sell rating for CRCT given the weak demand and outlook. I believe the negative macro environment will continue to put pressure on consumer discretionary spending, which directly impacts the sale of CRCT main machines. This weakness is expected to translate into fewer platform subscriptions and materials & accessory demand. Additionally, user metrics show a clear downtrend, which is very worrisome. Lastly, the new capital return program seems more like a desperate attempt to appease shareholders and doesn’t address the fact that growth is slowing/potentially turning negative.
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