Cricut: Near-Term Outlook Continues To See Pressure From Poor Macro Backdrop (NASDAQ:CRCT)

Investment overview

I wrote about Cricut, Inc. (NASDAQ:CRCT) previously (June 2024) with a sell rating as I expected demand to stay weak for the foreseeable future given the poor macro environment. Despite the stock down ~12% since my post, I still see downside to the share price as I believe near-term demand is going to remain weak. Until CRCT shows strong improvements in its key operating metrics (user engagement, growth, and conversion), I expect the stock to continue trading at the low end of its historical range.

Macro conditions remain poor

A large part of my negative view on the business outlook is because of the poor macro conditions back then, as CRCT is largely a discretionary spend. Between now and then, even though inflation rates have tapered, I believe consumers are still very cautious in their spending—i.e., the discretionary spending environment still remains poor. There are multiple macro indicators that point to this view, which I have written in my Savers Value Village (SVV) write-up. Below, I quote a relevant section:

“Firstly, consumer confidence is still poor. Secondly, consumers are pulling back on discretionary spending, as evident from what consumer-facing companies (such as Home Depot, travel and leisure companies, Disney, Airbnb, etc.) are experiencing. However, major retailers (Walmart and Target) that are known to keep prices low are not seeing any signs of a consumer slowdown. This dynamic tells me that consumers are gravitating their purchase behavior toward more value purchases…”

While the Fed cutting rates is a positive development for the macro climate, I don’t think investors should place their hope that this initial cut will drive a strong rebound in discretionary spending. Such things take time to translate into positive impact at the consumer end, and remember that rates are still at very elevated levels (even if the Fed cuts by half a percentage point) vs. the recent history. The biggest impact that a rate cut will have is on mortgage rates, and the idea is that lower mortgage rates reduce monthly household expenses, and this gives room for more discretionary spending. While true, I don’t think the impact will be sizeable with even a 100bps point cut, as a substantial portion of US mortgages are below 5%. Moreover, the recent job opening data in the US is not encouraging at all, as it suggests the economy remains weak (companies’ demand for workers is slowing).

As such, I don’t see a strong case for discretionary spending to pick up over the near term, and this directly impacts CRCT’s ability to grow.

Growth initiatives are encouraging but not enough

There are a few bright spots in the business that may look positive at a glance, but I believe the overall trajectory of the business (over the near term) is a negative one.

Firstly, connected machines grew ~18% in 2Q24, an acceleration from 8.3% in 1Q24. At face value, it seems like CRCT is able to capture demand despite a poor macro backdrop. However, I believe this is a result of CRCT pulling demand forward by adopting a promotional strategy (introduced in late 2023). Note that CRCT sales motion is selling to retailers (sell-in), who then sell out to end-users; as such, I believe the sizeable portion of the 18% growth is simply retailers stocking up their inventories since they haven’t done so in a while (FY21 average quarterly revenue was $137 million but dropped to $63 million in FY22 and $49 million in FY23). Moreover, if end demand is indeed strong, CRCT should have seen accessories and materials [ANM] revenue grow strongly, but it didn’t. ANM revenue continued to decline at a large magnitude of ~27% in 2Q24, accelerating by 20 bps sequentially.

Secondly, management also commented positively about its acquisition and engagement efforts relating to recently acquired cohorts. In particular, they highlighted a y/y growth in the number of members completing a project in their first day. Giving management the benefit of doubt that this is true, I don’t think it’s enough to rejuvenate growth. The reality I see today, as per the reported results, is continued softness across user acquisition, engagement, and conversion:

1. Average users fell sequentially from 5.952 million to 5.918 million.
2. Paid subscriber sequential growth remained poor at 0.6%.
3. Engaged users (users that created in the last 90 days) fell by 3% y/y to 3.54 million. Notably, this was driven mostly by continued engagement declines from both the 2020 and 2021 cohorts, despite management’s continuous implementation of strategic initiatives (e.g., better discovery algorithm) to drive engagement growth.

Expectations ahead / Valuation

Looking ahead, I believe CRCT will continue to report revenue decline for the near term, and management guidance and comment support my take. Specifically, they guided 3Q24 revenue to decline y/y and for FY24 to likely decline on a full-year basis. Also, they noted retailers continue to be cautious on restocking.

We expect continued sales pressure on our product segment, especially in accessories and materials, and accordingly, total company revenue may be down Q3 year-over-year. We will continue to accelerate marketing to generate consumer excitement, but given ongoing retail conservatism and pressure in our accessories and materials segment, as well as year-to-date performance, it is too soon to call an inflection point. Hence, we may even see a decline for full-year company revenue.

Some retailers started to restock inventory levels on connected machines partially in Q2, unlike in 2023, when they were destocking more broadly. Company 2Q24 earnings

To combat this, the management strategy is to continue implementing promotional activity to help spur demand (for connected machines). Certainly, this may drive sales growth (like it did in 2Q24), but I don’t see this as something sustainable given weakness at the end-user level. On the flip side, this just means that connected machines revenue growth will slow once promotion ends (dragging down overall growth). In addition, given that product revenue has a much lower gross margin profile (23.3% in 2Q24 vs. Platform at 88%), the higher mix of connected machine revenue will also pressure margins in the near term.

Currently, CRCT trades at 19.2x, and my view is that valuation, with all of the above in mind, will trade down to the low end of its historical trading range (18x to 33x forward PE) if CRCT reports soft revenue and operating metrics in the coming quarters. In the worst case, multiples could retract back to where it traded earlier this year at ~15.5x, and this implies ~20% downside.

Risk

An earlier than expected recovery in discretionary spending—be it driven by Fed rate cuts or any other drivers—could drive a recovery in growth. Given the multiple that CRCT is trading at today, which embeds little growth recovery expectation, this may drive a strong share price upside movement as the market rerates CRCT back to the historical average of 25x forward P/E.

Conclusion

I give a sell rating for CRCT. Despite efforts to drive growth and engagement, I still believe the near-term outlook remains bleak given the challenging macroeconomic environment. While the increased connected machine sales may seem positive at a glance, I don’t think it reflects an improving demand profile. As a result, I maintain a negative outlook for CRCT.