Can Naked Wines prove there’s life beyond the pandemic for its business?

In 2020, investors rushed to buy any equities that looked set to benefit from the pandemic, such as online grocer Ocado (LSE: OCDO). As sales on its platform surged, the stock shot to the top of the FTSE 100 leaderboard. It ended the year up 82%, the second-best performance in the FTSE 100.

Naked Wines (LSE: WINE), the company formerly known as Majestic Wine before it sold the legacy brick-and-mortar business in 2019, was also a pandemic winner. In the financial year to the end of March 2021, the company’s revenues jumped 70% and investors bid the shares higher by 200%.

But as the world has reopened, investors have turned their backs on the company, and bets against the business have mounted. The share price has fallen by 55% over the past 12 months and it has topped the table of the ten most-shorted equities on the London market, according to IHS Markit Ltd.

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However, the company’s fundamental performance is continuing to improve. Group sales rose by 3% in the year to the end of March, up 72% on a two-year basis when compared with 2020. More importantly for the subscription-based business, sales retention hit 80% compared to mid-70s guidance, while repeat customer sales grew by 11% year-on-year.

Naked Wines is building a competitive advantage in a tough market

Naked Wines’s direct-to-consumer model cuts out the middle retailer, which should give the company more flexibility, but it does expose the business to fickle consumers. It is also harder to grab market share as there are plenty of other businesses trying to develop the same model with varying degrees of success, such as Naked’s London-listed peer Virgin Wines (LSE:VINO).

There’s only ever going to be so much demand for wine subscriptions from UK consumers and costs will rise as companies such as Naked and Virgin battle it out for success. In this battleground, companies that can build a leading position early will have the advantage.

Naked Wines claims to be the “world’s number one” direct-to-consumer wine business, connecting 964,000 customers to 225 “world-class winemakers”. These customers are what the organisation calls “Active Angels” – customers who deposit funds into their Angel account every month and place at least one order over the course of a year.

This surprisingly sticky active customer base has helped Naked Wines move into the black for the first time as a pure-play online business. This week it announced that it expects to report a “low single digits” adjusted profit on an earnings before interest and tax (EBIT) basis for its fiscal year ending March 2022. This announcement startled the market and sent short-sellers rushing to cover their positions as analysts were expecting losses for at least the next two years.

These numbers seem to vindicate Naked Wines’s business model and could provide the company with the impetus to drive its growth further in the UK, and, perhaps more importantly, in the key US markets. With £40m of cash on the balance sheet, the organisation appears to have the financial resources to fund the expansion for the next year or so at least.

Risks are growing and Naked Wines stock is challenging to value

Naked Wines seems to have a leading position in the direct-to-consumer wine market, and it has outperformed City expectations this year. However, the company is facing growing challenges including increasing competition and the cost of living crisis. A monthly wine subscription package is likely to be one of the first discretionary expenses consumers will cut if they want to save cash.

Still, the firm’s size could act as a defensive edge in an uncertain economic climate and it has the funds to cover any potential losses as well as grab market share from competitors, which may be struggling.

Naked Wines’s latest update shows the company is heading in the right direction, but it is less clear if the business will perform as an investment from here. That seems to be the consensus of the City with four of the seven analysts rating the stock as a “hold” and one telling clients to “sell.”

Perhaps Wall Street bank Jefferies put it best, saying of the the firm’s latest trading statement: “We see this as a reassuring update”. Reassuring, but not wholly convincing.