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Over the past twelve months, the market has punished so-called “pandemic winners”, and Cricut (CRCT) certainly qualifies. The manufacturer of “smart cutting machines” was unquestionably a beneficiary of the coronavirus pandemic, which brought on millions of new customers and led to a dramatic jump in revenue and profits.

As with so many pandemic winners — Zoom Video Communications (ZM) and Teladoc Health (TDOC) being two of the most widely-owned — equity investors priced in long-term gains from that short-term boost. And, as with so many pandemic winners, those equity investors very quickly changed their mind:

source: finviz.com

To be sure, the run to $45+ last summer no doubt went too far in anticipating growth going forward. Indeed, Cricut’s outlook for 2022 reflects not only a business whose performance is normalizing, but one facing a potential headwind from demand pulled forward during the last two years.

That said, the decline to the single-digits too looks like it went too far. There is a real business here, and a better business than the “smart cutting machine” description might on its face suggest. Some of the customers brought on in 2020 and 2021 are going to depart; but some are going to stay on, and continue to generate revenue at enormous margins.

Since the financial crisis, “too cheap” in general has been a dangerous pillar for a bull case. The same has been true for the pandemic winner group over the past 12 months or so. But even looking at 2019 results, the current CRCT stock price is starting to look reasonable. When the market starts looking to 2023 results, the stock price should be able to move higher.

Really? A “Smart Cutting Machine”?

Cricut (pronounced like “cricket”) offers three “connected machines” which work with apps — both mobile and desktop-based — via Bluetooth to allow users to design and produce cards, T-shirts, mugs, hats, bags, and more. (One third-party site alone lists 100 potential projects.)

The Joy is the entry-level machine ($179.99 MSRP). It cuts and prints paper, cardstock, and vinyl. The better blade on the Explore ($249.99-$299.99) brings fabrics into the mix. The Maker ($399.99) can cut leather and wood, while allowing for debossing (ie, creating an imprinted effect), engraving, and the addition of foil effects.

All three machines run on the company’s Design Space software. Design Space is a freemium offering; free users can obtain ~1,000 images and ~250 projects, while paid subscribers get vastly more access (~200K+ images and several thousand projects).

On its face (particularly to those of us with limited interest in crafting) the offering doesn’t seem like that good a business — or even enough to support a publicly-traded company. But Cricut has a large user base. At the end of Q1 2022, Cricut had 6.9 million users, roughly one-third of which were paid subscribers. Both figures are a fraction of the company’s claimed Serviceable Addressable Market of 129 million potential customers (85M US + Canada, 44M international), let alone the Total Addressable Market of 402M (248M + 153M; more on TAM/SAM a bit later).

The company appears to be a market share leader. The chief rival is Silhouette, owned by Japan’s GraphTech Industries. Brother Industries (BRTHY) also offers cutting machines, but seems to be a distant third. Its entire Personal and Home Business segment, which includes cutting machines and sewing machines, generated ~$400M in revenue in 2021, less than one-third Cricut’s total sales of over $1.3 billion. Brother’s ScanNCut also is notably less powerful than the Cricut Maker.

It’s that user base that drives profits. This is a razor/blades model, albeit with two types of metaphorical blades: subscription revenue (~16% of 2021 sales) and materials and accessories (42%). The machines themselves probably are something close to loss leaders; Cricut generated $64 million in gross profit from machines in 2021, while R&D spend alone totaled $80 million.

Huge Growth During The Pandemic — But Before Then, Too

Obviously, Cricut benefited from the pandemic, and the absolute dearth of available activities particularly amid stay-at-home orders during 2020. That year, revenue nearly doubled, with the number of paid subscribers increasing 116%. EBITDA jumped 240%.

Last year, Cricut tacked on another 36% top-line growth. Total users rose 48%; paid subscribers 56%.

Again, the growth is not particularly surprising. Consumers during 2020 and 2021 had more time and more money. Other hobbies like gardening too saw a boom. But it’s important to note that Cricut is not just a pandemic winner:

source: Cricut Q1 earnings presentation

Revenue grew at a 46% CAGR between 2014 and 2019. Cricut ended that latter year with 2.5 million users and 600K paid subscribers. It generated $62.7 million in EBITDA in 2019, at a margin of 13%. GAAP net margins were 8%.

This was a great business during the pandemic. But it was a pretty good business even before the world came to an end. The current price below $8 suggests the market is forgetting that fact.

CRCT Stock Is Cheap

Even in the context of the fading pandemic tailwind, CRCT stock looks cheap. Backing out net cash, shares trade at less than 13x trailing twelve-month EPS. There’s likely some bottom-line pressure on the way this year (notably in Q2, given a still-tough comparison), but even relative to Street estimates (again, excluding cash) CRCT is at 13.6x 2022E EPS and less than 11x next year’s profit.

Certainly, those estimates could be too high. Indeed, the steady downtrend in Cricut stock (which has declined 83% from its 52-week high, and 65% year-to-date) suggests the market is pricing in further disappointment.

But at this point CRCT is starting to look intriguing relative to its pre-pandemic performance, too. Using 2019 results, the current enterprise value of ~$1.4 billion is ~1.5x revenue, ~22x EBITDA, and ~35x net income.

None of those multiples look out of line for a business that, again, was growing at a 40%-plus annualized clip. Nor was Cricut necessarily overearning; operating margins in 2019 were ~11% against a long-term target of 16% to 19% (and ~16% last year).

With subscription gross margins of 88%, there’s room for broader margin expansion from here. Cricut is offering new machines, new aspects of the Design Space platform (including a recent launch of a “monogram maker”), and sees opportunity for expansion overseas (international sales were just 11% of the 2021 total).

There is going to be volatility in coming quarters, as even Cricut management has admitted. But there’s still a pretty solid growth story here, and a valuation that is at least reasonable even assuming that pandemic benefits fade.

Of course, that’s not going to happen. Cricut has added over 4 million users since the end of 2019. Many of those users admittedly will lose interest in crafting and/or their Cricut machines. Many, however, will stick around. And it doesn’t take that much in the way of incremental revenue and profit versus pre-pandemic levels for CRCT stock to be a winner over the long haul.

Why Cricut Stock Has Fallen — And Why It Can Keep Falling

So why is the market selling the stock off?

One obvious reason is that recent results don’t look particularly solid. Fourth quarter revenue increased 5% year-over-year; Q1 sales dropped 24%. Profit figures are much worse: Q4 EPS was $0.05 against $0.30 the year before, while Q1 EPS fell 54%. Even though users and subscriptions are heading in the right direction, profits are not.

Meanwhile, even the relative good news in Q4-Q1 may well change. On the Q1 call, management cited a slowdown in orders in March, which executives blamed on macro headwinds. But lower sales suggest lower user adds; as a result, CFO Kimball Shill forecast that paid subscribers in Q2 and Q3 could be “flat or possibly decline” on a sequential basis.

Investors’ clear takeaway seems to be that Cricut has a sharp decline ahead. Add in a relatively thin float1 and a nervous market, and there are reasons why sellers might be overreacting here.

But, to be fair, there are reasons why they aren’t overreacting. It is possible that Cricut to at least some degree is a fad. Management has said that a chunk of users (and no doubt a greater portion of subscription) have purchased Cricut machines for business use. The relative newness of Shopify (SHOP), in particular, even before the pandemic and the ‘ease’ of combining a Shopify and Cricut subscription into a business might have goosed demand to unsustainable levels prior to 2020.

There are margin concerns as well. Cricut said after Q1 it would take pricing going forward — but that’s a dicey move at the same time demand is falling off. If Cricut can’t pass along higher input costs (most importantly for the machines, but also for materials as well), longer-term EBIT margins look more like 11%, the targeted 16%-19% and out-year profitability comes down.

As always, there are risks here. Short-term, the news here absolutely can get worse, and at the very least a long position here may be too early. (It’s not a great sign that CRCT dropped 3% last week, at a time when investors were in a ‘risk-on’ , ‘buy the dip’ mood.) Longer-term, it’s possible that actual performance of the business matches the initial impression of Cricut: that there shouldn’t be enough here to support an enterprise value still above $1.4 billion.

Taking The Long View

Indeed, as we’ve argued for a good number of our long ideas so far, there’s probably no need to rush in with a full position just yet. (Count us among those who see recent market action as most likely a leg of a bear market rally, rather than a true bottom.) Put-selling is an intriguing strategy, however: there’s decent liquidity and ~30% returns in the December 7.5.

And it’s possible that the news gets better quicker than bears might predict. Most notably, top-line comps get much easier starting in Q3. A Q2 report that’s simply not terrible could let investors turn their attention to the second half and then 2023, at which point Cricut presumably can get back to some sort of growth.

But beyond the timing issue, there does seem to be a solid long-term case here. Cricut was a pandemic winner, certainly, but with 2.5 million users even at the 2019 mark it’s not only a pandemic winner.

Meanwhile, all that’s priced in here, over time, is some growth from the 2019 baseline. With new products, 4 million-plus new users, and high-margin subscription revenue, that kind of growth seems achievable — at some point. It may take some time for that growth to show through the numbers, but once it does, CRCT should be back in the double digits.

As of this writing, Vince Martin has no positions in any securities mentioned. He may take a position in CRCT this week.

Tickers mentioned: CRCT

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