“In vino veritas” goes the old saying. But shareholders will be hoping that the share price of vino retailer Naked Wines (LSE: WINE) is not a true reflection of the company’s value. The Naked Wines share price has tumbled almost 90% in just one year. Even after a few glasses, that is a sobering thought.
So, is this a bin end bargain for my portfolio? Or does the massive fall signal deep problems that ought to keep me way from the shares?
Compelling business model
The interesting thing about the company for me is that I think it has a great business model. By replacing the middleman in wine sales it can make attractive profit margins. The more it sells to customers, the better it can understand their tastes, which should mean they become increasingly attached to Naked Wines. That should give it pricing power.
The online wine retailer saw sales boom during the pandemic. But Naked Wines is more than a one-trick pony. Over the past five years, it has seen sales grow at a compounded annual rate of 20%. I think that is impressive.
Naked Wines’ model relies on upfront marketing investment to attract buyers, which is then hopefully more than recouped in the years that follow if they keep buying. So after a year, the marketing investment in attracting and retaining a customer has already been more than covered. After five years, the company’s model suggests that it will have recouped triple the money it cost to attract the customer. I regard this as a virtuous circle. By retaining customers, Naked can get more value out of the relationship over time.
Why is the Naked Wines share price falling?
But if the business model is potentially so attractive, what explains the huge fall in the Naked Wines share price?
The main problem is translating sale growth into profits. Last year, sales grew 3% year-on-year to £350m. But the company’s loss almost doubled, to £11m.
That is not how I like a business to work. As sales grow, if the business has a lean cost base, profits ought to grow even faster. The opposite is happening at Naked Wines. There are lots of good reasons for that, from the cost of expanding its international footprint to the impact of higher costs for everything from glass bottles to packaging materials.
Some of those things are within the company’s control, but a lot are not. If it passes on all cost increases in the form of higher prices, it could lose customers. That is a challenge to its business model of investing early in the customer lifecycle with the aim of recouping those costs down the line.
I’m not buying
I really like this business and think it has loads of potential. It has a strong competitive advantage that can help keep its customer base loyal.
However, the reality is that right now it is struggling to show that it can be profitable on a sustained basis. That is the opposite of what I am looking for when I invest. The share price could go up from here if business improves, but it might also keep sinking if losses get even bigger. So until the bottom line improves, I will not be buying Naked Wine shares.
