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Shares of the audio streaming subscription service provider Spotify (SPOT) are up over 74% year-to-date. Spotify's robust premium subscriber trends, improving monetization, and strength across all profitability metrics are a few reasons why it has outperformed the S&P 500 Index’s ($SPX) 14.7% return this year.
While Spotify has delivered solid gains, its impressive rally has also raised concerns about whether the uptrend will persist through 2024 and beyond. Additionally, the company faces challenges in accelerating the growth rate of its monthly active users, sparking some doubts about its future trajectory.
Against this backdrop, let’s explore the factors influencing Spotify stock’s future price action.
The Bull Case for Spotify
Spotify’s business has shown sustained momentum across several key metrics, despite macro uncertainty. In the second quarter of 2024, Spotify reported substantial subscriber growth and significantly expanded gross margins. Notably, Spotify achieved its highest free cash flow quarter ever. Additionally, Spotify has been profitable for three quarters in a row, highlighting its focus on monetization.
In Q2 2024, Spotify gained 7 million net new subscribers, surpassing management’s forecast by 1 million. Thanks to this growth, its total revenue increased by 21% year-on-year. The company’s recent price hikes and improved product mix resulted in higher premium average revenue per user (ARPU). Further, Spotify’s advertising business grew by 12% year-on-year, despite volatility in brand-related ad spending.
What stands out is that Spotify's gross margin reached a Q2 record of 29.2%, exceeding management’s guidance by 110 basis points. Higher revenue outpacing music royalty and streaming delivery costs led to an expansion in gross margins. Operating income also hit a new high, driven by solid gross profit and reduced operating expenses. Free cash flow was a record €490 million, reflecting higher operating income and favorable net working capital.
This impressive financial performance is a result of Spotify’s efforts to accelerate growth and enhance monetization. The company has diversified its subscription offerings to cater to various consumer preferences. By introducing new subscription plans, including options for audiobooks access and basic tiers, Spotify has expanded its premium plans globally, providing subscribers with a wide range of listening choices.
Additionally, Spotify implemented a price increase in several key markets, including the U.S. Despite higher pricing, the company has seen lower churn in the recent round of price hikes than the previous one. This shows the added value of its services over the years. For example, Spotify’s subscribers now have access to 250,000 audiobooks, over 6 million podcasts, and an extensive music catalog, all for a subscription fee significantly lower than the cost of accessing similar content separately.
The company is poised for solid growth led by increased premium subscribers, strength in developed markets, and improved product offerings. Spotify’s profit margins could continue to improve through the rest of 2024, along with higher operating income. This could lead to record free cash flow and push its share price higher.
The Bear Case for Spotify
Spotify’s overall performance remains robust, but the company is grappling with challenges, particularly in its MAUs growth. It’s worth noting that Spotify’s business is divided into two segments: paid subscriptions, primarily in developed markets; and the free ad-supported segment, focused on developing markets.
The paid subscription business in developed markets continues to yield high returns on marketing investments, with strong market penetration and widespread brand awareness. Growth in these markets is driven by net subscriber additions and strategic pricing, and it shows no signs of slowing down.
Spotify sees significant potential to attract new users in developing markets. However, engagement and conversion to paid subscriptions is slower and less consistent in these regions. Users display different engagement patterns, making it more challenging to achieve the same marketing ROI as in developed markets.
Beyond MAU concerns, an increasingly competitive environment could negatively impact Spotify's premium subscriber base. Additionally, price increases could lead to higher-than-expected churn in the future.
The Bottom Line on SPOT Stock
Despite challenges with MAUs, Spotify remains focused on enhancing its marketing impact and improving its free product offerings to boost engagement and retention, particularly in developing markets. The company is also intensifying its efforts to maximize marketing effectiveness.
As a result of these efforts, Spotify’s management said during the Q2 conference call that the company is experiencing strong year-over-year MAU engagement trends. This means that the users it is acquiring are being retained, which is a promising sign for its platform and future monetization.
In developed markets, the widespread awareness and strong affinity for Spotify’s products lead many users to subscribe directly to paid tiers without needing a trial period. High engagement in these regions also enables price increases, supporting robust revenue growth even as these markets mature.
In summary, while Spotify faces some headwinds, its overall performance and strategic initiatives position the company for continued growth. The company’s efforts to enhance its product offerings, grow its premium member base, improve monetization, and expand in developing markets will likely drive future growth and help maintain its leadership in the audio streaming industry.
While most analysts share this optimism and recommend a “buy” on SPOT stock, some experts remain cautious due to the recent rally in its price. Among 26 analysts covering Spotify stock, 17 recommend a “strong buy,” two suggest a “moderate buy,” and seven have a “hold,” reflecting a consensus rating of “moderate buy.”
The average price target for Spotify’s stock is $363.33, indicating a further potential upside of about 12% from current levels.
On the date of publication, Amit Singh did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
