I'm calling Temple & Webster Group Ltd (ASX: TPW) a top stock that I believe could deliver strong returns in the long term.
In my view, the ASX retail company has great potential as it capitalises on digitalisation, online shopping, and AI trends.
Temple & Webster claims to be Australia's largest pure-play online retailer of furniture and homeware. It runs a drop-ship model where suppliers send products directly to customers, thereby reducing delivery times and the need to hold inventory. This allows the ASX share to sell a larger product range.
Its website has more than 200,000 products, including a private label range sourced directly from overseas suppliers. The company also operates TheBuild website, which sells a wide array of home improvement products.
Here are three key reasons why I think this top stock could outperform over the next three to five years.
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Significantly lower Temple & Webster share price
Despite this week's rally, the top ASX stock is still 27% lower than where it was in March 2024.
I really like being able to buy exciting, growing businesses at cheaper prices because it gives a higher margin of safety and makes achieving good returns more likely.
It's understandable that the Temple & Webster share price is volatile — household finances can sometimes go through difficult patches, such as right now amid a higher cost of living.
And while shares are still much higher than they were a year ago, the company is now generating more revenue and aiming for a lot more.
Revenue growth
I believe the companies that can significantly outperform the market over the long term are those that can continue growing revenue at a good pace for an extended period of time.
Despite difficult retailing conditions, Temple & Webster recently reported its sales from 1 January 2024 to 5 May 2024 were up 30% year over year. That growth rate is worthy of calling the company a top stock. It has demonstrated good revenue growth for many years.
It's aiming for at least $1 billion of annual sales within three to five years, up from $396 million in FY23. The company can benefit from online penetration of the sector growing from 18% to 28% as millennials become the largest-spending cohort, according to Temple & Webster. It wants to grow its online market share from 10% to 15%.
The company is looking to grow revenue for its trade, commercial, and home improvement divisions. These segments significantly increase the company's total addressable market and add revenue diversification.
Increased scale/revenue of the business comes with a number of benefits, including the potential to spend more on advertising. However, it could also lead to stronger profit margins for the ASX top stock.
Long-term margin growth expected
The business is investing in several areas to improve its operations. AI is a big focus, and it is more applicable to an online business than a physical store business.
Temple & Webster said most areas of its business "can be, and will be, materially disrupted by AI (customer care, operations, product development, tech, back office)."
Because it doesn't have physical store costs, its fixed cost base means that as its revenue grows, it reduces the fixed cost as a percentage of revenue.
In the first half of FY24, its fixed costs (wages and overheads) were 11% of sales, and its five-year target is for fixed costs to be less than 6% of revenue.
In FY23, the company achieved business as usual (BAU) earnings before interest, tax, depreciation, and amortisation (EBITDA) margin of 3.7%. Thanks to AI, scale benefits, and a higher level of repeat customers, it aims for a BAU EBITDA margin of at least 15% in the long term.
If the Temple & Webster share price doesn't keep rising, I'm likely to buy more shares of this top stock when Fool's trading rules next allow me to.
