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We reaffirm our Neutral recommendation on Shutterfly Inc. (SFLY - Analyst Report) following an appraisal of its fourth quarter 2012 results. While Shutterfly wrapped up the year 2012 on a strong note, beating estimates in all four quarters by significant margins, challenging economic conditions and seasonal headwinds in the upcoming quarter make us cautious at the current level.

Why the Reiteration?

Shutterfly’s recently-concluded fourth-quarter 2012 earnings per share breezed past the Zacks Consensus Estimate by 38.6% and the year-ago result by 44.3%. Increased revenues along with efficient cost containment led to the beat.

In the quarter under review, net revenues surged 33% year over year, significantly ahead of the Zacks Consensus Estimate, induced by sturdy sales from both Consumer and Enterprise categories.

According to Shutterfly, the market for social expression products in the U.S. alone, including one-for-one greeting cards, birthday cards, holiday cards, baby and wedding announcements, personalized stationery, and online greetings approximate $12 billion in annual sales. Presently, Shutterfly operates in less than 5% of this market. Such a limited presence in the online market leaves a huge room for expansion.

We also appreciate Shutterfly’s rapid inorganic growth. In the last three years ended 2012, Shutterfly took control of about 8 companies. We believe that all these strategic acquisitions augur well for Shutterfly and enable the company to enhance its portfolio and provide next generation photo solutions.

Despite sturdy fundamentals, there are some drags that keep us on the sidelines at the current level. Shutterfly’s business is highly seasonal. The company generates a large portion of its earnings during the fourth quarter of every year, which is the holiday season. More than 50% of net revenues are generated in the fourth quarter, which makes the first quarter seasonally weak.

Additionally, less pricing power in the printing business and faster-than-expected extinction of print photos due to social media sharing and adoption of home photo printers are expected to remain an overhang. Cutthroat competition in an anemic economy can also affect the company’s pricing power in its other businesses.

Other Stocks to Consider

Shutterfly currently retains Zacks Rank #3 (Hold). Some others players in the Internet content providers industry looking attractive at current levels include Angie's List Inc. (ANGI - Snapshot Report), Limited (CYOU - Snapshot Report) and Giant Interactive Group Inc. all carrying a Zacks Rank #2 (Buy).

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