Research Notes: Consumer Upstarts (Part II)
A review of a few more struggling consumer names
Welcome to Overlooked Alpha. Subscribe below to get our best investing ideas in your inbox every Sunday morning:
(Part I of this series, which covered FIGS (FIGS), The Honest Company (HNST), Oatly (OTLY), and Beyond Meat (BYND), was published last week.)
As we wrote last week, newer consumer brands have performed poorly over the past couple of years. Many went public — and then straight down, even at times when market sentiment was far more positive than it is at the moment. (HNST is a good example of this.)
The question now, as with so many stocks in this market, is whether the declines have gone too far. Surely, there is some value in these brands (Beyond Meat perhaps excepted) and surely there will be some takeover interest at the right time and the right price. Even Casper Sleep, a second-tier player in a tough industry, got a buyout offer that created some profit for investors who got in near the lows.
With the market gaining over the past couple of weeks, in what looks to us like a clear dead cat bounce/bear market rally, the cases for many of these names still don’t look strong enough. But this is also precisely the kind of market where investors should be looking and planning ahead, waiting for either another leg down or, perhaps, evidence that the broad market indeed is at a bottom.
In that context, these young and still-growing consumer brands comprise an interesting group. Here are thoughts on three more of those companies:
Warby Parker (WRBY)
In the first part of this series, we discussed the fact that many legacy consumer players — with Procter & Gamble (PG) and Coca-Cola (KO) among the exceptions — had struggled in recent years in part because of an influx of competition. Yet, again, many of those now-public competitors (and even some of the private ones) themselves are performing even worse.
There is some logic, perhaps, to that seeming contradiction: when a low-growth market (and nearly all consumer markets are low-growth) gets multiple new entrants, everyone loses. Warby Parker highlights a different but equally problematic trend: the inability of direct-to-consumer companies to stay direct-to-consumer.
We’ve seen this with Casper, Honest, and others. Warby Parker itself ended Q1 with 169 stores, with plans to hit 200 by year-end.
For Warby Parker, maybe the effort makes a bit more sense. As management noted on the Q1 call, there are ~41,000 optical shops in the US, so by year-end Warby Parker will have ~0.5% penetration. And relative to, say, a mattress retailer, required square footage (and thus lease expense) obviously is smaller.
Still, at the very least, these efforts to move to an omnichannel model increase both reward and risk. An online-only retailer probably has a lower ceiling on mid-term revenue — but a subscale omnichannel business can be zeroed out. (To be fair, Warby Parker, with free cash flow guided flattish this year and $230 million in cash on the books, is unlikely to be one of those businesses.) And moving to an in-store model undercuts one of the very real benefits of being online-only (one we highlighted last week): the ability to actually rent scale, whether in terms of marketing, IT power, etc.
What this means, simply, is there isn’t a lot of room for error. The performance of WRBY stock — now at $15.38, 71% below the reference price from its direct listing last year — shows that. Results haven’t been that bad (the stock has been +9.0%, +3.3%, and -5.3% one-day returns after the three earnings reports so far); WRBY just went public into the wrong market. Shares are down 70%-plus basically through a drip-drip process (the biggest one-day decline has been 13%, which came during the worst of last month’s sell-off).
That aside, WRBY highlights a third trend, one that applies to the likes of OTLY and BYND as well: down big, the stock does not look inexpensive by any fundamental measure. Shares are at ~60x this year’s EBITDA if you trust guidance, and after a miss-but-reiterate fiscal Q1 most investors probably don’t. Revenue grew just 10% in Q1, though the Street is looking for ~19% growth for the full year. Given a ~25% increase in the store count, that kind of growth is solid on an organic basis, but maybe not 60x EBITDA solid. It’s not a surprise that 24% of the float (~17% of shares outstanding) is sold short.
Yet…this might work? Simple retail footprint expansion + market growth + a few hundred basis points of EBITDA margin expansion (from ~6% this year) probably keeps the stock somewhere near these levels. (Double revenue and get margins to 10% and a 20x multiple implies modest upside.) The move into contact lenses is at least intriguing optionality: that industry is basically a four-player oligopoly and quite a good business (see the 13% annualized returns over 20 years from Cooper Companies (COO)).
I’ll put it this way: if an investor told me she was buying the dip in BYND, I’d legitimately question her judgment. If she instead said she was buying WRBY…OK, yeah.
On Holding AG (ONON)
The core reason to avoid ONON seems like the core reason to buy it. In the context of so many fallen DTC angels (though On, like so many others, has moved into the wholesale channel as well), this seems like a story that’s going to hit a few speed bumps relatively soon. Yes, the running shoe manufacturer’s current numbers are good — but these kinds of companies don’t grow in a straight line. (For further confirmation, an investor can look beyond more recent consumer stories to the broader sector, and the likes of Deckers Outdoor (DECK) or Under Armour (UA) (UAA).)
That said, this kind of sentiment — that every company in a group is going to head south at some point — is precisely what creates the “unjustified sell-off” so many of us are looking for. And there is a bull case here. The numbers indeed look good, particularly relative to other stocks in the group. On grew revenue 70% last year, 59% in 2020, and is guiding for a ~44% increase in sales this year. Adjusted EBITDA margins are targeted to 13%-plus. (Exclude stock comp, based on the Q1 run rate, and the figure drops to ~12%. This is a legitimately profitable business.)
To be sure, the numbers aren’t quite compelling. ONON still trades at almost 50x this year’s EBITDA. A $6 billion market cap seems like it could be a bit high, at least back of the envelope. Under Armour has a $5 billion valuation; yes, that stock seems like a massive disappointment, but the company has generated over $1 billion in free cash flow over the past three years. Reebok just sold for $2.5 billion; that’s a struggling/broken brand, probably, but it’s still a real brand.
This probably is a name that goes on the shopping list for if and when the equity market takes another leg down. It does seem like the shoes themselves are innovative and dearly loved (I haven’t personally worn a pair, admittedly). Growth is impressive. Valuation is reasonable.
If the story here works, ON can be a multi-year multi-bagger. But, again, at least from a ‘feel’ standpoint it’s not hard to worry that maybe it won’t work — simply because that’s so often how it goes at this point in a DTC and/or fitness/sporting industry company’s growth curve. (On was founded a decade ago.) As a result, it seems useful to try and obtain a lower price here, both to maximize the upside if On keeps growing and minimize the pain if history once again repeats.
Allbirds is another DTC company expanding its channels, with plans to ramp up wholesale revenue this year. It’s another DTC stock that’s been hammered: shares were priced at $15 in the company’s November IPO, closed above $28 their first day, and now trade at barely $5.
In this case, there’s more going on than just changing market sentiment. The stock fell double-digits after the company’s Q3 report — its first on the public market — and Allbirds then cut its guidance after last month’s Q1 release.
At these levels, the stock does look at least a little intriguing. EV/revenue (I know, I know, we’re not supposed to use that metric anymore) is ~1.7x based on this year’s guidance. Allbirds’ medium-term targets are for 20-30% revenue growth and 15-19% Adjusted EBITDA margin. Build in the low end of both ranges and in 2027 Allbirds is generating ~$125 million in Adjusted EBITDA. That’s maybe a triple from here (15x that multiple gets the stock around $15).
Of course, that’s the point: literally and figuratively the market isn’t buying that outlook. That might be wise: Allbirds is guiding for 21-24% revenue growth this year, with a pretty significant compression in gross margin. At the same out-year 15x multiple, a deceleration to a mid-teens 5-year CAGR and a resulting 10% Adjusted EBITDA margin moves annualized returns to something like 6%.
Allbirds is saying that this year’s growth is being depressed by weakness in the international business, driven in part by conflict in Europe. Margin pressure, too, might be somewhat transitory (at least in degree). It’s possible that, as management seems to believe, growth will re-accelerate both on the top and bottom line. But, again, it’s not as if valuation is so ridiculously compelling that the risk/reward of actually believing management is hugely attractive. Investors gain more if management is right than they lose if management is wrong. Most stocks work that way.
It’s getting boring to repeat, but the fundamentals in this group just really are not that attractive when looked at through fresh eyes. We’ve been pretty consistent in highlighting this issue across the market, and in reiterating our concern that we’re not near a bottom. Our very first post, in fact, covered exactly that latter point.
It’s not hard to wonder if part of the problem at the moment, and perhaps part of the reason we’ve seen a recent bounce, is that investors haven’t quite grasped how ridiculous 2020-2021 were. We’re likely no exception; we’ve been of the mind that “yes, Q4 2020-Q1 2021 was nuts, but it was no 1999.”
Perhaps we’re wrong. We’re reviewing IPOs here from less than a year ago that were well-received (again, BIRD jumped 91% on its first day of trading) and well-understood. And they’ve been hammered.
BIRD, for instance, is down 73% from its close on Dec. 27 — barely six months ago. Even among more professional investors, for whom the danger of anchoring bias is more well-understood, at some point those declines seem, on their face, like “too much.” Investors spent $19 million-plus on BIRD stock just on Dec. 27, betting the stock was too cheap; it would have to nearly quadruple just to get back to that point.
Were those investors really that wrong? Has the mid- to long-term macro outlook changed that much? It doesn’t seem like the answer to both questions can be “yes”.
And yet, you look at BIRD, and BYND, and WRBY, and so many others, and try desperately to do so with fresh eyes. (One nice thing about writing under your own name is that it makes it easier to do so; there’s fewer ways to feel dumb than to publicly make the “it’s too cheap” argument for a broken company when the stock is only through the first 70%-plus decline.) When doing so, the answer becomes pretty clear: these stocks are not cheap on a fundamental basis. They just aren’t by any reasonable measure.
This is a theme we’ll likely return to (for the last time, I promise) next week. To be clear, it’s not an argument that all seven of these consumer names are destined to keep falling. ONON and FIGS (highlighted last week) both look intriguing. In any of these bear markets, there are long-term winners (as so many market bulls have pointed out about Amazon.com (AMZN) in 2001).
But there are long-term winners in every market, of course. What makes a broad “buy the dip” opportunity (2009-2010, Q4 2011, Q4 2018 a bit) is when those long-term winners are easy to find; when an investor, not looking that hard, sees multiple stocks where the thesis pretty obviously is “this stock will be fine, sentiment just needs to change.”
This market is not one of those markets — not yet. These stocks are not those stocks — not yet. The best opportunities still lie ahead.
As of this writing, Vince Martin has no positions in any securities mentioned.
Disclaimer: The information in this newsletter is not and should not be construed as investment advice. Overlooked Alpha is for information, entertainment purposes only. Contributors are not registered financial advisors and do not purport to tell or recommend which securities customers should buy or sell for themselves. We strive to provide accurate analysis but mistakes and errors do occur. No warranty is made to the accuracy, completeness or correctness of the information provided. The information in the publication may become outdated and there is no obligation to update any such information. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Contributors may hold or acquire securities covered in this publication, and may purchase or sell such securities at any time, including security positions that are inconsistent or contrary to positions mentioned in this publication, all without prior notice to any of the subscribers to this publication. Investors should make their own decisions regarding the prospects of any company discussed herein based on such investors’ own review of publicly available information and should not rely on the information contained herein.