Thursday 28th April, 2022
If it can maintain its rapid growth and profitability, it’s a bargain
HelloFresh (XTRA: HFG) provides meal kits to customers in 16 countries and has grown sales at a 5yr CAGR of 60%! In absolute terms, sales have grown from €600m in 2016 to €6B in 2021. It currently has about €350m in Net Cash on the balance sheet and a market value of €6.3B. One reason for my initial interest was if the business could maintain even one-third this growth rate, and become consistently profitable, it was probably worth at least 5-times as much[1].
Like others in its industry, HelloFresh has grown by spending money on marketing to acquire new customers in new and existing markets. Customer count grew from 1m in 2016 to 7.2m in 2021 (€6B 2021 sales = 7.2m customers x 16 orders per year on average x €51 spend per average order).
In addition to this rapid growth, what also attracted me to the business was what looked like strong cost-controls and economies of scale in the model. This was reflected in their Gross Margins having steadily grown from 52% in 2015 to 66% in 2021.
But low barriers to entry have enabled an influx of new entrants that erode its sales growth potential
Despite these facts, it’s hard to contend with the competitive threats the business may face in the years ahead. They are operating in an industry with low barriers to entry (search “meal kits London” you’ll see Gousto, minfulchef, planty, Zested, Dishy, FeastBox – and that’s just Page 1 on Google).
What lowers the entry-cost for competitors is the fact that they don’t need to compete with HelloFresh in every country they are in, they can just choose to compete in say, London or New York – therefore only having to allocate marketing spend to that country. In addition to “meal-kit only” competitors, restaurants and supermarkets are also now offering meal kits – so HelloFresh’s menu is now also competing with chefs at Michelin star restaurants (dispatch.com specializes in this niche), Morrisons Eat Fresh and Cook with M&S Recipe Box.
The value for money they boast about offering may prove to be fleeting and a hinderance
Furthermore, while HelloFresh might be able to negotiate discounts on fresh ingredients for its meals, because it buys at scale, those discounts are country-specific because as their name suggests they need “fresh” ingredients, and they are unlikely to be able to leverage the cost advantages of single-sourcing across their global distribution network. This means that if HelloFresh does have any economies of scale, they are “local” not “global” and therefore any competitor that has sufficient scale in a particular region will be able to compete aggressively with HelloFresh on price. Here the Morrison’s and M&S offerings concern me.
Furthermore, the company mentioned they are also working to keep prices low for their customer base despite rising costs of ingredients, which will weigh on their gross margins. In their latest earnings call CFO Christian Gaertner stated that their price increases have been “meaningfully lower than the food price inflation we see in all markets”. The price HelloFresh pays for their ingredients has gone up 4%, but they have only increased prices by 2%.
It doesn’t provide me with the predictability of free-cash flow production I demand
As a result of these threats, there’s a reasonable probability the business will burn through all the cash it brings in just to maintain its market share, which would make it worth far less today. Furthermore, even as it grows, the business doesn’t appear to be making it harder for competitors to steal customers from them, which is a big problem when a lot of new competitors have already entered their markets.
In all, these create the conditions in which it is hard to say with confidence that the 3-5 year outcome of investing in this business will be positive, and therefore a risky proposition for a concentrated portfolio.
[1] 6B in sales growing at 20% CAGR gets to 21B in 7years, assuming 7% operating margins and 20% tax, that’s 1.2B in after-tax operating earnings by 2028. Taking a 8% discount rate and 3% Terminal growth rate, and adding the 300m in net cash, you get an equity value of 29B – 5x the current 6B market cap.
The Equity Analyst 