HLFFF - HelloFresh SE: Progress Made - But Growth Will Likely Be Incremental

Summary

• The company should be able to continue to grow, but it's likely going to be at a modest pace.
• While HLFFF has been boosting revenue recently, it is doing so with rising expenses and shrinking EBITDA.
• Europe has been showing signs of slowing, although the U.S. market has been picking up.
• Even though the company has plenty of available cash at this time, free cash flow has been taking a big hit in the first nine months of calendar 2022.

HelloFresh SE ( OTCPK:HLFFF ), a company that delivers meal kits in order to prepare home-cooked meals, has been struggling to regain momentum after the surge in demand it received during the pandemic, which drove the share price of the company over $110.00 per share before crashing to approximately $22.00 per share as I write.

The question for HLFFF is what is the new normal for delivering meal kits now that the effects of the pandemic on consumer lifestyles is largely over - at least in the West.

Recently, the company has been boosting revenue as a result of increasing Average Order Value [AOV], although its Customer Acquisition Cost [CAC] has risen with it, specifically in the U.S. market.

As for understanding the future performance of the company, it's hard because of the aforementioned pandemic and moving out of the shadow of the impact of that on in-home food demand, and now experiencing the effects of inflation, a weakening economy, and uncertainty in the labor market, all of which will have an impact on the performance of HLFFF over the next year.

But with much of the pent-up demand for travel possibly waning and consumers starting to prioritize spending, it remains to be seen if the weak economic environment and uncertain labor market results in people starting to cocoon in their homes again, which would be a tailwind for the company.

On the other hand, with food inflation expected to rise another 3 percent to percent in 2023, according to the USDA, how much of that can be passed on to customers without it impacting the AOV of the company remains to be seen.

In this article, we'll look at some of the recent numbers from its earnings report and the factors that will contribute to its future performance.

Some of the numbers:

Revenue in the third quarter of 2022 was €1.86 billion, up 31.4 percent from the €1.42 billion in revenue generated in the third quarter of 2021. Revenue for the first nine months of 2022 was €5.73 billion, 29.9 percent from €4.41 billion in revenue generated in the first nine months of 2021.

The deceleration in revenue growth in the third quarter of 2022 was probably from it being the historically slowest quarter for the company.

Revenue in the U.S. market for the third quarter of 2022 was €1.147 billion, up a hefty 45.3 percent from revenue of €789.3 from the third quarter of 2021. International revenue contributed €713.7 million in the third quarter, up 14 percent from revenue of €626.1 million in the third quarter of 2021.

For the first nine months of 2022 U.S. revenue was €3.4 billion, but 39.9 percent from the €2.44 billion in revenue in the first nine months of 2021. That showed some acceleration in revenue growth in the third quarter. Revenue for the first nine months of 2022 for International was €2.3 billion, up 17 percent from the €1.97 billion in revenue generated in the first nine months of 2021. International revenue decelerated in the reporting period.

Adjusted EBITDA in the reporting period was €71.8 billion, down 10 percent from adjusted EBITDA of €79 billion in the same quarter of 2021. For the first nine months of 2022 adjusted EBITDA was €317.1 million, down 20.1 percent from the €396.8 million in the first nine months of 2021.

Adjusted EBITDA margin in the third quarter of 2022 was only 3.9 percent, primarily from the 17.9 percent increase in marketing spend. The boost in spend came from the company focusing on Factor in the U.S. market, which, while enjoying higher AOVs, also comes with higher CACs.

Free cash flow was negative € (52.3) million in the quarter, plunging from €17.7 million in the third quarter of 2021. Free cash flow in the first nine months of 2022 was negative € (86.7) million, plummeting from the €250.2 million in free cash flow from the first nine months of 2021.

While the company has €600 million in cash and cash equivalents at the end of the third quarter of 2022, it was down from €955.1 million in the third quarter of 2021; that's a lot of cash burn in a short period of time.

If the company comes under pressure in 2023, which is possible, cash burn could become a serious issue going forward.

Mitigating some of the rising costs

Aside from sales and marketing spend needed to brand in the markets it competes in, there were three areas the company is focusing on to reduce costs.

The first one is partially offsetting the effect of inflation by increasing prices. When doing so, it has taken steps to ensure the price increases are lower than its supermarket, restaurant and take out competitors.

Second, it diversified supplier base allows it to share rising costs equally between the company and its suppliers in order to mitigate increasing expenses.

Third, with many of the ingredients it uses in its meal kits not experiencing the same levels of inflation, it has adjusted some of the ingredients in its recipes by including those less impacted by inflation, allowing it to moderate its price increases in some cases.

With food inflation expected to rise in 2023, albeit at a slower pace than in 2022, it remains to be seen how much HLFFF can use pricing to offset inflation on the input side of its business. The company hasn't faced economic conditions like this before, so we have no performance history to guide us under the current economic environment.

And fourth, the company has invested in boosting the efficiencies of its fulfillment centers, which "were unsustainably overstretched" in early 2022. If they can continue to improve productivity while increasing the efficiency of its fulfillment network, it should help offset some of the rising costs expected in 2023.

Valuation and peers

On valuation basis, HLFFF is mixed when measured against it peers. Its P/E [TTM], which stands at 27.72, is 34 percent higher than the 20.73 P/E average in the sector. On the other hand, in what I consider the more important metric of Price/Sales, it has an excellent TTM of 0.52 and FWD of 0.46, compared to the sector average of 1.15 TTM and 1.12 FWD.

That said, much of the P/S increase comes from OCDDY, which have P/S of 1.81. Competitors like MAKSY has P/S of 0.23 and JSAIY has P/S of 0.17. So while HLFFF outperforms some of its competitors in the important metric, it underperforms others.

It also should be considered that GO adds a hefty 51.27 to the average P/E numbers, with competitors like SFM, MAKSY and JSAIY being much lower than HLFFF.

As for direct competitor Blue Apron ( APRN ), one of the few things it has going for it is its P/S, which is an outstanding 0.06 [TTM] and 0.07 [FWD]. Other than that, it has earnings under immense pressure and growth slowing to a crawl.

Taking everything into account, including its recent performance, I think the decline in its share price is warranted, and it could still be overvalued based upon the pace of its future growth prospects. I think it'll grow, but it'll do so at a modest pace.

Conclusion

With the company burning a lot of cash and getting a modest return at this time from its rising expenses, I think it's probably going to get worse before it gets better in 2023.

There are some things to like about its performance, especially its improvement in AOV, but that's associated primarily with its existing customer base, which it has limited upside after price increases in 2022. I also think the lever of increasing prices is weakening, and it'll be limited to how much more it can raise prices in 2023 if the economy continues to weaken as expected and food prices continue to climb.

The one caveat I have is how consumers respond to the economic uncertainty ahead. If people decide to stay at home more because of a decline in disposable income and increasing debt levels to where they are at a ceiling in regard to paying back at inflated interest rates, they could spend more time in the home in 2023, which could be a tailwind for HLFFF if consumers don't start prioritizing food spending and start shopping primarily by price.

It's going to continue to cost more to grow market share in the U.S. and at least maintain market share in the international markets. What I believe will be limited upside on pricing, increasing expenses and high cash burn, the uncertainties of 2023 in regard to economics and consumer spending activity make it difficult to project the company's performance in the year ahead.

I think the company is likely to continue to grow revenue if the economy doesn't tank in a big way, it will do so at an incremental pace. And if pressure on EBITDA continues, it could bring disappointing results, which would put downward pressure on its share price.

When adding up everything together, I'm leaning toward HelloFresh having a higher percentage chance of underperforming in 2023, especially in the first half.

For further details see: