EYE - National Vision Holdings: Optometrist Capacity Issue Needs To Be Resolved Asap

2023-05-17 08:27:40 ET

Summary

• Despite reporting positive financial results for 1Q23, EYE faces challenges in achieving robust growth due to macroeconomic headwinds impacting its core customers.
• EYE's ability to provide eye exams is constrained by a shortage of optometrists.
• EYE's market position and value proposition may limit its short-term ability to raise prices, potentially leading to margin compression.

Summary

National Vision Holdings ( EYE ) is a US-based optical retailer that offers services such as eye exams and sells eyeglasses and contact lenses. EYE reported $62.8 million in adj. EBITDA for 1Q23, driven by higher-than-expected sales and margins. While the headline results appear to be positive, I am concerned about the company's growth prospects and ability to manage profit margins.

First, despite the fact that comparable sales growth was positive this quarter, it is still weak because core customers are still feeling the effects of macro headwinds. Importantly, management anticipates that the reduced tax refunds will put pressure on 2Q23 as well. Second, capacity constraints for optometrists continue to be an obstacle to EYE's ability to provide eye exams. If not managed properly, I believe this will have a significant impact on profit margins. The increase in Optometrist wages will be difficult for EYE because it will have to choose between raising prices to combat this and risking disrupting its value proposition to consumers. I am not a fan of this “iffy” situation which could result in volatility in between quarters, as I expect price increases to be smoothen out across periods so that consumers do not feel the increase (but optometrist wages have already increased). I am recommending a neutral rating at this point until I see a visible path for EYE to resolve this. Once this hurdle is cleared, I believe it will be easier to invest in EYE as the valuation (forward EBITDA multiple is at -1 standard deviation from the average) is quite attractive now.

1Q23 quarter performance

EYE's net revenue for 1Q23 was $562.4 million, exceeding the consensus estimate of $551.6 million. Adjusted comparable store sales increased by 0.8% year on year. The company's adjusted EBITDA for the quarter was $62.8 million, which surpassed the consensus estimate of $53.7 million. Adjusted earnings per share were $0.31, exceeding the consensus estimate of $0.20.

In my opinion, the managed care division was largely responsible for the increase in comparable store sales, which shows how important the managed care segment is. That said, 4Q and 1Q are generally the better performing quarters, as such the 0.8% growth was actually quite disappointing and really shows how challenging the current environment is.

Optometrist constraint

My main concern is how EYE will deal with the capacity constraint it is experiencing with Optometrists. The obvious impact is a drag on revenue growth because EYE cannot provide eye exams, which is a common step in the customer purchase journey.

To address this, EYE must hire more EYE, which is not as simple as it sounds given the high demand (commentary from Warby Parker also indicates the high demand for optometrists as they are investing significantly into eye exam capabilities). The high demand directly translates to higher wage costs, putting pressure on the EYE margin. This structurally higher wage cost could permanently impair EYE margin if they are unable to raise prices tactically (without harming its value proposition) to compensate.

Having said that, it is encouraging that management has implemented the flexibility work schedule system, if successful, we should see an increase in optometrist retention at EYE. The introduction of remote services should also contribute to increasing exam capacity, thereby driving growth at lower cost (high utilization since it is remote). Management has noted that stores with capacity constraints are experiencing positive growth; therefore, it is critical for EYE to quickly fix this situation and demonstrate to the market that growth is faster than reported (and margin is not getting compressed).

Margin

Aside from the optometrist constraint issue weighing on margin and growth, I believe EYE market position and value proposition to consumers will limit its ability to raise prices in the short-term. As such, we could see margin compression in the near-term. If true, I would not surprise to the stock price facing a drawback or be in a rangebound as investors look for further datapoints/comments that EYE is able to raise prices.

That said, over the long-term, I am mostly positive that EYE can pass through prices over the mid to long-term as consumers will not feel the pain overnight. Also, by FY25, I anticipate that the implementation of remote care and electronic health records will have reached full productivity, enabling EYE to drive margin expansion. Currently, there are about 300 stores with remote care service, and is already EBITDA positive in 1Q23. Management plans to roll this out to around 500 stores by FY23.

Conclusion

While EYE reported positive financial results for 1Q23, I have concerns regarding the company's growth prospects and its ability to manage profit margins. EYE's core customers continue to be impacted by macroeconomic headwinds, and reduced tax refunds are expected to further pressure the company in the upcoming quarter. A significant obstacle for EYE is the capacity constraint for optometrists, which hampers the company's ability to provide eye exams and impacts revenue growth. The high demand for optometrists results in higher wage costs, which could potentially strain EYE's profit margins. While management has implemented initiatives to address the problem, the long-term success of these efforts remains to be seen. Furthermore, the market position and value proposition of EYE may limit its ability to raise prices in the short term, potentially leading to margin compression. Considering these factors, I recommend a neutral rating for EYE stock at this point.

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