WRBY - National Vision Holdings: Uncertain Prospects In Both The Near And Long Term

2023-09-20 11:26:22 ET

Summary

• EYE experienced weak sales performance and a decline in gross margin in 2Q, raising concerns about its growth potential and profit margins.
• The termination of its partnership with WMT adds uncertainty to its long-term growth prospects and will impact revenue in the near term.
• EYE's capacity limitations among optometrists continue to pose a significant challenge, but there is optimism that optometrist capacity will gradually improve through recruitment and retention efforts and the implementation of a remote medicine program.

Summary

Readers may find my previous coverage via this link . My previous rating was neutral as I was concerned about National Vision Holdings' (EYE) growth potential and its ability to effectively manage profit margins. The company experienced weak sales performance, with core customers feeling the impact of broader macroeconomic challenges. Furthermore, capacity limitations among optometrists have disrupted EYE's value proposition and profit margins, primarily driven by the rising wages of optometrists.

I am reiterating my neutral rating due to its poor 2Q results, the optometrist's capacity issue that continues to pose a significant challenge for EYE which resulted in contraction of EYE's gross margin and added uncertainty in its long-term growth prospects due to the termination of its multi-decade relationship with Walmart (WMT).

Financials

EYE's 2Q results were notably weak. Net revenue exhibited a modest 3.1% YoY increase, amounting to $525.3 million. This figure represents a decline compared to the 1Q, which reported $568 million in revenue. The gross margin also suffered a YoY dip, falling to 52.8%, in stark contrast to the 1Q 54.8%. This decline was primarily attributable to the escalation of optometrist-related expenses. Additionally, the adjusted EBITDA witnessed a substantial 22.8% YoY decrease, totaling $39.5 million, in contrast to the $62.8 million reported in the 1Q. Consequently, the adjusted EBITDA margin also experienced a YoY decline, dwindling to 7.5%, compared to the 11.2% recorded in the 1Q.

As previously mentioned in my earlier post, I raised concerns regarding EYE's growth prospects and its ability to manage profit margins effectively. The lackluster performance in 2Q only serves to underscore these concerns, and I anticipate that these challenges may persist into the forthcoming quarters.

Valuation

Based on my view on the business, EYE will experience a 3% decline in growth in FY24. This projection is primarily attributed to the subdued revenue growth observed in 2Q and the company's decision to terminate its long-standing partnership with WMT. The growth rate aligns with market consensus.

My model uses a margin of 56% for FY24. This estimate is underpinned by a positive outlook, as there is optimism surrounding the gradual improvement of optometrist capacity. This improvement is expected to materialize through ongoing recruitment and retention initiatives, as well as the implementation of EYE's remote medicine program. It's worth noting that while the company is currently facing some pressure in this quarter, it is anticipated that these challenges will ease in the near future, therefore driving margins to expand.

The forward price-to-earnings ratio for EYE is currently 28x. In comparison, similar companies like Staar Surgical (STAA) and Warby Parker (WRBY) have a PE ratio of around 45x. When compared to its peers, EYE's valuation seems reasonable, as its 53.85% EBITDA margin is lower than the industry average of 57.02%. EYE also has a relatively high leverage ratio (D/E) of 112.08%, significantly higher than the peers' average of 56.39%. Lastly, the market has also priced in the WMT termination news, which is viewed as a negative on EYE's future revenue growth. Therefore, I find the current valuation to be reasonable. Based on my analysis, I have set a target price of $17.90 for EYE.

Comments

The capacity of optometrists continues to pose a significant challenge for EYE. In 2Q, a yoy decrease in gross margin to 52.8% was primarily attributed to elevated costs associated with optometrists, as indicated by management. In the near-term, I expect pressure to continue into 2H23. However, if I were to look at the medium-to-long-term ahead, there is optimism that optometrist capacity will gradually improve, driven by ongoing recruitment and retention efforts. Furthermore, the introduction of EYE's remote medicine program is expected to bolster capacity. The company's strategic focus is now directed towards implementing this program in stores facing optometrist capacity limitations, alleviating the need to hire more optometrists to sustain growth expansion. I believe that in the long term, margins will start to improve as optometrist's capacity stabilizes.

Another factor that I expect to pressure margin is EYE's pricing strategy, which aims to remain competitive in the broader market despite increasing costs. This pricing approach is rooted in the management's commitment to maintaining the company's value proposition. Consequently, the sole avenue for margin improvement, in light of rising costs, is to further increase prices. However, given the prevailing inflationary environment and EYE's commitment to its value proposition, such a move may potentially dampen demand, counteracting the benefits of price hikes. Hence, I expect short-term margins to be under increased pressure, exacerbated by the shortage of optometrists driving up costs.

In addition to weak near-term margin, another concern appeared this quarter regarding EYE long-term growth prospect due to the termination of its multi-decade relationship with WMT in 2024. The decision to end this longstanding partnership, through which EYE managed vision services within Wal-Mart stores and handled online contact lens sales for WMT, was unexpected and represents a negative development for the company. In the near term, it is anticipated that this move will impact EYE's revenue, stemming from the loss of revenue generated from Walmart.

Risk & conclusion

Potential risks encompass a slower-than-anticipated revenue rebound due to deferred demand among lower-income customers, a lesser-than-expected shift to lower-cost options, margin challenges arising from increased labor costs, and the possibility of lingering expenses tied to the terminated WMT partnership.

In conclusion, EYE is grappling with a persistent challenge in recruiting and retaining optometrists, which has put pressure on their profit margins. 2Q of the year saw a YoY drop in gross margin to 52.8%, mainly due to increased costs associated with optometrists. This trend is expected to continue into the second half of 2023. Moreover, their pricing strategy aims to remain competitive, but raising prices may dampen demand in the face of inflation and the company's commitment to value. Finally, the termination of a long-standing partnership with Walmart in 2024 adds uncertainty to EYE's long-term growth prospects, impacting revenue in the near term.

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