OTLY - Oatly: Dairy Free And Profit Free

Summary

• Oatly is a prime example of a busted IPO, but is there a long-term growth story hidden in the carnage?
• Shares are down 89% since the 2021 highs, but this doesn’t necessarily mean it is undervalued.
• They already lost their first-mover advantage and will continue to lose market share.

Oatly ( OTLY ) has been a very interesting story considering its relatively short time in the limelight. It is a mission-driven company in the plant-based space known for its unique advertising. There have already been several controversies from different angles in this company's story. The scope of this article is not to address concerns over the product/industry itself, I merely want to know if this can be a good growth story.

First of all, they deserve credit for not only having the first mover advantage but single-handedly creating the demand for their category of product in the first place. They weren't chasing a fad, they came up with the fad. This took some time as well, the company was founded in 1994, and only in recent years revenue has grown significantly.

The fact that they made oat milk mainstream came with looming danger though. Competitors got in on the action very fast, and OTLY has now been overtaken by lower-priced competitor Planet Oat, owned by HP Hood, in the US.

Industry

The global oat milk market is estimated to grow at almost 8% till 2026. Oat prices are down 50% since April, but other inputs along the production process are still resulting in price increases from OTLY. You can see the volatility of oat prices below:

There aren't any other competitors who are solely oat-based, so these are in the dairy alternative and plant-based category.

Source: QuickFS

Below is revenue/invested capital to gauge the price of growth:

If the goal is to scale globally, the quickest path would be as a takeover target by one of the big CPG companies. The big players already have the infrastructure and distribution set up, and this would be the fastest way to scale. The problem is, this company is undoubtedly mission-driven, therefore wouldn't want to be swallowed up by one of the food or beverage giants.

Moat

The most important question is if OTLY has an actual moat or something close to it. Being a young, growth company, they are losing money and have no returns on capital to show, which is how the most common underlying measurement of a moat.

The one moat-like characteristic OTLY has would be their proprietary method of adding enzymes during the production process. They claim it is hard to copy , and do own some IP around it as well. The company certainly has brand power, but not nearly enough to qualify as a legitimate moat. Make no mistake, this is a commodity company that is now losing brand power over time.

Risk

The demand is clearly abundant and there's no reason to think the general trend will slow anytime soon. Oat milk itself has become a permanent fixture for many consumers. The problem isn't with the trend, it's the competitive nature of the beverage space, combined with operational deficiencies. OTLY has had a significant market share for a long time but clearly underestimated how quickly and strongly competition would come.

Some of the supply issues were not their fault, such as COVID itself and various supply chain shocks, but this isn't giving them a pass at all. They blundered their most important account, SBUX, running out of oat milk which forced SBUX to turn to a different supplier. The CEO claims that the demand was so immense that there physically wasn't enough capacity anywhere to produce enough to meet demand.

This highlights why not all growth is always good. They seemed to have bitten off more than they could chew with the Starbucks (SBUX) deal.

The biggest risk is already here and getting worse with every tick of the clock. OTLY is losing market share while spending ever-increasing amounts on growth. They clearly underestimated how much it would cost to grow, and also how quickly competition would spring up. The beverage space is inherently competitive, and OTLY doesn't have the executive experience of successfully scaling a brand worldwide.

As of now, revenue growth won't increase easily or cheaply. They had the market almost entirely to themselves for so long, and now face the opposite, a very crowded and competitive market. Of the $1.4 billion raised by the IPO plus $200 million investment made by Blackstone in 2020, only $275 million remains. Long-term debt is at manageable levels now, only $129 million, but the chance of future debt plus dilution is almost inevitable.

To be blunt, I believe much of the ambition within this company is still directed towards generalized promotion of plant-based products, rather than capitalizing on their first mover advantage and growing more efficiently. They deserve credit for their unique marketing style, but clearly, the brand is not being maximized to its fullest. To think that being the first mover guarantees that you will remain the dominant, go-to, brand forever is a vital error.

Valuation

There were many high-flying companies that benefited from COVID stimulus/speculative mania and subsequently came down 90% from those highs, and Oatly is one of them. Price decline doesn't always mean undervaluation. Sometimes a busted IPO can provide a chance for investors to have their cake and eat it too, i.e. a growth company that trades like a value stock. This is not the case with OTLY. What happened here is that the IPO was overpriced in the first place, shortly followed by the final thrust of the speculative frenzy of multiple asset classes.

Source: QuickFS

I'm actually so bearish on the fundamentals of the company, specifically the management's ability to grow properly, that I won't use a DCF, since that model only works if you expect the company to become profitable one day. At this point, I see a fairly high probability that they never become truly profitable. I would be very surprised to see a friendly takeover, even if it's the only way for the brand to live on.

Conclusion

Oatly has been through a lot in its short time in the public spotlight. Its tenure as a public company has been dreadful for shareholders, as this fits the mold of a busted IPO. The massive decline in share price doesn't mean an actual discount is presented. The company blundered its most important account, showing it couldn't handle the growth.

The growth story of this being a dominant brand is clearly over, and the path to profitability becomes evermore unclear and murky. OTLY will keep growing, but the market demand is a rising tide that will lift all boats. The company obviously benefits from this, but it will have a very difficult time forging out its own growth. A busted IPO can in some cases offer a chance to overlap growth and value investing, but this isn't the case here. There's almost no amount of discount that can justify owning a company with such difficult growth prospects.

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