OTLY - Oatly: Market Leader In The Oat Milk Industry

Summary

• Animal-free dairy products are becoming more popular.
• Oatly Group AB is a leading player in the industry.
• Oatly Group has strong distribution capacity.
• Oatly Group plans to invest in capacity to remove key hurdle to growth.

Description

I recommend buying Oatly Group AB ( OTLY ). The demand for plant-based dairy products has been increasing due to their perceived environmental and health benefits, and OTLY is a leading player in the industry with strong distribution capacity. Oatly Group's go-to-market strategy has been successful in increasing brand awareness and driving demand for OTLY's products. One of the main challenges that OTLY has faced is a lack of production capacity, but the company is investing in expanding its production capabilities to meet the growing demand for its products. Overall, the increasing demand for plant-based dairy products and OTLY's strong market position and distribution capabilities make it an attractive investment opportunity.

Company overview

To put it simply, OTLY makes oat beverages. The business processes liquid oats to create edible products with high nutritional value and low ecological impact.

Plant-based dairy is gaining adoption

About a quarter of all global warming due to human activities can be traced back to the global food industry. That's way above the estimated 14% of global greenhouse gas emissions that come from all modes of global transportation combined. While providing over half of the emissions from the world's food production, animal products contribute to less than 20% of our total caloric intake.

To combat the effects of climate change and the depletion of natural resources brought on by industries dependent on livestock, such as the dairy industry, I believe that plant-based dairy products are essential. According to Euromonitor, plant-based dairy is one of the top five key trends shaping the global dairy industry. I believe this trend represents a significant opportunity for OTLY by increasing the total addressable market.

Sustainability is, in my opinion, a major factor in this widespread adoption. Large numbers of people are switching to plant-based dairy products because they are learning about the environmental and health benefits of doing so. Sources cited in the prospectus claim that 60 percent of U.S. consumers have adopted a healthier lifestyle and diet as a result of the current health consciousness movement. Numerous studies have shown that switching to a plant-based diet has health benefits, such as lower risk of heart disease, lower risk of certain cancers, and higher fiber intake. In my opinion, the substantial underlying global demand for plant-based dairy is a direct result of the nutritional and environmental benefits of plant-based alternatives, which make them a more appealing option for consumers.

Leading player in the industry

When it comes to oat-based products, Oatly Group AB dominates the market. They have figured out that the oat base crop was the key, and they patented a method that uses enzymes to transform oats into tasty foods without destroying their nutritional value. Through strategic expansions, Oatly has achieved unprecedented growth, reporting 73% and 50% CAGRs in revenue and gross profit between FY17 and FY21, respectively. I think this explosive expansion is fueling demand for all dairy alternatives, not just those made from oats, in the markets where they are most successful. For instance, since Oatly's launch in Germany, the share of the total dairy alternative category held by oat milk has increased from 23% in 2018 to 60% in 2020, as reported in the S-1. I believe OTLY can continue to grow by increasing their brand's visibility and penetrating new markets to meet rising consumer demand.

Strong distribution capacity

OTLY's specialty foodservice-led go-to-market strategy is designed to increase product and brand awareness in their targeted market. Because of this excellent brand-building strategy, consumers are introduced to Oatly in a familiar and comforting context, like while enjoying a cup of coffee at their favorite Café. As a result of their positive experience with Oatly's high-quality products, consumers are more likely to try new plant-based foods and beverages, such as those found in grocery stores or online. Notably, this strategy is possible thanks to OTLY's local teams learning the ins and outs of each market's unique distribution networks, making it incredibly hard to replicate. While the barista connections at OTLY coffee are the best example of this strategy so far, I think it could be applied to other product categories through the corresponding foodservice channels. By forming alliances with multi-location independents and major coffee chains, this strategy also paves the way for OTLY's international expansion.

Invest in capacity to remove key hurdle to growth

In my opinion, OTLY expansion has been hampered most by a lack of production capacity. Demand for Oatly products has historically outstripped supply around the world, but OTLY plans to remedy this by opening new production facilities in the near future. Growing the top line and satisfying current consumer demand are both goals I believe OTLY can achieve by expanding operations.

OTLY's management seems to have hinted at a shift toward a hybrid model in 3Q22 earnings, and the company is continuing to rely on outside services (such as co-packers) to supplement its in-house production. Ultimately, I believe that OTLY should revert to the strategy it laid out during the IPO (end-to-end manufacturing) in order to provide high speed-to-market and long-term self-sustainability. This strategy has already proven to work in Sweden where it showed that bringing manufacturing capabilities in in-house leads to better unit economics.

In my opinion, this strategy has a number of competitive benefits, including: guaranteed capacity; comprehensive oversight over processes that provides quality assurance; command of machinery and procedures that contribute to environmental friendliness; and bring distribution closer to consumer end markets, all of which drives attractive production economics.

The shift towards a plant-based food is just getting started, and I believe OTLY should keep investing to meet these demands.

Valuation

I believe Oatly Group AB is worth USD$1.83 today, a 29% increase from the current stock price based on my 10Y DCF model. This is based the following assumptions:

1. Revenue will growth dip as per guidance in FY22 due to all the headwinds experienced but will see a recovery in FY23 with growth stronger than FY22. Over the next decade, growth will continuously slow down as OTLY revenue base gets larger and penetrating new markets are not as easy as it sounds.
2. Net margins to gradually improve to positive territory, reaching 10% in FY26 (assuming 20% in OPEX but gross margin goes up to 30+%).
3. Discount rate: 10%; terminal growth: 3%.

Key risks

Raising cash

As of now, it looks like management is pretty confident that they can raise $200 million by next June. Lenders may be interested in Oatly's revised growth projections. This could be a major red flag if next June rolls around and no funding has been provided.

Investors losing confidence in management words as they flipflop to a hybrid production model

During the IPO, the company detailed how it planned to increase gross margins to over 40% by moving production in-house from beginning to end. It was promoted to investors at the time that self-manufacturing offered superior profit margins to hybrid manufacturing and was the best method for safeguarding intellectual property. So, it's not clear why OTLY is moving away from an end-to-end model, but I suspect that going hybrid is a result of a need to cut costs during a difficult economic period. One positive development is that management claims it has reduced difference in profit margins as it has become more familiar with the hybrid model. Ultimately, OTLY could theoretically go back to an end-to-end model if its financial situation improves.

Summary

Plant-based dairy product demand has been on the rise as people recognize the positive effects that they can have on the planet and their health. In which, Oatly Group AB is a market leader with extensive distribution capabilities. Lack of production capacity is one of OTLY's biggest problems, but the company is making investments to increase output to keep up with rising demand. Overall, Oatly Group AB represents an appealing investment opportunity due to its prominent market position and distribution capabilities, as well as the rising demand for plant-based dairy products.

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