OLPX - Olaplex: FY23 Guide Might Be Too Aggressive

2023-04-03 09:53:12 ET

Summary

• Management's guidance for FY23 may be too aggressive, given the uncertainties and negative product feedback overhang.
• OLPX is making investments in advertising, free-trial programs, and high-touch sales teams to support growth.
• The company's new product launch, Lashbond Building Serum, has the potential to tap into a growing market, but customer acceptance is uncertain.

Investment thesis

Olaplex ( OLPX ) 4Q22 results were much lower than I anticipated. The results of 4Q22 showed that demand growth had slowed and that retailers were holding onto excess inventory, which led to a de-stock driven drop in net sales. To give context on how bad the declines are, pre-4Q, growth was still in the high-single digit (at least), and before that growth was extraordinary. But in 4Q22, revenue collapsed by 21.5% and we are still in the midst of a very bad macro environment – and consensus now expected revenue to decline by 30 to 40% in 1Q23 and 2Q23. In hindsight, I believe I made the mistake of being too confident in OLPX market position.

Ultimately, this is a very discretionary product that is heavily influence by its salon channel. In good times, people visit salons and spend on good and expensive products. In bad times, any normal salons will suffix. The negative feedback from OLPX users also did not make the situation any better. Despite management's rapid response and increased investment to counter what it calls false information, I think it will be some time before customers forget about this. As such, this reduces any near-term recovery growth outlook. Nonetheless, management is optimistic that it will revive growth by year's end, so it's worth keeping an eye on. I have faith in its potential success, but I also know that knowing if, when, and how much it will cost is extremely difficult. All in all, I downgrade the stock to hold from my previous buy rating as a result.

Growth outlook

Weaker demand across channels for OLPX persists. Due to longer intervals between client visits, management has been buying only as much Pro stock as is absolutely necessary. In addition, OLPX's tight promotion structure harmed business in the fourth quarter as management acknowledged that specialty consumers are price sensitive. Management has reduced inventory levels in response to softening demand in the specialty retail sector. In light of these dismal demand signs, management has released its forecast for FY23, projecting net sales of $563 million to $634 million. It is also anticipated that the gross margin will decrease by 300–400 bps, while adj EBITDA margin will reach 48.7%. Management is also guiding for adjusted net income in the range of $176–224 million.

What worries me is that management expects sales to drop 41% in 1Q23 across the board, with declines of 43%, 47%, and 28% expected in Professional, Specialty Retail, and Direct-to-Consumer channels. Using management 1Q23 guidance, it implies management are expecting growth to accelerate for the rest of the year in order to hit FY23 guidance. I believe this might be a little too aggressive to guide at this stage given all the uncertainties and the negative product feedback overhang. On this note, I have concerns that OLPX management team are guiding relatively “strongly” to support its stock valuation – which could due to a lack of experience managing expectations as a public company (OLPX only IPO-ed in 2021). Also, given that OLPX has been growing very fast in the past, management might be overplaying its hand this time round, in my opinion. To be upfront, this does not mean that the guidance cannot be met, it only meant that expectations are high and OLPX has a lot to lose if they miss.

The fact that management is making a number of investments gives hope that there is a higher chance of meet guidance (I believe). To begin, OLPX is increasing the budget for its advertising and free-trial programs. This, I believe, will allow it to increase the quantity of samples available, the quality of its digital advertising campaigns, and its ability to communicate with salons. OLPX is also expanding the number of US Sephora and Ulta locations where their high-touch sales team will be available to educate customers at the register. My guess is that this will increase the company's high-end cosmetics sales in the United States at Sephora and Ulta. However, the return on these investments is uncertain at best. On the other hand, while it has relied on user-generated content in the past, this tactic is backfiring now that many customers are more likely to share their complaints about the product's quality than their praise for it. For this reason, I wonder if OLPX will need to put more money into a conventional advertising campaign in order to alter the dialogue and alter people's perceptions.

New product launch

I'd also like to draw attention to the newest offering from OLPX, Lashbond Building Serum . The fact that OLPX has released its first product in a different market than haircare gives me hope that growth runway is longer now. The global eyelash serum market was sized at $825 million in 2022 and is projected to grow to $1.3 billion by 2030, according to Polaris Market Research . With haircare routines only being able to grow so much, the risk of incremental SKU launches becoming cannibalistic is real, so I applaud management for making this move in light of the massive TAM and the diversification angle. If I may offer a word of caution, I would say that a large customer base in one product category is no guarantee of acceptance in another. While I applaud the industry's growth, I'm waiting to hear how customers respond to the various products in the lash market before taking a strong stance on OLPX market position. As OLPX expands into new product categories, it will likely need to allocate more resources to advertising. Since there is no lash serum pro network, I expect OLPX to heavily invest in marketing in order to break into the market, which could be painful in the short term but beneficial in the long run.

Conclusion

After reviewing OLPX 4Q22 results and growth outlook, I revised my buy rating to a hold. Weaker demand and negative product feedback have reduced the near-term recovery growth outlook, and I have concerns that management's guidance is relatively aggressive, considering the uncertainties and negative feedback overhang. However, management's increased investment in advertising and free-trial programs, as well as the launch of a new product in a different market, gives hope for longer-term growth potential. Overall, it is worth keeping an eye on OLPX progress, but there are still many uncertainties that could impact the near-term growth.

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