OLPX - Olaplex: Ongoing Struggle Is No Surprise

2023-03-15 16:40:56 ET

Summary

• Olaplex's sales continue to decline, indicating that much of the company's recent growth was due to an unsustainable surge in demand.
• Olaplex's costs are rising at the same time as revenues are falling, causing significant margin compression. This was completely predictable, given Olaplex's bare-bones approach in the past.
• On a forward-looking basis, the stock is not particularly cheap, particularly with a growing risk of recession.

Olaplex's (OLPX) financial performance continues to disappoint due to a confluence of negative factors. Much of this was foreseeable 12 months ago , when the stock traded above 20 USD per share. While the current share price presents a far better entry point, the looming prospect of a recession and questions about Olaplex's ability to generate further growth should give pause to potential investors.

Market

While the economy is widely considered to be performing well, many consumer facing companies are finding the environment increasingly difficult. Consumers are becoming increasingly price sensitive, with many companies observing customers trading down. This could be a problem for Olaplex as they offer premium products, which are quite expensive if customers are employing a total regimen.

Normalization of consumer behavior post-COVID may also be weighing on Olaplex's performance. There was a boom in visits to hairdressers when the economy reopened in 2021, and this has likely become a headwind in 2022 as demand has normalized. Olaplex has suggested that professional stylists in the US are buying less and delaying purchases until closer to when the product is actually required. This may be in response to a reported lengthening in the time between client visits to the salon.

Using personal care services inflation as a proxy for hairdresser/hair stylist demand indicates that the market is still fairly robust though. This also shows that demand drops significantly during recessions, which could be problematic for Olaplex given their heavy reliance on the professional stylist channel.

These demand problems are being exacerbated by high customer inventory levels. Many retailers are destocking in response to elevated inventory levels and soft demand, a trend that Olaplex has not been immune to.

Olaplex

Olaplex is in a difficult situation, as significant investments may be required to try and offset soft demand. Part of this stems from the fact that at the time of listing, Olaplex was essentially a product supported by a skeleton staff, with most activities outsourced. For example, Olaplex only hired a Chief Marketing Officer in January 2022, despite the fact that their market capitalization was close to 20 billion USD. While this resulted in amazing margins, it was not sustainable for a large organization. Olaplex is now being forced to build out capabilities, like marketing, which is expensive and may not yield significant results, as they are largely acquiring resources they should have already had.

In the past, Olaplex has been able to rely on their products selling themselves, due to their high efficacy and a lack of competition. Olaplex also claims that they have been trying to avoid over promotion to manage the health of the brand, which has contributed to recent poor performance. Now that demand is stagnating, Olaplex is investing more in sales and marketing, education and partner relationships.

Olaplex also believes that sampling is an effective customer acquisition tool (conversion rates on samples range from 30-40% ), due to the efficacy of their products. As a result, Olaplex is planning on increasing samples from approximately six million in 2022 to 10 million in 2023.

Interestingly, Olaplex spent a significant amount of time on the fourth quarter earnings call discussing negative PR and misinformation. This would suggest that claims of Olaplex causing hair loss have been damaging consumer perception of the product. Whether there is any substance to the claims may not matter, recovering from this type of damage could be difficult.

Third-party data indicates that Olaplex's user retention across retail channels is significantly higher than their peers. This suggests that Olaplex's current problems are more related to customer acquisition than retention, something that they have previously shared. The rapid decline in revenue suggests problems that extend beyond customer acquisition though. If customers are not churning, then they are clearly purchasing less frequently or have smaller basket sizes.

To achieve the type of success that was once envisioned for Olaplex, their products need to be much more broadly adopted and customers must use a range of Olaplex products as part of a haircare regimen. Bond repairing treatments are still a fairly niche product though and there is a risk that Olaplex proves to be a fad. For example, Olaplex is only 15% penetrated at professional salons. Conversely this presents an opportunity to build awareness and grow adoption.

Olaplex has also pointed towards a multiyear product pipeline in haircare, adjacencies and new categories which could support future growth. This is something that they have been claiming for over 12 months though, and with little investment currently dedicated to R&D, it is not clear to what extent there truly is an innovative pipeline of products. So far, Olaplex has primarily been building out an increasingly niche portfolio of haircare products based around one chemistry breakthrough.

Olaplex can also achieve growth by expanding geographically. So far, the company has little presence in the Middle East, Latin America and Asia Pacific.

Financial Analysis

Olaplex's sales continue to contract sharply, although there have been a number of one-time factors that have exacerbated this. Management has suggested that retailer destocking is causing their sales to look far weaker than actual sales to consumers. Olaplex attributed 29 million USD in lost sales in the fourth quarter to customers reducing inventory levels in response to weak demand.

Olaplex's sales in the fourth quarter of 2021 and the first quarter of 2022 were also elevated due to Ulta building inventory for Olaplex's launch. An additional 10 million USD of sales were attributed to Q1 2022 as a result of this. As Olaplex is in the process of lapping these data points, growth is being artificially dragged lower.

For 2023, net sales are expected to decline by 15% and adjusted EBITDA is expected to decline by 32%. Net sales growth and profit margins are expected to improve as the year progresses, with positive growth expected in the fourth quarter of 2023. Olaplex currently expects net sales to decline 41% in the first quarter.

A number of data points suggest that Olaplex's brand awareness and customer acquisition has stalled, indicating a problem that goes beyond just softer end market demand. Whether increased marketing spend can reverse this trend remains to be seen.

Olaplex's gross profit margin has declined significantly over the past 12 months, and now sits only modestly higher than their operating profit margin in early 2021. This decline comes even after Olaplex increased prices in 2022, and has been attributed to a mixture of inflation, product mix, increased sampling and customer mix.

Olaplex expects a 3-4% decline in gross profit margins in 2023, due to inflation and lower sales volumes.

Olaplex's operating expenses are also rising as sales fall, greatly impacting operating profitability. Much of this is due to workforce expansion and increased sales and marketing expenses. In 2023, Olaplex expect to spend 70 million USD on marketing , relative to a 40 million USD budget in 2022. It should be noted that despite the large increase in spend, Olaplex's marketing spend is still quite small relative to their sales.

The drop in profitability has so far been painted as a temporary event, with margins expected to recover as sales begin to grow again. This could be considered optimistic though as Olaplex will need to continue building out their organization, and softer demand in conjunction with increased competition could necessitate permanently higher marketing spend.

Valuation

Olaplex's stock may currently seem cheap on backwards looking metrics, particularly for investors who still believe in the growth story, but depending on how much sales fall and margins compress in 2023, the company's forward PE ratio is likely close to 20.

While Olaplex's stock has already fallen significantly, increasing costs and questionable growth prospects could cause further downside. With the probability of a substantial decline in consumer spending increasing, it is hard to get excited about a premium haircare company that may have already saturated its core market.

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