LRLCF - Olaplex: Poor Momentum In A Complex Market

2023-04-16 02:26:03 ET

Summary

• Olaplex boomed between 2019 and 2021, triplicating its revenue and earnings.
• However, the situation has turned around, and the business' momentum is terrible.
• Shares have plummeted 55% this year and 80% since its IPO.
• OLPX stock seems cheap, but with such momentum and uncertainty, it looks like a value trap.

Olaplex Holdings ( OLPX ) is an American brand that develops hair care products. The company IPOed after the pandemic, coinciding with its boom on social media. However, it has had an 82% downturn since then, and the situation could be far from improving.

A simple investment thesis

Olaplex offers a variety of hair care products. They specialize in hair repair and reconstruction. The hair care market is expected to grow at almost 6% CAGR in the following six years. Olaplex is then backed up by a nice tailwind.

However, growth expectations were a lot higher than that. The market expected Olaplex to grow its revenue at high-double digits, penetrating different markets worldwide.

The company built a high-quality product, effective and that rapidly caught on. Olaplex uses BIS-AMINO as their key ingredient. This patented molecule can protect, repair, and strengthen the hair's cortex, making visible changes in its quality.

Nowadays, Olaplex has 11 products in their portfolio. They have progressively launched new products. However, the most popular is still the first they launched. The popularity of the latest products has nothing to do with the originals, which are still the most sold. Because of this, despite the initial success, Olaplex's sales have stagnated.

Sadly, this doesn't say pleasing things about their ability to innovate, and in such a competitive market, innovation is a must.

A highly competitive market

As we can see with L'Oréal and Estée Lauder, selling cosmetics is a very profitable business in which companies can easily average great returns on invested capital. Indeed, Olaplex has averaged a 20% return on invested capital and 70% gross margins.

Nonetheless, in such profitable businesses, competitive advantages are a must. Companies must have strong moats to protect their returns and competitiveness. Sadly, it seems that Olaplex moat is nonexistent.

Too much reliance on social media

The brand caught on after the pandemic, thanks to its popularity on social media. The first products went down well, and the word was spread on different platforms. At the drop of a hat, Olaplex had over 2M followers on Instagram. As a result, many influencers promoted the brand on their accounts. Celebrities such as Kim Kardashian and Katy Perry are only a few of the famous people that promoted their products.

This popularity was beneficial to their international expansion. Thanks to it, they successfully integrated the European and Asian markets. Olaplex sales and popularity suddenly skyrocketed, doubling their revenue in 2021.

However, their brand prevalence has always depended on social media popularity, which has been a double-edged sword. Indeed, the most recent products didn't go down well, and the word was spread on social media. Furthermore, contrary to some months ago, Olaplex has lost some popularity on social media. As a result, the last year was worse than expected, and next year is expected to be dismal.

Patent protected product

Olaplex's BIS-AMINO is patent protected. The brand has some patents safeguarding its products.

In fact, before Olaplex's IPO, L'Oréal ( OTCPK:LRLCF ) tried to buy the company. However, they suddenly backed out of the deal. After realizing the power of the hair repair market, L'Oréal launched a range of products (L'Oréal Professional) whose objective was to compete with Olaplex. However, Olaplex brought a lawsuit against L'Oréal. The lawsuit was accepted, and L'Oréal had to indemnify them.

Still, L'Oréal has developed other products competing in the market and damaging Olaplex's sales. In effect, competing with such big companies is very complicated and is the main reason those small businesses tend to become unprofitable or finish being IPOed by those kings in the market.

Nevertheless, patent protected products are usually insufficient: K18

It is often thought that patent-protected products are impossible to copy or surpass. Nonetheless, I believe patents and technological innovations are the least powerful moats. Olaplex is a great example.

In September 2022, Piper Sandler downgraded their rating on Olaplex. The reason was that a new product, K18, was catching on, replacing Olaplex in many hair salons, and was supposedly better than Olaplex. After the news, I did fieldwork and asked different hair saloons what they thought about the product. The results were surprising. Almost every hairdresser knew K18 and thought it was better than Olaplex. Finally, I asked my hairdresser about both products, and he said that K18 was way better than Olaplex because of the nature of the products. Effectively, they are both in charge of hair repair, but they act completely differently.

Olaplex treats the cortex, the outer part of the hair, whereas K18 penetrates the deepest layer, the polypeptide chains. As a result, K18 repairs the nucleus of the hair, being much more effective than Olaplex. In one usage, K18 can do what Olaplex would do in several more applications. Furthermore, the K18 treatment is more durable than Olaplex as it treats the nucleus.

Still, everything is not impeccable with K18, which saves Olaplex. K18 is two to three times more expensive than Olaplex. Nonetheless, its technology is more effective and efficient than Olaplex. Because of this, the price difference is not that much in the end.

Olaplex's momentum is terrible

After two stellar years, Olaplex didn't reach expectations in 2022. They started the year on the right foot, with a 56% revenue growth. The company forecasted a 36% revenue growth and a 35% net income growth for the entire year. Despite this, the company only managed to grow its revenue by 18% and net income by 11% y-o-y. Though these are still great numbers, they were disappointing.

Olaplex announced in October that they wouldn't match the expectations, and the actual numbers were far off the initial target. That news didn't go down well, and the stock plummeted 55% in a single day.

In addition to their increasing competition and declining growth, Olaplex faces other problems that could be even more worrying.

On the one hand, after increasing troubles replaced the revenue growth, some influential board directors and board members left the business . In a range of 5 months, 8 top executives left the company and joined other competitors.

On the other hand, the company is facing a lawsuit, accused by one hundred people of inducing hair loss. It seems that the suit will fail, but those accusations always harm their reputation.

Rather than being a bargain, it looks more like a value trap

Olaplex trails at an LTM P/E of 11x and an LTM EV/FCF Yield of 8%. Considering their average multiples and peers' valuations, those seem appealing.

However, we can't compare today's valuation with their average multiples. Firstly, those averages are biased, as the stock traded at 70x P/E when IPOed, and their multiples have continuously contracted. Secondly, the expectations were much better a year ago than today.

Furthermore, peers like L'Oréal and Esteé Lauder ( EL ) trade at around 40x LTM earnings, respectively. However, we can't compare Olaplex with those peers. Effectively, those are the market kings, with enormous competitive advantages and a proven track record of sustainable growth and value creation.

The future is too uncertain

According to the company's guidance , this year, revenues will decline between 10% and 20%, and earnings decline will be between 10% and 30%. Those figures would imply a P/E ratio between 12 to 15 times earnings. Below average, but I wouldn't buy such an uncertain business.

I need predictable revenue and cashflows to value a business, and Olaplex's future needs to be more foreseeable for me to do so. The only thing I can undoubtedly predict is that revenues will be declining this year, which isn't encouraging, even more, if the momentum is already terrible.

Finally, Seeking Alpha's Quant gives a Strong Sell rating to Olaplex, reaffirming the concerns about the business.

Conclusion

Olaplex's situation is tricky. The business had a fantastic run after the pandemic, and its popularity was outstanding. Their products were a novelty, and people loved them. However, the increasing competition and the failure of the new products provoked a dangerous situation that harmed the business and its future.

The stock seems to be a bargain considering the multiples. However, the future is too uncertain and could be a value trap. Earnings are declining, and, for the moment, there isn't any encouraging news or products.

To conclude, I rate OLPX stock as a Hold . I don't rate it as a Sell because the business could revert to its previous path, stabilizing and launching new products. In this case, the stock could be attractive. Still, I think Olaplex lacks competitive advantages, and I am not too confident about its future. I believe Olaplex has the makings of being bought by a king like L'Oréal and Esteé Lauder, which would save the company in the worst scenario.

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