OLPX - Olaplex: Rating Downgrade As The Business Might Be Structurally Impaired

2023-08-19 00:27:45 ET

Summary

• I give a sell rating due to concerns about potential structural impairment and the need for a complete rebranding and change of strategy.
• 2Q23 results were significantly lower than expected, with a 48% drop in revenue and poor performance in the Professional and Specialty Retail segments.
• Despite increased marketing efforts, Olaplex is still facing challenges with misinformation and increased competition, and management's estimates suggest a lack of near-term recovery potential.

Overview

My recommendation for Olaplex ( OLPX ) is a sell rating, as I do not see any possible catalyst that might drive the stock upwards in the near term. As of the current situation, I have concerns that the business might be structurally impaired (i.e., brand image), and there might be a need for OLPX to completely restructure its brand and strategy moving forward. Until we have more information regarding the trajectory of the business, I don’t think any investors will be interested in the stock. Note that I previously gave a hold rating to OLPX as I awaited more data points and signs that the business could meet FY23 guidance.

Recent results & updates

OLPX's 2Q23 results were significantly lower than anticipated due to weaker-than-anticipated performance in the Professional and Specialty Retail segments. Starting with revenue, it plummeted by a shocking 48%, to $109 million. Reasons for the precipitous drop include weakening demand, rising competition, rebalancing inventories, and poor performance in Professional channel. Specifically, sales through the professional channel dropped by 61% to $41 million, retail sales dropped by 54% to $30 million, and direct-to-consumer sales dropped by 6.4% to $39 million, demonstrating widespread weakness. Management had already warned of a weak 2Q23 in 1Q (refer to my previous writeup), but the results were still worse than expected. The worst news is that the company's fundamental trends have been getting worse over time. The situation was so bad that management had to reduce their expectations for all of the most important metrics in FY23, including revenue, gross margin, adjusted EBITDA, and net income. The revised forecast is based on a much lower expectation of underlying demand.

With the 2Q23 results and negative comments from management, I am shifting my recommendation from a hold rating to a sell rating, as I don’t see any way the stock would see positive traction in the near term. For the stock to work, OLPX must repair its brand image, but so far, marketing efforts have yet to show any turnaround. Despite increased marketing and education investment, OLPX is still fighting misinformation and increased competition. My worry is that the brand damage (from the PR crisis ) is more severe than anticipated, and it would take a lot more for OLPX to fix it, both in time and resources. The best indicator that suggests OLPX is still far from recovery is the 61% drop in Professional sales (recall that this channel is a key part of OLPX's go-to-market strategy).

On the other hand, management saw an uptick in visitors to Olaplex.com after launching an advertising push. Despite the fact that this should have a knock-on effect on the rest of its operations, I remain skeptical of its true significance, as the actual results so far have been nothing but horrible. Overall, I think investors will continue to avoid the stock for the foreseeable future due to disappointing Q2 results and management's estimates that consumption in key accounts was down -26% in 1H23. To add, management is essentially "throwing in the towel" for FY23 now that they are not anticipating a rise in baseline demand despite an uptick in spending on marketing and advertising in 2H23. With that in mind, I don’t see any catalysts that will drive the stock up until FY24, at the minimum.

Summary

I am skipping my usual valuation segment for this post as I believe there could be a structural change in the business that is hard to model today. There is simply too much uncertainty in the business. The worst-case scenario is that OLPX needs a complete rebranding and change of strategy, which might significantly deter the business's growth trajectory.

In conclusion, I am downgrading OLPX to a sell rating due to concerning factors that suggest potential structural impairment. The recent 2Q23 results were notably worse than anticipated, reflecting significant drops in revenue across various segments due to weakening demand, competition, and channel-specific challenges. Management's lowered guidance for key metrics underscores the scale of the underlying demand issue. Despite increased marketing and educational investments, OLPX is still grappling with misinformation and heightened competition. The brand's damage from a PR crisis appears more severe than initially thought, raising doubts about a swift turnaround. The stock's prospects seem grim as management's estimates and actions suggest a lack of near-term recovery potential. Given the uncertain landscape, traditional valuation analysis is challenging, and the possibility of a substantial business rebranding and strategic shift further clouds the growth outlook.

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