OLPX - Olaplex: Signs Of Turnaround Need To Surface In The Financials To Convince The Market

2023-06-22 06:56:59 ET

Summary

• I maintain a hold rating due to concerns about meeting FY23 guidance and weak 2Q performance, despite management's reassurance.
• Significant growth acceleration is needed in 2H23 for Olaplex to meet FY23 guide.
• Positive indicators such as stabilizing underlying trends and improving consumer sentiment could increase confidence in OLPX turnaround if it shows up in the P&L.

Investment thesis

As I wait for more data points and signs that Olaplex ( OLPX ) can meet FY23 guidance, I am maintaining my hold rating. While management reiterated its guidance, I am concerned about the fact that reported figures (1Q23 results were bad with US sales down 60%) are saying otherwise. Management has stated that demand for the company's core services has remained steady from 4Q22 through 1Q23. However, 1Q23 results did not reflect this at all, in my opinion. In addition, management has indicated that 2Q23 sales is likely to be modestly better than 1Q23, which means OLPX will need to significantly accelerate in 2H23 if it wants to meet FY23 guidance. Despite my current level of skepticism, I believe it is possible for OLPX to achieve this goal by increasing its international distribution and penetrating new markets through a combination of marketing and innovation. Given the unknowns, however, it is not my investment style to make bets in such circumstances. I would prefer to see signs of growth acceleration; in that it is possible to hit FY23 guide without too much leap of faith.

Near-term outlook

The biggest overhang to the stock today is that expected weak 2Q performance, which management has warned. On top of the poor baseline performance, I would add that many one-offs from last year, such as the $22 million extraordinary sale from 1-Liter size offerings and the $10 million pull forward in sales ahead of the price increase in July 2022, make 2Q22 an extremely tough comparison. Many investors, in my opinion, are overlooking the fact that this weakness extends beyond the top line. I think the shock to investors might come from how much EBITDA would decline. Keep in mind that OLPX is still in the midst of turning things around following the recent PR crisis , and as a result, a lot of resources (expenses) are being directed toward rebuilding the brand and promoting it. I anticipate a significant drop in EBITDA in 2Q23 as a result of the increased spending and the poor performance during the quarter. Since revenue growth is only anticipated to be moderate in the second quarter, the consensus expectation of a 44% EBITDA margin, an increase of 300 basis points from 1Q23, may be overly optimistic. In fact, the word “modestly” led me to think that there is room for growth to turn negative as management does not sound confident at all.

Positive indicators and strategies

Financial results that back up management's claims of stabilizing underlying trends and improving consumer sentiment would increase my faith in OLPX's turnaround. According to management, consistent like-for-like sell-out trends since the end of the year suggest that the company's underlying momentum is stabilizing. If these hold true, I believe that OLPX is just getting started with its growth acceleration, which should pick up steam in 2H23. Management has also noted an uptick in positive feedback as a result of their brand damage recovery and damage control marketing initiatives. To further promote product/brand recognition, management noted they are also rolling out additional sampling campaigns to. Once the company passes the challenging 2Q22 comparison, the confluence of these factors could trigger acceleration in 2H23. Growth in the top line and the ability to leverage fixed costs should lead to a rise in the EBITDA margin beginning in 3Q23.

Putting aside near-term weaknesses, I believe there are significant opportunities for OLPX to expand its business in the long run. OLPX, with its relatively few stock-keeping units (SKUs), should innovate and release new products to address different aspects of a single vertical. For instance, in one simple of haircare category there are: hair conditioner, dry shampoo, hair gel, hair mask, etc. International expansion seems like the next logical step for OLPX once it has established a solid foundation in terms of product SKUs and operational capacity (procurement, manufacturing, etc.).

Guidance

Management has reaffirmed its financial guidance for FY23, anticipating only a modest sequential increase in sales for 2Q. In my opinion, this situation poses a heightened risk to achieving the FY23 targets, as the company's performance in the 2H23 needs to be exceptionally strong. Additionally, if the performance in 3Q23 fails to meet expectations, I believe the market will adopt an extremely risk-averse stance, remaining cautious and hesitant. This outcome would place even greater pressure on the 4Q23 to deliver significant results. For context, the reiterated guidance for 2023 predicts a year-on-year sales decline of 15% at the midpoint. Considering the Q2 outlook (modest improvement from 1Q23), which indicates that sales in the 1H23 are likely to decline by around 40 to 50%, achieving the midpoint of the annual guidance would require OLPX to achieve a 20+% growth in the top line during 2H23. In terms of absolute dollars, it would mean that OLPX needs to achieve a quarterly sales run rate of around $184 million in the second half, which I think is hard to underwrite as OLPX only surpassed $180 million in quarterly sales during 1Q and 2Q of 2022 (prior to the PR crisis).

Conclusion

In conclusion, I maintain a hold rating on OLPX as I wait for more data and indications that the company can meet its FY23 guidance. While management has reiterated their guidance, I have concerns as it is dependent on an acceleration in growth during 2H23. Management also claims steady demand for core services, but the recent results do not support this. The upcoming weak 2Q performance and potential decline in EBITDA further contribute to the uncertainties.

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