OLPX - Olaplex: Still Very Negative Despite Stabilization Progress

2023-12-06 16:25:49 ET

Summary

• Olaplex sales declined by 30% in 3Q23, with weak growth across all segments and a contraction in gross margin.
• Management guidance for 4Q23 projects a 17% decline in net sales, relying on historical trends that may not be applicable.
• Uncertainties remain regarding the time needed for demand stabilization, brand recovery, and the impact of inflation on the recovery timeline.

Overview

My recommendation for Olaplex Holdings, Inc. ( OLPX ) is still a sell rating, as I remain negative on the business outlook. Not that my sell rating does not mean to short the stock; rather, it is to underweight it as I remain negative about the business outlook. It is still very unclear how long it would take for OLPX to rebase and grow the business. 3Q23 sales remain very weak with -30% growth, and gross margin continues to be soft. While there are signs of stabilization, I think one quarter is not sufficient to establish a trend. Note that I previously rated a sell rating for OLPX as there wasn't any visible catalyst that would drive the stock price up. I was also afraid that the business might be structurally impaired, as the brand reputation damage was too huge to recover from.

Recent results & updates

As expected, OLPX sales growth continues to be sluggish. In 3Q23 , OLPX reported a decline of 30% in net sales to $123.6 million. The declines were largely consistent across the US and Internationally and sell-out was down roughly 28% in the quarter for the key accounts. By segment, Professional was down 23%, and Specialty Retail was down 42%, and DTC was down 18%. Weak growth was tagged along with a weak gross margin that saw a contraction of 5400bps vs. last year to 69.7%. The contrary was seen in the opex line, where it grew 15%, resulting in EBITDA of $51.5 million. While OLPX reported better-than-consensus results and some investors might be positive about the stabilization progress (as reflected in the recovery in share price), I think OLPX still has a lot to show before I will be convinced.

I get the fact that sales decline on a percentage and absolute dollar basis improved sequentially, but this does not remove the fact that the business is declining by 30%. While management guidance, at the midpoint, implies a 4Q23 net sales forecast of $108 million, or 17% decline (13 points of acceleration sequentially), note that this is based on a similar stable, seasonally adjusted trend for the business in the 4Q. Given the structural shift in demand profile and OLPX brand, I don't think historical trends for the business are a good benchmark for guidance. Since 4Q22, so much has happened: demand was decimated across all channels, and customers cut back on orders, which led to an increase in inventory. While inventory levels seem to have stabilized, I think one quarter does not represent any trend.

Most importantly, sell-out remains negative, and OLPX clearly needs more investments (they increased marketing budget guidance for FY23) to recoup the brand image and also on other initiatives like education (they now have a team of educators and field sales team) to regain its competitive position in Professional and Specialty Retail channels. All of these are good initiatives and could work, but as an equity investor, I think It is unclear how long it may take for OLPX to stabilize demand and then to actually grow sales from there. As such, I am still negative about the outlook of the business and would take management guidance with a pinch of salt. I could be wrong in not giving the benefit of the doubt, but it doesn't hurt to wait for a few more quarters of solid improvements.

Aside from growth, OLPX's gross margin (management defined) continues to be weak. Gross margin is likely to stay low as long as management needs to keep reinvesting into marketing, which is critical for both short-term sales growth and OLPX brand image recovery. As such, I don't think OLPX is going to recover to >70% gross margin anytime soon. With consumers still feeling the pinch of inflation, the recovery timeline could get even longer.

Valuation and risk

As I did not update my model in the previous write-up, I thought I should this time around. According to my model, OLPX is valued at $2.48 based on my FY25 estimates. I believe the focus is on the near term, as this is a turnaround situation. My aim for the model is to show readers that, even if OLPX does execute a tremendous turnaround in the near term, driving y/y decline to just 10% in FY24 (I anchored it against 4Q23 guidance, which is expected to decline by 17%) and a positive 10% growth in FY25, with strong margin expansion (as consensus expects), the stock is still not going to generate positive returns. Some might argue that valuation multiples could re-rate higher given the positive recovery momentum. I disagree because OLPX's revenue and profits are still way below historical levels. Pre-3Q22, the stock used to trade in the high-20s as it was growing at insanely high rates, but the stock re-rated down to mid-teens in 3Q22 as growth slowed to just 10% (which is my FY25 assumptions). Given that OLPX is now a smaller business with a weaker brand image and the same growth rate as 3Q22, I don't see any reason for the multiple to re-rate upwards.

Summary

In summary, I continue to recommend a sell rating for OLPX (not a short sell recommendation, but underweight) as I remained concerned about the business outlook despite signs of stabilization. The fact is that OLPX 3Q23 sales declined by 30% and gross margin contracted by 540bps. Management guidance for 4Q23, projecting a 17% decline in net sales, relies on historical trends that may not hold given the substantial shifts in demand and brand perception. Despite initiatives to revitalize the brand and increase marketing spend, uncertainties persist regarding the time needed for demand stabilization and subsequent growth. Gross margin challenges, ongoing inventory issues, and the inflationary environment further cloud the recovery timeline. Even if OLPX does see a recovery, my model suggests limited positive returns even with an optimistic turnaround scenario.

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