2023-11-30 11:00:00 ET
Summary
- Hims & Hers Health exhibits similarities to previous "100 Bagger" stocks, which I believe the market has not noticed at all. I wanted to bring this to the forefront.
- The company has the potential to be a transformative force in healthcare, with accelerating top-line growth, expanding margins, and a sticky subscriber base.
- HIMS has strong fundamentals, including profitability potential, high gross margins, value-added services, strong sales growth, and a growing subscriber base.
- For investors who can stomach the risk, this is a company worth investigating further. There are numerous risks to consider, some of which are discussed at the end.
Introduction and Disclosure
Who knows how many articles I have written on Hims & Hers Health (HIMS) at this point, but as one of the first mainstream analysts to bring this company to light, I feel compelled to continue writing on it. Fun fact - I found out about this company via a comment left by a reader on someone else's Seeking Alpha article.
Witnessing the growth of this company fills me with excitement, especially considering its potential to be a transformative force in healthcare. Despite my optimism, however, it's crucial to delve into the fundamentals and ascertain whether the company genuinely holds promise or if I've simply "drank the Kool-Aid."
Announcement : I have been inactive for most of the year as I have been working on something incredibly exciting. I have officially opened my own registered investment advisory firm, DocShah Financial. Also, I am celebrating my six-year anniversary of being a Seeking Alpha contributor! One of the best decisions I have ever made was to be an author on this platform. Lastly, please note the full disclosure at the end of the article.
Thesis
HIMS is a company that I believe to be undervalued by the market based on its fundamentals. The company has an accelerating top line, expanding margins, a sticky subscriber base, and a developing moat.
For this piece, I am going to write from a different perspective. Rather than rehash many of the same points made by other authors (exceptionally, by the way), I am going to present HIMS' fundamentals through the lens of a book called, "100 Baggers," by Christopher Mayer. I expect this approach to provide readers with an intriguing and thought-provoking viewpoint.
100 Baggers Background
Christopher Mayer's book, "100 Baggers," delves into the shared traits of stocks which have experienced a remarkable 100-1 increase. Mayer interviews analysts and researchers who offer insightful case studies on these unicorn-type stocks as a result of having studied them extensively.
As I read through the book, a sense of déjà vu struck me multiple times. This feeling stemmed from the realization that HIMS exhibits many of the same characteristics as the legendary 100 baggers of the past.
At this point, I need to make something clear : I am not suggesting HIMS will be a 100-bagger stock. Achieving such a feat would necessitate the company's market capitalization to surge from $2B to $200B. To put this in perspective, CVS, a well-established company, doesn't even have a market cap of $90B. However, there are certain striking similarities that HIMS shares with previous stocks that went up 100-fold. That is what we will be studying.
There are five primary similarities between HIMS and the 100 Baggers of the past. Below are the traits we will examine:
- Profit
- Gross Margin
- Value Add
- Sales
- Subscribers
Is There Really a Lack of Profit?
Hims Projected Income Statement (DocShah Financial (Author))
The table on the left is a bare-bones representation of HIMS' 2023 income statement based on management guidance and historical performance. Assuming nothing changes, there would be a relatively small loss of about $42MM for FY 2023.
However, here is where our thought experiment begins : Notice that marketing is by far the biggest expense on the company's income statement, which would surprise many investors to know that this is a very good thing.
As the stock price declined from $12 down to $6 this year, many investors were wracking their brains to find an explanation. Somehow or another, the idea that HIMS' high marketing spend was a cause of the decline started to circulate. In fact, there was a movement amongst retailers trying to get HIMS to cut back on their marketing spend. Ironically, the marketing spend being the largest expense is a great thing. Why?
Because, technically speaking, marketing is discretionary . The lack of profitability is the result of choice, not force. Yes, I acknowledge that growth requires ongoing marketing expenditures, however, consider this hypothetical scenario:
What if management decided growth is no longer a goal and from this day forward, their only priority is to service their existing customer base?
What would the company be worth?
Now we can see the income statement a bit more clearly. Humor me for a second and let's entirely eliminate marketing expenses (table on the right). In this event, the company would produce $318MM in net income, which would result in an EPS of $1.50. Applying a P/E of 15, the stock would be worth $22.53 per share.
I'm sure many readers are screaming, "you still have to spend some money on marketing to your existing customer base!" Again, I acknowledge that. We can meet in the middle [table] where marketing expenses have been halved to 25% of revenue. In this scenario, net income would be $147MM, which results in an EPS of 69¢. Applying a P/E of 15, the stock would be worth $10.40 per share.
To reiterate : I understand marketing expense is needed to grow. The point I am making by removing it is that the company is essentially already profitable. If management wanted to, they could amortize marketing expenses, keeping only what's needed to maintain the customer base and produce a positive bottom line.
100 Baggers Perspective on Profit
In his book, Christopher Mayer interviews an analyst named Thompson Clark, who has studied Amazon extensively.
Here is an excerpt from the book that is an exact parallel to what I am seeing in HIMS' stock today:
Looking at Amazon's reported operating income, it doesn't look profitable,' Thompson continues. 'On $88 billion in 2014 sales, Amazon earned a measly $178 million in operating income. That's a razor-thin 0.20% operating margin.
Adding back R&D, however, paints a completely different picture. In 2014, Amazon spent $9.2 billion on R&D. Adding that back to operating income, Amazon generated adjusted operating income of $9.4 billion in 2014. That's an operating margin of 10.6%."
Adding back R&D [removing it from the income statement as we did with marketing in HIMS' case] may sound crazy, but the point is to think of R&D as an investment in this case.
My higher level point is simply that Amazon could have been profitable if it wanted to. If it wanted to show earnings, it could have. It didn't. The layman who might be interested in buying Amazon stock would certainly be turned off by its lack of ever being profitable. Well, if you back out R&D-effectively backing out capex-you see how profitable it really has been.'
He recognizes to do this properly you'd want to amortize those R&D costs over some time period, the same way a firm would amortize costs spent on equipment. There is some component of R&D that is essential to keep Amazon going, but there is also a growth component that helps generate future sales.
Back to HIMS
Hopefully, by now, the exact parallels are clear… simply replace 'R&D expense' with 'marketing expense' and replace 'Amazon' with 'Hims & Hers Health' and we have essentially, an identical case study . We are seeing the same scenario play out today with HIMS that we saw a decade ago with Amazon.
Gross Margins? More Like Delicious Margins
HIMS has the best gross margin in the telehealth industry and believe it or not, it is actually expanding. Below are two charts comparing HIMS' gross margins over time and then in comparison to competitors.
Hims' Gross Margins (DocShah Financial (Author))
100 Baggers Perspective on Gross Margins
Mathew Berry, another analyst and researcher, interviewed by Christopher Mayer for his book has some interesting observations about 100 bagger stocks and gross margins.
Berry states:
High gross margins are the most important single factor of long run performance. The resilience of gross margins pegs companies to a level of performance. Scale and track record also stand out as useful indicators.
Mayer adds that companies with high gross margins tend to keep them and ones with poor gross margins tend to keep them, too. In order words, gross margins are persistent.
Back to HIMS
One of the most significant competitive edges a company can possess is being the lowest-cost provider. It's a common misconception among investors to associate the lowest-cost provider with the company selling its products at the lowest price.
However, the true lowest-cost provider is the company with the widest gross margins. By definition, having the widest gross margins means you are selling your product for maximum profit (highest price, lowest cost), which gives you immense pricing power, brand recognition, and flexibility. HIMS has the widest gross margins in the telehealth industry and thus, has the biggest competitive advantage.
Value Add (Moat)
Similar to competitive advantage, I see people write time and time again that HIMS has no moat, which could not be further from the truth. First of all, the value proposition comes first, and the moat comes second. Investors who focus on the latter, are "putting the cart before the horse."
Investors used to claim Netflix had no moat because anyone could start a business shipping DVDs. After all, any two idiots with a garage could do that.
What made Netflix special was its value proposition - it provided a service that was better than anything competitors offered. Netflix was easier to use, more convenient, faster, early to market, had solid branding, and had customer-friendly policies. Over time, the company expanded upon its value proposition by adding streaming, original content, games, etc. It is exactly this value expansion that is what investors unknowingly refer to as a moat .
HIMS' value proposition is that it provides a 24/7 service, creates custom formularies, and most importantly, allows patients to access traditional healthcare on a modern platform. Over time, the company's value proposition will create a recognizable moat. If another company wants to compete for market share, it will have to top HIMS' value proposition, not cross its moat.
100 Baggers Perspective on Value Add
Mayer writes:
Berry thinks gross margin is a good indication of the price people are willing to pay relative to the input costs required to provide the good. It's a measure of value added for the customer. Not every company shows a huge gross margin.
'Amazon's are pretty mediocre," Berry pointed out in an email to me, 'but it is clear that the value added is in the selection and the convenience, not in the good itself (which could be found anywhere). But if you can't see how or where a company adds value for customers in its business model, then you can be pretty sure that it won't be a 100-bagger.'
Back to HIMS
Just as the goods on Amazon can be found anywhere, so can the products on HIMS' platform. While the company is swiftly expanding its custom formularies, its primary focus has essentially been on selling generics at a markup. For instance, all of their hair regrowth products share the same common active ingredient as every single other hair regrowth product on the market - minoxidil.
The value adds for HIMS are actually quite similar to the ones for Amazon, namely selection and convenience. But, unlike Amazon's struggle with gross margin, HIMS has an extraordinarily wide gross margin.
Also, HIMS' paramount value add is it offers everyday, diligent, and honest people a liberation of shame related to health concerns beyond their control (since all the consultations are screenings are done virtually and privately). As a result, we can add hope to HIMS' value adds and this is the single biggest value add any company can provide a person. Hope combined with selection and convenience, is going to create a one heckuva moat for HIMS over time.
Sales, Sales, and More Sales
HIMS' sales have exploded at a CAGR of 79% since inception and 47% in the past three years. I think the runway is longer than investors believe and I would not be surprised to see double-digit growth sustained for the next decade.
100 Baggers Perspective on Sales
Mayer states:
There is no way around it. Almost all of the businesses in the 100-bagger study were substantially bigger businesses at the end than when they began.
So, you need growth-and lots of it. But not just any growth. You want value-added growth. You want "good growth." If a company doubles its sales, but also doubles the shares outstanding, that's no good. You want to focus on growth in sales and earnings per share.
Likewise, if a company generates a lot of extra sales by cutting its prices and driving down its return on equity, that may not be the kind of growth you're looking for. You want to find a business that has lots of room to expand-it's what drives those reinvestment opportunities.
Back to HIMS
HIMS has had a lot of good growth. The company's share count has only slightly crept up in the last three years, although I would expect that to change if the price goes higher.
Next, if HIMS can mix in some organic growth to sustain its sales runway, the company will be a substantially bigger business in ten years. To date, the company has grown its sales by delivering on its value proposition, not lowering its prices. If anything, prices are increasing due to robust demand, leading to an expansion in margins.
Subscribers
Subscribers are an asset. They have a value to every company, which is often difficult to calculate exactly for outsiders. The more HIMS can accumulate subscribers, the more chance that the "flywheel effect" will take place. This will help alleviate some of the burden of marketing spend.
HIMS' has rapidly expanded its subscriber base and as a result, its assets. The company has grown its subscribers 54% YOY to a record 1.4MM subscribers.
100 Baggers & Subscribers
Mayer writes:
Comcast is an interesting case study because, as with Amazon, you did not see steadily growing earnings. In fact, Comcast often reported losses as it spent heavily on building its cable systems.
You had to see beyond reported figures to understand the value of its subscriber network. Sticky customers who pay every month, year after year, formed the backbone of any Comcast investment thesis. While you did not see earnings, what you did see was sales growth and growth in subscribers.
Bonus: One Up on Wall Street
Author Peter Lynch states:
Fifteen years ago [late 1970s], each cable subscriber was worth about $200 to the buyer of a cable franchise, then ten years ago it was $400, five years ago $1,000, and now it's as high as $2,200. People in the industry keep up with these numbers, so it's not exactly esoteric information. The millions of subscribers to Telecommunications, Inc., made it a huge asset.
Back to HIMS
The level of multi-month subscribers has increased confirming the stickiness of the platform. I expect this to further improve as HIMS continues expanding its offerings and value proposition. I think the flywheel effect mentioned before will take place in the next middle range of the next decade. At that point, the company will have had time to create hybrids/personals, vertically integrate, and expand its overall presence.
Risks
With the goal of producing the most accurate, balanced piece, here are some (but not all) of the risks to consider.
- Larger, more established companies leverage their infrastructure and steal market share from HIMS.
- Government regulation runs rampant in the healthcare industry and will likely spread to the telehealth industry, which could significantly disrupt HIMS' business operations.
- Recession may force consumers to cut back on discretionary spending or seek less expensive alternatives.
- Price war breaks out amongst telehealth competitors due to low barriers to entry and lack of product segment differentiation.
- Excessive stock-based compensation dilutes shareholders from materializing future profits after they [the shareholders] have made such significant investments of time and capital.
- The company's vibrant and cheerful branding might face challenges in maintaining its effectiveness as it expands. In its present state, some may argue that it could be perceived as overly casual for serious health issues
- Litigation for an incorrectly prescribed medication could result in a costly lawsuit and a reputation as a "fad company, not to be taken seriously."
- For the company's set of risks, please click here ( LINK ).
Takeaway
I think this quote from 100 Baggers sums up my thesis in HIMS quite well:
Netting a 100-bagger takes vision and tenacity and, often, a conviction in an idea that may not yet be obvious in the financials.
I think HIMS' vision and execution is suburb and while it hasn't translated to the bottom line officially, I remind everyone that we are in the first inning of this ball game. Considering that the company just became public a few years ago and started its operations a few years before that, it has delivered highly impressive results in such a short time frame.
The income statement, when adjusted, reveals the tremendous potential this company has at its fingertips. Combined with the pristine balance sheet ($200MM cash and $0 debt), this is an opportunity worth investigating for more investors who can handle the risk.
For further details see:
Hims & Hers Health: What Would The Author Of 100 Baggers Say?