Summary
- The Honest Company has been challenged in recent quarters, with sales coming in weak and bottom line results worsening year-over-year.
- 2023 is likely to be better for the firm than 2022 was, but this doesn't make the company an attractive prospect.
- The firm is unlikely to grow into its valuation and, as a result, the company looks undesirable to me.
Companies that focus on the production and sale of miscellaneous consumer items can be an attractive opportunity if they are priced right and if their overall trajectory is positive. Unfortunately, not every player that operates in this sphere is all it's cracked up to be. One such firm that's at least worth investors knowing about is The Honest Company ( HNST ). Over the past few years, the company had demonstrated attractive growth on its top line. However, that growth has since stalled and bottom line results remain an issue. If the company was growing more rapidly, a case could be made that it could grow into its troubles. But that no longer appears to be the case. While it is entirely possible that the company could go on to generate attractive value for its investors, I am incredibly skeptical at this point in time. In fact, I would even go so far as to rate this enterprise a soft ‘sell’, a rating that reflects my view that shares are likely to meaningfully underperform the broader market moving forward.
Honest pain
The management team at The Honest Company describes the firm as a mission-driven lifestyle brand that formulates, designs, and sells clean products while focusing on promoting sustainability and thoughtful designs. Unfortunately, this description does not really provide much in the way of detail as to what specifically the company does. To best understand the firm, we should dig into its specific product categories. The first of these categories is referred to as Diapers and Wipes. As you can imagine, this portion of the firm is dedicated to selling diapers and wipes to its customers. But according to management, the firm's particular niche centers around making sure that the major components from these diapers are sustainably harvested and totally free of chlorine. According to management, this particular category was responsible for 63% of the company's revenue during the firm’s 2021 fiscal year.
The next segment to pay attention to is called Skin and Personal Care Products. This category involves the sale of bath, body, skincare, and beauty products, all designed for different skin types and concerns. Some of its products are even certified by the National Eczema Association. Just like the Diapers and Wipes category, this particular portfolio of products focuses on the use of clean and safe ingredients, such as plant-based ingredients that management claims are ethically sourced and black parabens or paraffins, synthetic fragrances, silicones, and mineral oil. Using data from 2021, this product category accounted for 32% of the company's revenue. And finally, we have the Household and Wellness niche. This unit is responsible for a variety of offerings such as sanitizing wipes, hand sanitizer made from plant-based ingredients, disinfecting spray, and prenatal vitamins. New vitamin and supplement products were also introduced by the company last year. During 2021 though, this represented the smallest portion of the firm, accounting for only about 5% of sales.
Over the past few years, the revenue trend achieved by the company has been positive. Sales increased each year between 2019 and 2021, rising from $235.6 million to $318.6 million. The 6% increase experienced from 2020 to 2021 would have been greater had it not been for a 50.8% decline in sales under the Household and Wellness category, caused by a decrease in consumer demand for sanitation and disinfecting products because of the waning of the COVID-19 pandemic. The Diapers and Wipes portion of the company reported a 6.6% rise in sales thanks to an increase in sales volume, particularly on the retail side of the business. But the greatest growth came from the Skin and Personal Care portion of the firm, with revenue spiking 27.9% from $79.5 million to $101.7 million. That increase, management said, was thanks to an increase in the volume of products across the retail channel due to continued investments in marketing, distribution, merchandising programs, and more.
Although it's great to see revenue increase, it would be nice to see profits rise as well. But the sad truth is that the company went from generating a net loss of $31.1 million in 2019 to generating an even larger loss of $38.7 million in 2021. Operating cash flow went from negative $20 million to negative $38.2 million over that same window of time. Even if we adjust for changes in working capital, it would have worsened slightly, turning from a negative $15.2 million to a negative $17.4 million. The only metric to really show any improvement over this time was EBITDA, which went from negative $23.8 million to negative $3.5 million.
When it comes to the 2022 fiscal year, management has provided details for the first nine months . Sales during this time actually decreased, falling from $238.3 million to $231.8 million. You might think that this would have resulted in bottom line results improving. But you would be wrong. The company went from generating a net loss of $29.7 million in the first nine months of 2021 to generating a loss of $36.4 million the same time of its 2022 fiscal year. Operating cash outflows went from $36.4 million to $50.7 million, while the adjusted figures for this went from $13.1 million to $18.2 million. Even EBITDA worsened, turning from $0.4 million to negative $21 million. During this time, the only strength the company experienced was a 28.9% surge in revenue associated with its Household and Wellness offerings, driven in large part by a $3.8 million increase in sales coming from its decision to transition from a license agreement to a supplier service agreement for its Honest Baby Clothing offerings. Weak consumer demand, combined with liquidation sales associated with certain legacy inventories, as well as some other miscellaneous factors, pushed the other two product categories lower.
The only bright spot for the company during this time involved the third quarter of 2022. Sales here actually managed to increase year over year, climbing from $82.7 million to $84.6 million. This came as the company experienced a slight improvement in sales under the Diapers and Wipes category and as the Household and Wellness category saw the largest spike in revenue from the aforementioned transition. But still, bottom line results for the company largely worsened. The firm's net loss went from $5.1 million to $11.8 million. Yes, operating cash flow did improve, turning from $3.8 million to $25.3 million. But if we adjust for changes in working capital, it would have worsened from $0.7 million to a negative $5.7 million. Also on the decline was EBITDA, going from a positive $1.3 million to a negative $5.6 million.
When it comes to 2022 as a whole, management expects revenue to be between $310 million and $315 million. Even at the high end, this would be lower than what the company experienced in 2021. Meanwhile, EBITDA is expected to be between negative $10 million and negative $20 million. This is not to say that everything looks bad moving forward. Management did say that, for the first half of the 2023 fiscal year, sales should grow by between 7% and 10% year over year. But sadly, that's not enough growth to justify the significant losses the company is experiencing. Truth be told, you can't really even value a company like this. But you can ask yourself what kind of cash flows would be necessary in order for the company to be at least fairly valued. As you can see in the table below, I looked at four different scenarios. The most liberal scenario would imply a situation where the company would be worth five times its adjusted operating cash flow and five times its EBITDA. The second scenario moves this up to a multiple of 10, while the other two scenarios move it up to 15 and 20, respectively. Even if you make the case that the company would be worth a multiple of 20, cash flows are still quite a bit higher than what the company has achieved previously.
Takeaway
Perhaps in the long run The Honest Company will do well for itself. But right now, the picture doesn't look great. The only good news is that the company has cash in excess of debt of $40.8 million. That does give it some runway to work with. But sadly, cash flows continue to be negative and growth is not high enough to assume that the company will realistically grow into its valuation. Given these factors, I feel that a ‘sell’ rating is appropriate at this time to reflect my view that shares will likely underperform the broader market moving forward.
For further details see:
The Honest Company Is Honestly In Pain