An Honest Summary on the Honest Company:
- After starting the Honest Company ($HNST) back in 2012, Jessica Alba has finally completed the IPO last week, which saw a great public debut. Since the IPO, shares have continued to decline due to underlying growth slowing down quite signficantly and growth stocks taking a back seat for now.
- The overall sentiment is great, the core mission is well supported, but sales multiples are high compared to blue chip stocks such as Proctor and Gamble ($PG) and others.
- $HSNT has generated over half their sales from digital growth and the remainder from retail such as Target, Walmart and Amazon. Increasing brick and mortar through the economy opening up and capitalizing on increased digital age presents a positive story.
- While the long-term story is there, I believe investors could benefit on both sides of the trade. It's my belief that downside will continue until $10-12/share, at which point I will enter into a long position. My exit rate would be at $35/share, which represents ~200% ROI and 65% since IPO levels.
Fundamentals & IPO Discussion
At the initial IPO, $HNST aimed to sell 25.8 million shares in a price range between $14 and $17 per share, with final pricing set above the midpoint of the offering range, at $16 per share. It's important to note that a smaller portion of these proceeds will benefit the company with almost 6.5 million shares sold by the company and the other shares offered by selling shareholders. Since there were 90.5 million shares outstanding following the IPO, the valuation comes at $1.45B.
The underlying results reveal a rapidly growing operation, certainly in this segment of the marketplace.
- The company generated $235 million in revenues in 2019 on which a $31 million operating loss was reported.
- Revenues rose 28% in 2020 to just over $300 million as operating losses narrowed to $13 million.
- The $1.45B valuation translated into ~5x forward sales.
- The historical rapid pace of growth demostrates a reasonable multiple but competitors are trading in a smaller forward sales range.
Glancing at the quarterly results, we have seen some well established trends throughout 2020.
- The results have been a bit rocky with first quarter sales up 36% as growth slowed down to 16% in the second quarter, when the pandemic really hit.
- Growth accelerated to 38% in the third quarter, only to slow down to 22% again in the final quarter of the year.
- Another interesting point is that nearly the entire operating loss was "booked" in the fourth quarter, suggesting that growth might be slower than perhaps anticipated, even if it surpasses the $300 million mark already on an annual basis.
The momentum from the 4Q2020 continues to fade if we look at the initial 1Q2021 results with sales seen at $79MM which suggest 10% growth. At the IPO levels of $21/share, or $1.9MM valuation, the company starts to trade above 6x forward sales. Compared to blue chip names such as Proctor & Gamble ($PG) whose valuation is supported at $370B and 4-5x sales, the Honest Company starts to look a bit overpriced. $PG has very high margins and some organic growth but most of the profit is from their great track record of margin. The same is to be said for other competitors in the industry, most of them trade between 3-5x sales.
Short To Medium Term Bear Case
Competition is the main key concern as big brands are launching smaller brands to capture the movement. Their resources, marketing power and knowledge is very good; creating formidable competitors. The appeal of the brand is very high and the relative sales multiples in combination with the valuation do actually leave potential for a take-out of the company as well as some blue chip names might miss the boat on this trend.
Risks include the fact that these are higher end products which makes them more susceptible to economic conditions, as the brand reputation is a key asset as well. If we start to see the economy opening up and consumer spending on the rise, it could paint a better story. The biggest risk in the short run is the rather dramatic growth slowdown over the past two quarters.
As stated above, I am in doubt on the high multiples in terms of sales representing a premium over major peers. The Honest Company is also growing at much slower pace. In the short to medium term, I believe this stock will see $10-12/share as we learn more. If shares dip and if second quarter growth can be maintained and accelerate a bit, I might be inclined to start initiating a position, but the valuation seems too rich given the cooled down operating momentum.
I will look for further declining share price over the second quarter and wait until earnings week to initiate a position. I believe the real growth starts once we learn how they will mange growth, margins and forward sales.