Blue Apron: Problems Delayed, But Not Solved

Summary

• Blue Apron is up sharply after posting Q1 results that featured a much narrower loss than investors were hoping.
• Despite a small miss on revenues, adjusted EBITDA loss of -$17 million was about half of what Wall Street had expected.
• The -24% y/y deterioration in customer counts, however, is alarming.
• Cash burn continues to be an issue, and free cash flow of -$25 million in the quarter eats up Blue Apron's liquidity extremely quickly.

Investors breathed a sigh of relief when Blue Apron (NYSE:APRN) posted Q1 results last week. At face value, the fact that Blue Apron shares rallied to just under $3 isn't that impressive (after all, shares went public at $10 per share), but if you consider the fact that Blue Apron has risen about 60% from its all-time lows in a very short span of time, it's certainly impressive. Investors could have made a bundle by timing the bottom.

APRN data by YCharts

The question for investors now is: is Blue Apron on a course for recovery, or is this rally a temporary phase that will recede back into a doom-and-gloom narrative?

There were certainly positive elements in the quarter. Blue Apron's improvement in gross margins is one of the biggest highlights, as the deterioration of gross margin was one of the chief causes of Blue Apron's losses. The company has finally begun to achieve cost benefits from the opening of its troubled distribution facility in Linden, New Jersey.

But on the whole, I don't think Blue Apron's prospects have changed much. In the third quarter, orders on the platform declined 19% y/y to 3.5 million. Likewise, active customers dropped 24% y/y to just 786k. Is it possible to sustain a business where customers are contracting?

Source: Blue Apron investor relations

Blue Apron bulls will point to the fact that orders per customer are up to 4.4 in the quarter, from 4.1 in 1Q17. The fact that average revenue per customer is also up 6% y/y to $250 is also a positive sign. These customer metrics altogether tell a fairly obvious narrative: Blue Apron's more casual users, perhaps those who ordered only on the sign-up bonus, have begun to defect, while its core customer base has slightly stepped up their order frequency.

Blue Apron also noted it has "methodically reaccelerated marketing efforts in the first quarter of 2018 with a focus on building efficient and sustainable growth." Sales and marketing expenses were 20% of revenues this quarter, versus 25% in 1Q17. But on the whole, I wouldn't feel comfortable investing in a company whose customer counts are declining so sharply. We have yet to see whether Blue Apron's reinvigorated advertising efforts can bring in a new batch of customers to replace them, but until I can see positive results, I won't put the cart before the horse.

Costco: looks good at first, but there's risk as well

Then there's talk of the Costco (COST) deal. Earlier this month, Blue Apron announced a partnership with Costco in which the warehouse giant is piloting sales of Blue Apron meal kits in a few California/Pacific Northwest test locations. The deal got plenty of screen time from Brad Dickerson, Blue Apron's new CEO, in the earnings call:

One piece of this growth strategy is the launch of our first retail expansion with Costco, one of the largest retailers in the world. We began selling Blue Apron meals specifically designed for Costco members in select locations across the Pacific Northwest and San Francisco Bay area with the opportunity for further integration. The meals which will rotate monthly are designed as a convenient on-demand dinner solution. This pilot extends our existing relationship with Costco, while exposing the Blue Apron brand's new consumer segments. In the months ahead, we will continue to launch new partnerships with different products and price points to further broaden our geographic reach, introduce the Blue Apron brand to new consumer segments and expand our total addressable market. In our view, we have only scratched the surface of how the Blue Apron Meal experience can engage with consumers."

While Blue Apron's channel expansion is certainly a good way to stave off the decline in active customers, the issue is with pricing. Blue Apron meal kits in Costco, as expected, are much cheaper than those sold online. As reported by Business Insider, meal kits at Costco run at $24.99 for 4-person servings ($6.25 per serving), about 30% lower than Blue Apron's direct channel kits online.

Blue Apron's margin on Costco kits is probably about the same, even after you account for the lower price and the wholesale markup. A large part of Blue Apron's cost is in logistics and delivery, and selling in bulk to Costco takes those costs away. But the issue is customer alienation. Blue Apron has a powerful brand to its most loyal customers, and suddenly pivoting to sell meal kits at Costco can potentially be extremely dilutive. And when there isn't any pricing parity with Costco meal kits substantially cheaper, will Blue Apron customers start peeling off if they feel they're being gouged on the subscription kits they purchase online?

It's probably too early to tell whether the impact of Costco will be net beneficial, but I also wouldn't say the possibilities are all positive.

Q1 download

Here's a look at Blue Apron's Q1 results:

Figure 1. Blue Apron Q1 earningsSource: Blue Apron investor relations

Total revenues declined 20% y/y to $196.7 million, missing analyst estimates of $197.3 million by a hair. Most of this decline was due to the drop in order counts and active customers, as well as a slight decline in average order values.

Again, there's a myriad of issues with investing in a company with revenues declining so rapidly. Of course, we understand that Blue Apron's drop in revenues is associated with a planned reduction in marketing costs, but can the company return to growth without plunging itself into bankruptcy via advertising?

At the very least, one of the major highlights in the quarter was a boost in gross margins to 31.2%, up 320bps year over year and 430bps from last quarter. This, along with the reduction in marketing expenses as well as product, technology, and general costs, have slimmed Blue Apron's operating losses to -$29.9 million, or -15% of revenues, compared to 21% of revenues in 1Q17. Adjusted EBITDA of -$17.2 million was substantially better than -$46.3 million last year and the -$31.2 million that analysts were expecting.

But you can't save a company on cost improvements alone. The real trick for Blue Apron will be to figure out how to re-ignite growth while not sacrificing the improvements in profitability it's made. Obviously, the gross margin improvements made from ramping up the Linden, NJ facility are there to stay, but it's unclear if other cost efficiencies (particularly, marketing) will remain if the company chases after growth.

And as usual, liquidity continues to be a pressing problem for the company. Free cash flow in the quarter was -$25.6 million. On Blue Apron's most recent balance sheet it's just $203.5 million of cash, as well as $195.6 million in debt. Though adjusted EBITDA made improvements in the quarter over last year, free cash flow continued to burn at about the same pace from 1Q17. If this run rate holds, Blue Apron has about 8 quarters left before it runs out of cash, and with its stock already at lows and balance sheet already stretched with debt, neither debt nor equity capital seems a likely possibility.

Final thoughts

Blue Apron's ability to stave off large losses in Q1 was certainly impressive, but the coast isn't quite yet clear for the company. The implementation of a wide Costco rollout is also a huge opportunity for the company, but must also be weighed against the risk of alienating current customers.

All in all, Blue Apron's problems still persist, as a declining customer base feeds into a continuous pileup of losses that Blue Apron will eventually have to finance. The company's uncertainties remain as numerous as ever, so investors would be wise to stay cautious on this name.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.