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Following a 60% decline, and with its market cap now sitting at around €6 billion, I believe that HelloFresh SE (OTCPK:HLFFF) shares are looking tasty right now (I’m sorry, I had to). The market currently doesn’t like lockdown beneficiaries, but HelloFresh has continued to deliver strong growth on top of an incredible few years. Here’s why I think this is a business that is set up to succeed for the future.
As a quick introduction, HelloFresh is a meal kit delivery services company that ships weekly boxes of fresh, pre-portioned ingredients and recipes to its customers, with step-by-step instructions that enable anyone to make tasty, fresh, homemade meals. It’s also the largest global meal kit provider, and accounts for ~69% of the total U.S. meal kit market according to Bloomberg Second Measure Data. In this business, size does matter, and HelloFresh has been able to leverage its global reach and scale to achieve profitable growth *gasps*.
I can see two key economic moats that HelloFresh possesses, but I can’t say I’m fully convinced by one. Clearly the scale at which HelloFresh operates puts them in a much stronger position than national competitors, who have struggled to turn a profit and have faced financial hardship (apologies Blue Apron (APRN)). But I don’t think that in itself is enough for HelloFresh to thrive – they need more, and I believe they might have this in the way of switching costs.
I’m a HelloFresh customer, and I receive 5 meals a week from the company – the maximum available – and I’ll be honest, I don’t want to go back to having to plan my shopping, remember the recipes, and eat the same 3 meals that I know how to cook on repeat. In one sense, the switching costs are low; anyone could switch back to buying raw ingredients from a supermarket or order a takeaway. However, the real switching costs come from the convenience and variety offered by HelloFresh, and the subscription model that keeps your orders coming on repeat.
In fact, I only see one reason that people would switch – cost. HelloFresh is a luxury product right now, and there’s no question that I could probably cut my shopping bill in half if I bought directly from a supermarket. We’re entering a period where people are talking about recessions, and disposable income is reducing. Yet I think HelloFresh still shows strength here: its profitability enables more flexibility with pricing, its scale gives the company a cost advantage over competitors, and investments into its supply chain should serve HelloFresh well over the coming years. In fact, HelloFresh customers will be feeling the heat of inflation a lot less, as the below graph from their latest investor presentation shows.
The company has also successfully diversified, with brands such as EveryPlate offering more affordable meal kits, and other brands such as Green Chef offering higher-end meal kits for specific dietary requirements (Hello Keto). The company also took the plunge into the ready-to-eat (RTE) market with acquisitions of Factor75 (or Factor) and YouFoodz. These companies deliver freshly cooked meals that just need to be popped into the microwave, which is ideal for someone who is more conscious about their health and time than they are about price. In fact, since HelloFresh acquired Factor (the U.S. RTE leader) in 2020, Factor has seen a 54% reduction in customer acquisition costs, 16% savings on its shipping and packaging costs, and a 37% higher conversion rate.
As we saw earlier, HelloFresh has been growing its market share in the United States (its largest market), cutting Blue Apron’s share from more than 20% in 2019 to less than 10% in 2021. The two main players that HelloFresh competes with in the US are Blue Apron and Home Chef, with the latter being able to defend its market share more robustly than the former, but neither company have been able to stop HelloFresh from becoming increasingly dominant.
Blue Apron is the only US-based publicly traded meal kit delivery specialist (other than HelloFresh), so we can draw some comparisons between the two – but, in truth, the comparisons are minimal. If we look purely from a revenue point of view, we can see below that whilst HelloFresh has grown at a CAGR of 61% from 2016 through to 2021, Blue Apron’s revenues have actually been shrinking by 10% a year; not exactly what you’d expect to see from one of the first movers in this growing industry.
It will probably not surprise you that Blue Apron has never turned a profit; in fact, it has never had a positive operating margin. Again, a comparison against HelloFresh shows that the German meal kit provider is in a league of its own when compared to Blue Apron.
Home Chef has held up a lot better than Blue Apron, and announced in October 2021 that it had reached $1 billion in annual sales (for comparison, HelloFresh achieved €3.3 billion in annual US sales for 2021). Home Chef merged with Kroger (KR) in 2018, and the backing of this supermarket giant is likely to enable it to compete with the scale that HelloFresh has. It’s also worth highlighting that Home Chef has been rated as the number one company for customer satisfaction among leading meal kit companies, according to Market Force Information U.S. Grocery Benchmark Study. So far, HelloFresh has managed to keep Home Chef at bay, but it is one to keep an eye on.
The meal kit delivery industry has a multitude of smaller, national players that compete with HelloFresh, but so far none of them have been able to stop it from continuing to grow. I think this is an industry where scale drives margins, and the scale of HelloFresh is far greater than that of its competitors. This puts the company in a position where it has a lot more flexibility on the prices charged, more pricing power across the supply chain, and more opportunities to reinvest into the business for future growth.
Whilst HelloFresh has seen stellar growth over the past few years (67% 3YR revenue CAGR), it is still in the early innings of a huge opportunity. Its current household penetration is less than 5%, and according to Statista, the global meal kit service market is expected to grow at a 17.4% CAGR from $15.2b in 2021 to $64.4b in 2030 – with HelloFresh leading the way. Even more impressively, the growth of HelloFresh’s revenues have significantly outpaced its household penetration growth, as it continues to flex its pricing muscles, benefits from additional meals being sold, and offers additional add-ons (such a breakfast, lunch, desserts etc.) that boost the company’s bottom line.
You would be forgiven for assuming that a highly capital-intensive, fast-growing meal kit company would be unprofitable – but HelloFresh bucks this trend, having been GAAP profitable for the past two years (2020: €369m, 2021: €256m). This is not a company that has reached peak operating leverage, in fact I would guess that the recent profitability was something of an accident. Demand shot up, and they accidentally flipped into profitability, but I’ll take it!
Shareholders should expect margins and cash flow to deteriorate in the short term, as HelloFresh has outlined a plan to invest heavily in its warehouses and supply chain. But as long-term shareholders, this is a great sign; the company has successfully generated enough cash to do this, and it will just widen the gap between HelloFresh and the competition.
Approaches to valuation will differ from person to person; my general focus is investing in high-growth, innovative companies which are, surprise surprise, pretty tough to value appropriately. Given this, I have a simpler approach to valuation which I use to decide whether or not a company looks insanely overvalued or undervalued – above everything, it is the business itself that I focus on.
The model assumes a revenue CAGR of 15% annually through to 2026; this is coming off the back of an assumed 23% revenue growth in 2022 (management have guided for 20%-26%), but I think it is still relatively conservative given that the overall meal kit delivery market is expected to grow at over 17% annually – but I’d rather be too conservative than too optimistic.
I’ve assumed 2026 EBIT margins at 10% (up from 7% in 2021) as HelloFresh’s management state their medium-term ambition for AEBITDA to be 10%-15%, so I believe a 10% EBIT margin is reasonable.
I’ve also calculated the amount of cash I expect them to generate over this period, assuming that operating cash flow ends up at around 11% of 2026 estimated revenue (8% in 2021) as HelloFresh continues to scale up further.
I’ve taken several potential 2026 EV / EBIT multiples into account, with a low estimate of 8x (which is incredibly low), a medium estimate of 16x (which I also believe to be conservative), and a high estimate of 30x. Given all these assumptions, and working back from enterprise value to find the market capitalization, at the current price, I believe HelloFresh capable of achieving a CAGR of 30% through to 2026. But, this is not without its risks.
Whilst 2020 and 2021 were years of opportunity for HelloFresh (that they successfully capitalized on), 2022 appears to be the year of headwinds. Not only are they coming up against difficult comparisons vs a strong 2021, but companies across the globe have been hit with supply chain issues, rising fuel costs, rising inflation, geopolitical conflicts, and general economic uncertainty. This is one of the reasons that I was particularly impressed when HelloFresh beat their Q1 guidance and reiterated their 20%-26% revenue growth expectations for 2022, in a world where many of the previous stay-at-home stocks have started to struggle.
Clearly, the first risk is that these headwinds persist for longer than expected. HelloFresh performed well in Q1, but they might struggle if their customers find their wallets being hit by inflation, and look to cut costs by switching from HelloFresh to a cheaper option - e.g., supermarkets.
The main long-term risk for HelloFresh is simply that the trend of meal kit deliveries does not grow at the expected rate. Personally, I believe that if a meal kit delivery company can compete with supermarket pricing, then the ability to cook easy, healthy, different meals every week with pre-portioned ingredients is too high a value proposition for consumers to ignore. This may or may not play out, and the scale of HelloFresh might never reach a point where it can compete with supermarkets and their raw ingredients, but if it does… well, that would be transformational.
In short, I believe that HelloFresh will continue to dominate the meal kit delivery market, as it continues to expand its offerings and grow its distribution network. The short-term headwinds the company faces are likely to cause some pain, particularly as inflation bites both its customers and the cost of its goods, but I believe that this a company poised for long-term success.
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Disclosure: I/we have a beneficial long position in the shares of HLFFF either through stock ownership, options, or other derivatives. 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.