In June, I believed that The Honest Company (NASDAQ:HNST) was running out of options. This came as the business was delivering on one disappointment after another, as gross margins were dismal. With cash balances down substantially given the continued losses, and no quick fixes in sight, all options were on the table.
After a quiet summer, which includes second quarter results showing minimal improvements, the situation remains dire as there are still few options available with losses not really expected to come down in the second half of this year. This makes me cautious with cash holdings continuing to come down.
Disappointment From The Start
Since The Honest Company went public in May 2021, it was a poor first day performance which was the writing on the wall, if we look at the situation with the benefit of hindsight. A good mission and a relatively low sales multiple, in the IPO environment of 2021, made that the shares look interesting. At the same time, growth was coming down quite a bit, as margins were lackluster.
Founded in 2012, The Honest Company started with a focus on people, health, fairness and the planet, as the business focused on categories such as diapers, wipes, personal care and wellness products.
Trading at $16, the business was valued at $1.5 billion, a valuation applied to a business which generated $235 million in sales in 2019, although accompanied by a $31 million loss. Revenues rose 28% to $300 million in the year 2020, as operating losses narrowed to $13 million. Trading at a 5 times sales multiple, this was largely in line with consumer package companies, although The Honest Company posts substantial losses, albeit that it showed much quicker growth.
Pre-IPO it was obvious that operating momentum was cooling down with first quarter sales for 2021 slowing down to just 10%. Slower growth made that shares fell to the $10 mark late in 2022, to end 2023 at just $3 per share. The same shares only fell further so far this year, and by now trade near their lows at $1 and change.
Real Concerns
While the company did end up growing 2021 sales by 6% to $318 million, operating losses rose from $13 million in 2020 to $37 million, a dreadful result as the topline momentum had clearly gone as well. Moreover, the company only guided for flattish 2022 sales, with modest deleveraging seen on the bottom line.
As it turned out, 2022 sales fell a percent to $313 million as operating losses rose to $50 million, as the stagnation (in terms of sales) and downfall (in terms of profits) was clearly disappointing. With 2023 sales and EBITDA seen largely flattish, that outlook is quite shocking, certainly as cash holdings were rapidly coming down.
A 21% increase in first quarter sales to $83 million looked very strong, but this was driven by promotional activity with gross profits (in dollar terms) actually being down. In fact, operating losses increased by 4 million to $18 million for the quarterly period. While the company upped the full year guidance a bit on the back of this strong quarter, EBITDA losses were now seen at $25-$30 million for the year, a bit worse than originally guided for.
With the business trading at a fraction of sales (about a 0.5 times sales multiple) the valuation looked very modest, but the issue is that the business is unable to post a profit, but moreover cash holdings have been down a lot.
While the business has no debt and access to a revolving facility, the issue is that the business now moves full speed ahead to financial distress, even as the company has a great mission and a nice little sales base. Unfortunately, there were few immediate solutions out there, other than perhaps M&A interest from a large peer.
Still Tough
After voicing a very cautious tone in June, shares have been trading flattish over the summer. In August, the business posted second quarter results with revenues up 8% to nearly $85 million, driven by strength in the household and wellness category. Gross profits were down again in absolute dollar terms and as operating expenses were up in dollar terms as well, the company saw operating losses increase from nearly $11 million this quarter in 2022 to more than $13 million.
The company hiked the full year guidance in a minimal fashion with sales seen up from low-single digits to mid-single digit increases, after only guiding for a low-single digit increase before. The midpoint of the adjusted EBITDA loss is now seen at $24 million, an improvement from the previous $27.5 million guidance. That shows modest improvements, although the second quarter adjusted EBITDA of $4 million is suggesting that the current pace of losses is more or less expected to continue in the second half of this year.
With 94 million shares trading at $1.4 per share, the market value of the firm has fallen to about $130 million, as this even includes an $18 million net cash position. Some cash has been generated as the company has cut back on inventories, but current losses are indeed very substantial in relation to the dwindling cash balances.
Therefore, a great deal of improvements is needed in a tougher environment for the business, even as inflation comes down. Right here, I view the situation as largely the same as June as shares remain uninvestable for me, with no easy ways out, despite small improvements on the horizon, as the hole to plug is still very substantial.
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