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Edited by Brian Birnbaum.
HelloFresh is entering the Goldilocks zone.
In my original HelloFresh deep dive I explain how the stock is moving towards a potentially highly asymmetric scenario. They have a tough challenge ahead, but if they get it right they tap into an uncontested trillion dollar market. Simultaneously, the company remains pessimistically valued, at just 0.21 times sales, despite the stock being up over 60% since I released my deep dive. Meanwhile, HelloFresh continues to exhibit notable process power and, in the Q2 earnings report, I saw HelloFresh making encouraging progress.
Namely, HelloFresh is now increasingly pointing towards customers that value time over money. HelloFresh has an incredibly efficient and complex infrastructure that sends both meal kits and ready to eat meals to millions of people around the globe. But the unit economics don’t work because the offerings are not quite cheap enough relative to buying food directly from the supermarket and cooking it yourself. In the deep dive I explain how HelloFresh could potentially fix this by capitalizing on pockets of the market that are tight on time and have big wallets.
In Q2 AEBITDA (adjusted earnings before interest, taxes, depreciation, and amortization) came in at 7.5%, which is at the upper end of the guidance issued by management in Q1 2024. Allegedly, this is due to HelloFresh reassigning marketing dollars from lower quality customers to higher quality customers. This metric is actually down from 10% YoY, as you can see in the graph below, so the data remains blurry. But there’s a catch - I see an intra-quarter inflection point in the margins driven by this reallocation of the marketing budget.
Before digging in, the source of this opacity is the meal kit business, which grew very fast during the pandemic and is now right-sizing. This is the biggest of two divisions in the company and so the deleveraging is taking a toll on financials across the board. Meanwhile, the RTE (ready to eat) business is growing fast and this requires considerable investment on behalf of HelloFresh, particularly on the procurement side because RTE requires cooking the actual meals.
RTE has lower margins than meal kits and the former’s revenue has grown at 45% YoY. The fast growth of RTE is thus dilutive to margins. But, meal kit margins have stabilized, coming in at 12.2% this quarter, slightly down from 12.9% YoY. Although the decline is not excellent news, the stabilization coincides with the change in the marketing philosophy. Additionally, HelloFresh is has now lowered price incentives as it assigns a higher percentage of the marketing budget to the RTE business. In turn, RTE margins are up from -4.3% in Q2 2023 to 4% in Q2 2024.
The change in the marketing philosophy was well summarized by co-founder and CEO Dominik Rikter, during the Q2 2024 earnings call:
Overall, for both product categories, as flagged a few times now over the last few months on this call, we recalibrated how we split our economic marketing budget between price incentives and paid channels, i.e., compared to last year, we started in Q1 to weigh more to the latter–i.e., to pay channels with an overall beneficial impact on customer quality and retention.
In short, margins are up (adjusting for the downsizing of the meal kit business), as HelloFresh is now tentatively pointing towards customers of higher value. In the deep dive I use the diagram that you see below to illustrate HelloFresh’s unit economic issue. For most of its customers it seems that HelloFresh is a nice-to-have. But now I see the company on its way towards becoming an acute problem solver. The fastest growing component of the RTE business is the brand HelloFresh uses to operate in the United States, called Factor.
Qualitatively, I sense Factor as being on the right side of the spectrum.
Although HelloFresh has historically been on the nice-to-have side of things, the company has been printing cash from operations since the start of the pandemic, as you can see in the graph below. As I explain in the deep dive, this company operates one of the most complex supply chains on Earth. Moving perishables around with such precision requires a world-class ability to optimize processes. And this is why I say at the start of this write up that the company continues to exhibit notable process power.
This ability to print cash without being entirely on the right side of the spectrum is what truly caught my eye. Indeed, now that the company is moving in the right direction, shifting towards the crucial-pain-solving side of things can be highly accretive to the company’s cash flow production. While the shift is yet to tangibly materialize, this quarter the company’s cash from operations levels remain in line with previous quarters, as you can see in the graph below.
What did increase this quarter was free cash flow production, as CapEx is trending down. As you can see in the graph below, FCF production is up 33.9% from H1 2023 to H1 2024. In the original deep dive I highlight how for years HelloFresh’s CapEx has been exceeding cash from operations by quite a margin and that this situation reversed for the first time in the company’s history last quarter. My major concern was that management would be cutting short the current CapEx cycle, due to a not-so-ample net cash position and a rapidly declining meal kit division and that this would hinder HelloFresh’s ability to make it into the right side of the spectrum.
But now that we’re two quarters into the CapEx decline, I see some of the company KPI’s evolving healthily and thus my concerns are mitigated. For example, average order value (AOV) is up 5.6% YoY, as depicted in the graph below, as HelloFresh continues to make more items available at its HelloFresh Market. Simultaneously, revenue is up 0.9% YoY which, far from being delightful, does not quite imply a collapse of the company’s earning power. Together with the expanding AEBITDA margins (adjusting for the deleveraging of the meal kit division) I see a healthy organization.
During the Q2 earnings call, CEO and co-founder Dominik Rikter explained that the AOV increase stems from a number of factors, beyond just the aforementioned HelloFresh Market variable. Per this remark and the aforementioned metrics, I see a company that hasn’t cut a CapEx cycle short:
Notably, we saw an increase in AOV year-over-year, the majority of which was not driven by like-for-like price increases but rather a combination of the following factors.
In North America we saw a revenue mix increase towards RTE, which typically has higher AOVs.
For both North America and International, our focus on more premium meal options and broadening the assortment of our HelloFresh marketplace led to increased basket values.
And finally, for both America and International, we benefited from lower price incentives given, driving up net AOV per order.
This has resulted in North America increasing AOV year-over-year by 5.4% and International increasing AOV year-over-year by 3.7%.
In conclusion, I like the direction HelloFresh is heading in. I see them shifting towards the right side of the spectrum, with the odds of them improving their unit economics going up in the last two quarters. HelloFresh’s process power has been evident to me since I first analyzed the company and should they become a crucial-pain-solver, I see considerable upside ahead. Not only because the current valuation is excessively pessimistic, but because success on the unit economic front would imply HelloFresh evolving into a winner-takes-all player.
They don’t have any competition and the world is increasingly full of people that don’t have time to cook.
Until next time!
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Although you mention that HelloFresh has no competition, aren't there many options available for the consumer that does not have time to cook? From directly eating at a restaurant to grabbing a quick pre-cooked meal, there is a broad range of products at different quality/price ranges that compete with HelloFresh, don't you think?