Analyst Insight: Oatly Round 2
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We’re about 10 months on from my First Look into Oatly, the maker of the incredibly popular dairy alternative. It’s fair to say that 2021 was not a kind year for newly public companies as investors abandoned growth at any cost and became far more concerned with reliable profits. With Oatly now trading about 80% below its IPO price, it’s worth reviewing what happened to this hotly-followed stock.
From my First Look:
Valuation-wise, we’re beyond nose-bleed levels here. The company is currently trading at a market capitalization of $12.8 billion — a 26x sales multiple. Valuing companies on a sales multiple is typically reserved for high-growth, high-margin, recurring revenue business models, like SaaS. While Oatly is certainly high-growth, it only generates gross margins of 30% (which contracted 2% last year) and it doesn’t have any recurring revenue. Even if it was a high-growth, high-margin, recurring revenue business, 26x is a lot.
Part of the MyWallSt ethos is that we accept that premium businesses will typically trade at premium prices. However, no business is worth an infinite amount of money and sometimes you need to take a pass, particularly with a company that was so new to the public markets.
It was, of course, easy to understand where all that hype was coming from. When Oatly went public last year, reports emerged that it had attracted a star-studded lineup of investors that included Oprah Winfrey, Jay-Z, Beyonce, Natalie Portman, and even Starbucks’ Howard Schultz. The company had spent millions of dollars plastering its billboards across the country and oat milk was the fastest-growing dairy alternative in the United States. On top of that, Oatly had secured one of the most prized partnerships in the space with Starbucks, which launched a number of Oatly-based beverages nationwide.
Things were going so well that Oatly even invested in a Super Bowl commercial, in which its actual CEO sits in a field of oats singing a song he wrote himself with the lyrics “Wow, wow, no cow”.
No, I’m not joking, you can watch it here.
It all seemed to be working well. Oatly, which was already the dominant oat milk brand in Europe, was aggressively expanding into new markets like the United Kingdom, America, and even China. A novel marketing campaign that leveraged baristas at some of the coolest coffee spots got the word out that oat milk was an attractive dairy alternative and demand was spiking.
From my First Look:
In the UK, dairy alternatives saw 31% growth in 2020, while Oatly grew 99%. In Germany, dairy alternatives grew 44%, while Oatly grew 199%. And in the U.S., dairy alternatives grew 20%, while Oatly grew 182%. It’s important to note that these are all recently-entered markets, so they’re starting from a low baseline, but still, the numbers are impressive.
However, successful marketing is only one part of running a successful business and the wheels quickly started coming off.
Demand v Supply
Oatly’s U.S. expansion can really only be described as a disaster. The company raced to fulfill the demand that its clever marketing had created, only to put its entire business in serious jeopardy.
The challenges with building new factories were totally underestimated. Budgets swelled and timelines came and went. According to documents obtained by The Wall Street Journal, at one factory in Millville, the company was creating four times more wastewater than they initially specified to city officials.
From The Wall Street Journal:
Oatly began trucking the wastewater to Pennsylvania for disposal, the documents show. Executives discussed the costs of adding a wastewater treatment system, a fixture at many food plants used to remove contaminants from water, and the cost of the trucking disposal method, which totaled at least $104,000 a month, the documents show.
At another plant in Ogden, Utah, executives told the board it would cost $50 million to retrofit an old Hershey’s plant for production. It ended up opening more than a year later than expected, costing more than $100 million.
All this delay caused chaos for Oatly’s distribution partners. Many smaller grocers were left with empty shelves and had to source oat milk from other suppliers. The coffee shops that had been early adopters and spearheaded the brand were left having to buy cartons at retail — if they could find them. Even its trophy client, Starbucks, was left without. Just weeks after the launch of their co-branded drinks, the coffee chain had to remove them from their app until they were restocked. They subsequently signed up with an Oatly competitor to satisfy customer demand.
Since then, Oatly has managed to get at least some of its factories’ problems in order and increased its supply. However, to do this, it has had to rely on co-packaging and hybrid production models that squeeze profitability. In 2021, the company only managed to self-manufacture 21% of all its products, with 79% coming from either co-packaging or hybrid. That saw gross margins in the last quarter drop from 27.7% to 15.9%. The company claims this was due to COVID-related supply chain disruptions and new facility start-up costs, but it’s clear from the below graphic that shifting production models are where the fault lies, and right now they are far from their long-term goals.
All the while, competitors have not been sitting on their hands. Oatly may have created this market, but it is now far from the only player. SunOpta, which also makes soy and almond milk, was the business that Starbucks partnered up with when Oatly let it down.
Chobani, a major yogurt manufacturer, managed to launch its first oat milk product in under 12 months, and won a major deal to supply Tim Hortons in December last year. Danone, which owns the Silk brand of dairy alternatives, and Califia Farms have also expanded into the space, while Planet Oat, made by dairy giant HP Hood, has overtaken Oatly as the top U.S. selling brand.
Meanwhile, Oatly has come under fire from groups and even an advertising watchdog in the United Kingdom over its environmental claims.
It’s not all doom and gloom for Oatly. In its latest report posted just last week, the company gave moderately good guidance for the coming year. Revenue is set to come in at between $880 and $920 million — between 37% and 43% growth. The company also believes it will hit a run rate capacity of 900 million liters by the end of the year — almost double what it could produce in 2021. However, it didn’t specify how much of that is going to be produced internally and capital expenditure is set to jump significantly. That will mean either it issues new shares — not great when you’re down 80% — or it takes on debt, which won’t be cheap.
Moreover, I think there’s a great lesson here to be learned for investors. Sometimes businesses come along and grab a lot of attention simply because they are the only pure-play in an exciting space. Companies can make us believe they are the future of a particular space with cool branding and a compelling narrative. In the end, without a sustainable competitive advantage, it’s impossible to prevent the bigger players from making your life hard.
At the moment, I don’t see Oatly’s days getting much easier any time soon.