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With every announcement of the quarterly figures of the HelloFresh share I have the same feeling. Now' it will be decided where the company is heading in the long term and every time I get the impression after the figures that it is still not open for all to see that the provider of food solutions will have sustainable success. How I myself judge this is, of course, a completely different matter. Classifying HelloFresh's figures is not a task we can accomplish by simply looking at the annual report. I consider the earnings call to be elementary, especially for this share, because the Management Board is very open about negative factors or generally individual items in the annual reports that would otherwise not be available to us.
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Earnings in line with expectations
Once again, HelloFresh was able to exceed expectations in terms of sales. Instead of the consensus estimate of 1.79 billion euros, a result of 1.86 billion was achieved. A year-on-year growth of 31.4 %. However, it should be borne in mind here that this is mainly due to the strong dollar and the high US share of sales. Under constant exchange rates, growth amounts to 17.9 %.
As usual, however, growth is not the point of doubt for HelloFresh stock, but how the company achieves it. As we all know, Q3 is always a weak quarter, but the 'adjusted' EBITDA margin fell by as much as 10 % y-o-y to 71.8 million, below the consensus estimate of 75.6 million. The margin was thus 3.9 % instead of the 5.6 % in the previous year. It should also be considered that the AEBITDA margin, which HelloFresh primarily communicates to the outside world, is actually relatively meaningless for investors, as it does not include components that are quite relevant. More common comparable margins have been 0.1 % EBIT and 2.5 % EBITDA margin. The from my point of view tangible concern that the company cannot generate sustainable earnings could therefore at least not be obviously refuted.
A year-on-year increase of 8.2% was achieved in active customers, although the total number of active subscriptions decreased significantly by around 0.5 million compared to the previous quarter. However, this is primarily due to the typical seasonality of HelloFresh.
The gap between the USA and the International Segment has also widened visibly. Although there are even slightly fewer active customers in the USA, sales are significantly higher than in the International Segment. Another striking feature is the very significant increase in AEBITDA in the USA accompanied by a sharp decline in the margin internationally. The reasons and the classification of these are elementary in my view to confirm or refute the current investment case.
The figures in detail
So far, it has always been worthwhile to listen closely to the HelloFresh share during the earnings call, when CEO Dominik Richter and CFO Christian Gärtner answered the very specific questions of the analysts and also spoke in detail about individual positions. This call was no exception.
Contribution margin significantly improved
A major concern that accompanied inflation was that HelloFresh would not be able to pass on the increased prices to its clientele, or would do so only poorly. This seems to have been disproven for now. Although revenues only increased by 31.4 %, the contribution margin increased significantly by 43.5 %. CFO Gärtner also emphasized that they seem to be doing a good job of cushioning the effects of inflation without passing on the costs one-to-one to the customer base. He emphasized, as in the last call, that their advantage is the different suppliers for each ingredient, but also the ability to find a healthy middle ground between avoiding expensive food and what customers want, based on their data base. According to CEO Richter, price increases have now also come to an end for the time being. In his view, price elasticity has worked very much in the company's favor, and I feel that this can be seen in the strong increase in sales, higher order values and yet YoY slightly higher customer numbers. However, Richter also stressed that they would still be very cautious about price increases, keeping long-term effects in mind. After all, higher prices also make it more difficult to reactivate existing accounts and acquire new customers.
However, CFO Gärtner sees increased productivity as the most important factor in the gross margin. On the one hand, the repeal of Corona measures is particularly noticeable in a year-on-year comparison, which is why the processes in production are more direct; on the other hand, the automation measures, which were already announced in Q1 for the second half of the year, are already having an effect.
Provided that this development is sustainable, this is quite pleasing and removes a major point of criticism or concern regarding the business model. Higher prices can apparently be implemented without significant distortions in active subscriptions, whereby the considerable difference between the U.S. and international is remarkable. The fact that the price measures have now ended for the time being, according to Richter, and that the difference between the two segments is so great, then leads to the conclusion, in my view, that it was apparently not possible to increase prices in Europe without endangering the number of active customers. In the following, we look at why this must be only partly correct.
Average order value increased significantly
The Average Order Value (AOV), combined with the Management Board statements, shows what else, apart from pure price increases, is responsible for the higher sales with only a slight increase in active customers. According to Richter, only half of the year-on-year increase in AOV was due to higher prices. In the U.S., he said, the main reason was the high-priced and fast-growing ready-to-eat subsidiary Factor. Basically, he said, the roll-out of HelloFresh Market and the wider selection of dishes were responsible for higher basket values.
HelloFresh Market, which offers customers the option of adding small add-ons such as soups, antipasti, etc. to their cooking box dishes, is now gradually being activated in the various markets. In the pilot markets, contrary to my original suspicions, Market has led to significantly higher AOVs, according to Richter. I myself always find it tempting to order a quick little lunch in the form of wraps, soups, etc. to go with it, though I avoid it because of the price. However, I am also a special case when it comes to price consciousness. For people who put convenience first, their finger will get lost on the "add" button more often than not.
According to Richter, the increasing number of new recipes and greater selection options in the individual weeks also have a significant share in the higher order values. Customers who have been cooking with HelloFresh for a long time are more inclined to add another recipe or order an add-on/snack from HelloFresh Market.
If Market and the new recipes really do have as positive an effect as Richter assumes, this is an advantage for the company that should not be underestimated. The add-ons in particular seem to me to have very high margins, and since they are shipped together with the cookbox meals that are ordered anyway, HelloFresh incurs proportionately lower costs for handling, shipping, and packaging. As a result, there is a good opportunity to expand margins here, primarily by reducing fulfillment costs. I am curious to see how much this will make itself felt in the coming quarters. In any case, the potential is enormous if it is accepted by the customers.
Average order rate above pre-Corona level
There appeared to be a slight setback in terms of the Average Order Rate (AOV). This decreased to 3.9 orders per active subscription. However, it is well above the pre-Corona level of 3.5. The lower value compared with previous quarters is due to typical seasonality. Fewer orders are placed in the summer months in particular, as customers tend to take their vacations during these months.
Deutsche Bank analyst Naizer then wanted to know how the older customer cohorts were behaving. Whether it could be seen that they order more than before. According to Richter, they order at a stable high level and also tend to order an additional dish or something from HelloFresh Market. That's exactly what it often seems like to me. The longer people in my circle order from HelloFresh, the less they question the price and appreciate the convenience so much that they channel more and more responsibility towards HelloFresh. This also shows the value of long-term customer relationships and why the Management Board is proceeding so cautiously here.
Marketing via original announcements
While the points mentioned so far went as originally announced by the Management Board, we now come to the point where HelloFresh regularly has to put up with critical questions, and in my opinion not entirely unjustifiably, because the amount of marketing expenses was originally communicated or planned differently. At 59.4% YoY, it increased significantly more than sales.
The Executive Board cited Factor as the main reason for this, as it incurs significantly higher customer acquisition costs (CAC), but CACs were also higher in general. CFO Gärtner also said that it is seasonally normal for marketing costs to be like this and that they are only 0.5-1 % point higher than planned. The newly added markets also play a role here, where marketing expenses are quite high, especially at the beginning.
Richter added, when asked by an analyst, that web traffic was particularly low at the beginning of Q3 and then they ramped up spending towards the end of Q3 as traffic picked up. He also sees macro effects as an additional reason. Customers are no longer as willing to try new things. Spending is at the level the board wants it to be, he said.
According to the Management Board, we have to expect 16 % marketing expenses in Q4. They will therefore remain at a constant level, even if they are comparatively low over a period of several years and adjusted for Covid.
In principle, I have nothing against higher spending on marketing. Here in particular, we have to distinguish between strategic and tactical decisions. In the long term, HelloFresh wants to bring customers on board and keep them because they order more and more over the entire term, which justifies higher CACs, so in my opinion they should definitely react to short-term circumstances and adjust marketing spend dynamically. Due to the increased contribution margin, the company has also earned this increase to a certain extent. Nevertheless, consistently high marketing expenses 'in relation' to sales are not something that needs to be glossed over. For me, they remain the biggest and most directly effective lever on the margin.
Other weighty factors
What also stands out are the very sharp increases in general & administrative (G&A) costs. This was also the point of the Citi analyst's question. Gärtner correctly emphasized that they had announced very early on that they would be increasing the number of teams assigned to G&A. Primarily, these are the Tech & Data teams. According to Gärtner, it is primarily these that are responsible for many improvements. This relates to both knowledge of customer behavior and increasing the efficiency of the fulfillment centers. When the first increase in this area was seen, I was also a bit surprised, since in principle overhead costs should decrease when sales are expanded so much. However, since the development was announced early on and I increasingly get the impression that both customer knowledge and efficiency are increasing elsewhere, I don't see it with concern.
In addition, Richter pointed out that the ramp-up of new brands and markets in Europe in particular has led to considerable costs. These are said to amount to around 60 million. I had read an otherwise very good article in a forum to the effect that we would need to know how high the impact had been in the previous year. I see it differently. We decide here and now whether to buy the stock, and if the CFO suggests to us that we have 60 million in costs here that will be eliminated in the future, then that stands for itself, because it theoretically gives us a look at normalized earnings, i.e. if the company were to stop growing overnight and only reap the fruits of its labor up to that point. Accordingly, this also applies to future ramp-ups.
Free cash flow calculation
HelloFresh itself reports free cash flow (FCF) of -52.3 million euros for the 3rd quarter. As usual, I do not completely agree with it or, better said, usually classify it differently for me. The aim is to calculate a FCF that is as sustainable as possible and to which we as investors are also really entitled.
The main differences between my own calculation and that of the company are, firstly, the consideration of operating cash flow after deducting movements in working capital. These are often only of a short-term nature and only say something about the company's ability to generate cash to a limited extent. Especially since the concerns about HelloFresh in this regard are so high in some places, it makes sense to take a look at the cash flows that is as normalized as possible. I also subtract share-based compensations (SBC). I have the reasons for this if you are interested, in a separate article presented in detail. These show a significant increase over the previous quarter, as the program has been significantly expanded and employees have been given the right to choose between RSUs and VSOPs. If that doesn't mean anything to you at this point, it's not worth bothering with. Just think of the SBC as a salary expense and you're doing everything right.
After deducting net capital expenditures (CapEx) and finance leases, the FCF amounts to -123.8 million euros. This is nothing that would make anyone jump for joy. The continuing high level of capital expenditure obviously has a major impact, but is not the sole reason for the stagnation in cash generation. Adjusted operating cash flow is only weakly positive and here, of course, the new brands and stores being ramped up as well as the generally weak quarter are having an impact. Still, we should face the fact that HelloFresh is not generating any cash this quarter and not much lately. Whether this should be seen as critical or not is something that everyone can judge for themselves. As already mentioned, Q3 is basically a weak quarter.
Guidance
Not surprisingly, many questions in the call also revolved around guidance. In this respect, there was initially no too good news for investors. In terms of margin and revenue, the Management Board expects earnings to be in the lower half of the full-year guidance. In terms of active customers, the company expects mid-single-digit growth in Q4. In Q4-2021, by the way, the figure was 7.22 million. Unsurprisingly, we must therefore assume a decline or stagnation from Q3 into Q4-2022.
BNP analyst Andrew Gwynn then wanted to know from Gärtner whether HelloFresh will grow in 2023 and whether he still stands by the medium-term guidance until 2025. Gärtner was able to answer both in the affirmative, but wanted to wait with official guidance until March, when the annual figures for 2022 are presented.
CapEx
There was also a demand with regard to CapEx expenditures. How flexible the current capacity could be cut back if the utilization rate is not reached. Gärtner did not want to know anything about scaling back capacity, at least to my sensation, but emphasized that there is still a capacity bottleneck in some regions. For example, in Arizona for the Factor subsidiary. In addition, where old leases expire, the sites will be replaced by modern and automated ones, which should continue to have a positive impact on the gross margin. The Richmont site will probably fall into this category, at least officially, whose closure was recently announced. Considering that Richter's Q4-2021 call projected 60-70% utilization toward year-end 2022, that's not much of a surprise either.
Here, too, we have to look again at the difference between strategic and tactical decisions. Inflation in this form was not to be expected at the beginning of the capacity expansion. HelloFresh has since adjusted its pricing very sharply and had to reckon with correspondingly weaker customer growth. That is the price for such a measure. The fact that individual inefficient locations are being closed as a result of overcapacity that was planned anyway is not something that I hold against the company.
Factor 75
The HelloFresh subsidiary Factor 75, which sets the tone in the ready-to-eat segment, is apparently still on course for significant growth. When asked, Dominik Richter confirmed that we can expect sales of 600 million by the end of the year. At the beginning of the year, it was just 300 million. In addition, Factor is now also being rolled out in Canada. In this country, we still have to be patient. I had actually forwarded the question of when we can expect Factor in Germany to Markus Koch, who then answered it for Christian Gärtner in a very recommendlensworthy interview set.
Conclusion
Frankly, I don't think the market is mispricing HelloFresh right now. What is currently seen in the cash flow statement and margins is also correctly reflected by the market. The company continues to invest heavily and if I didn't think the success of that was likely, I wouldn't have been invested for a long time. Based on the AOV, the increased sales and still high number of customers, we can definitely see that HelloFresh also has sustainable success and obviously offers added value to many people, which is reflected in a price elasticity that works very much in favor of the company. Consequently, inflation does not seem to be a primary issue for the time being.
Nevertheless, there are some points that should be viewed critically. I continue to view the ongoing issue of marketing with skepticism. Especially when the Board of Management says that customer acquisition has become more expensive. In principle, of course, it is still a good thing that these expenditures are made in order to benefit from the operating leverage at another level. As long as marketing costs do not continue to rise, this should have a positive effect.
As always, I had the feeling that the Board of Management understands its figures and basically does not drive on sight. That is why I remain invested.
Disclosure: I am invested in HelloFresh.
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