Description

I recommend shorting OTLY shares down to $1.80, or a 28% decline from a recent price of $2.50. $1.80 would be 1.3x my estimate of FY2023 trailing revenue. Growth continues to slow, is propped up by unsustainable spending, and cash flow breakeven is nowhere on the horizon. I believe the shares will eventually revisit the vicinity of recent lows should growth slow any further.

Sweden-based Oatly Group AB is a producer of oat milk and a range of oat milk based products including oat “yogurt” and frozen desserts. The company has a market cap of ~$1.5B and trades on the U.S. Nasdaq market and reports in U.S. dollars. Sales of Oatly products are often #1 or #2 in markets in which they have a major presence, including Sweden, Germany, the USA and the UK. Sales are 33% Americas, 45% EMEA, 22% Asia.

I deploy price-to-sales as a metric to close out the short as the company does not generate earnings, burns mind boggling amounts of cash, and to get to cash breakeven would need to dramatically reduce marketing spend which would in turn bring growth to a grinding halt. Even when OTLY inevitably normalizes the outrageous customer acquisition spend, the margins on this near commodity product will never meet management’s overly optimistic projections. However, perhaps a strategic buyer would pay 1x or more time sales for the brand so I use p/s as a metric to guide closing out the short.

A near-term risk, or perhaps delay, to this short working is that management is taking first steps to decrease a second overspending addiction; namely, capex; as well as make some cost cuts to corporate overhead. As this plays out perhaps the market gives management – and the stock price – some leeway to learn the outcome. However, I see this as a delay and only if they can keep growth at current levels.

Revenue from their oat-based products continue to grow, but the rate continues to decrease from high levels. 2020 and 2021 revenue growth yoy was 106% and 53%, respectively. Clearly many a pandemic morning was kicked off with oatmilk in one’s coffee and closed out with a delicious plant-based burger.

2022 growth, though returning to earth, stands to finish at a credible +/- 20% in constant fx, but only approximately 13% in USD due to negative impact of strong USD. In the last reported period, 2022 Q3, revenue grew only 7.0% yoy in USD, but was 16.7% in constant fx. Though full-year 2020 growth may average around 20% in constant fx, it will be due to +20% growth in the 1H and mid to high teens in the 2H, evidence that growth continues to ease. Volumes may be the best “tell”: Q3 volumes grew 14.5% yoy and to me seem like the right metric to view the current sales growth run rate given impacts of fx and inflation.

The company is a prolific cash incinerator. In 2021, on revenue of $641M, they had negative cash flow of $439m. In the first three quarters of 2022, on revenues of $527m, they have burned another $375m and are on track to make a total of $495m disappear in the full year just ended. Using my estimates to close out Q4, 2022 I see a two-year cash burn of $934m, $503m of which has been capex as they build out their self-owned manufacturing facilities. As recently as Q2, management was broadcasting the benefits of this wholly-owned manufacturing strategy as a factor that set them apart as it allowed them to control quality and generate higher margins when fully implemented.

However, cash is dwindling. The balance sheet showed $120m cash as of Q3-end and I estimate is on track to be $5m as of 12/31/22. Running out of cash, management has made a complete strategic about face on their centerpiece strategy of owning their own facilities. On the Q3 call they outlined that they were working on a plan to identify partners to come in on their manufacturing facilities. On Jan 3 of this year they announced a switch to lean more into a hybrid manufacturing strategy via a deal with Ya Ya Foods. Ya Ya will acquire much of their Ogden, UT and Fort Worth, TX facilities for a sum of $98m, of which $52m is paid in cash now and the remainder in a combination of a $22m note and the rest in credits against future production.

Oatly will maintain ownership of the production line machinery. Oatly will make the oatmilk on their equipment in Ya Ya’s facility and then Ya Ya will be the onsight copacker. The Q4 earnings call will provide more detail.

Deal annoucement: https://investors.oatly.com/news-releases/news-release-details/oatly-and-ya-ya-foods-announce-long-term-strategic-hybrid

Oatly was compelled to do this deal in order to raise cash and limit future capex, but also to get out of what was becoming a failed strategy: their competence is not production and they continue to have production issues.  This will be Ya Ya’s first foray into production in the US, so they may very well encounter their own issues, but perhaps those will not be costed to OTLY. I know nothing about Ya Ya, but for the sake of conservativism, will give them the benefit of the doubt that they can do what Oatly needs. Ya Ya Foods: www.yayafoods.com.

Let’s say I am correct and cash on the balance sheet at year-end 2022 was $5m.  Then further assume they will soon receive the $52m cash portion of the Ya Ya deal. In addition, in the Q3 call they outlined $25m annual run rate in cost cutting and business simplificaiton that would take effect by beginning of 2023 and another $25m of additional run rate savings by end of 1H 2023.  Taken together, at max, that gives them $57m in direct liquidity and another up to $50m in less losses due to less spending. Even still, the company is not likely to be cash flow positive in 2023 and probably is on track to be cash flow negative by another $100m.

2022 incurred major impacts from rising costs and production issues. My model assumes these problems begin to normalize and they recover a more normalized level of gross margin. Beyond that, the more structural factor keeping them from not approaching anything near break even is a massive spend on marketing and branding within SG&A, of which I do not have the precise amount. (I can sort of piece it together from filings, but not fully.) However, whatever the amount is it is unsustainable and when it ends, it is likely growth does, too. Specifically, I suspect growth would abruptly stop short. Management noted in the 2022 Q2 call that SG&A spending is a “direct link to revenue growth” and that they expect absolute dollar increases as sales rise. It is pretty clear they can’t stop or even ease on this spend.

In fact, there does not appear to be much or any leverage to the outsized spending. On a year-by-year basis, when I compare the amount of incremental dollars of revenue generated by each incremental dollar of SG&A I see a continued decline in the new, incremental dollars of the former generated by each incremental dollar spent of the latter.

In 2020, each additional dollar of SG&A spent above that in spent in 2019 generated 2.9 dollars of revenue. In 2021 that ratio declined to 1.9 dollars of revenue generated for each dollar of SG&A. I believe 2022 is on track to be 1.0; that is, every one dollar of additional SG&A generated only $1 dollar of revenue. Fx impact may be impacting these numbers, but nonetheless the trend is clear. They have to paddle harder just to stay in place. This can’t continue forever because no one will fund it. They need to get to cash flow positive (if they even can).

Of course, SG&A includes many costs beyond marketing. If as planned they eliminate $50m in runrate costs (half now and the other half by mid-year, as noted above), it will help improve in their favor my rough ratio of incremental new revenue to incremental SG&A. But the trend in marketing efficiency remains in place and it is downward.

As percent of sales, SG&A was 55% in 2021 and is on track for similar or modeslty higher amounts in 2022. On 2022e revenue of ~$721m they are on track to spend at least $408m in SGA (on top of $643m in COGS).

Even with all the marketing spend (and backing out fx impacts) we know growth continues to moderate. Management has mentioned in recent quarters that the trend away from diary milk to plant-based milk is slowing. The Oppenheimer analyst mentioned it again on the call and asked for management to comment on it, but management clearly did not want to address it directly and diflected. Fwiw, even within plant based, there are sub-trends that can pull from oat.

In addition to the potential slowing rate of oatmilk adoption (certainly the easy share gains to oatmilk from diary milk are in the rearview mirror), it may be that Oatly is loosing shelf space to competitors. The debate is if this is due to OTLY’s inability to fill orders (production issues) or something more.  To this point, the Cowen and Company analyst pointed out:

“I wanted to talk about the U.S., total distribution points in the tracked channels appear to

decelerate meaningfully commensurate with the recent shelf resets, Several of your oat-milk competitors accelerated simultaneously. How much of that dynamic that we're seeing is just your inability to supply at this point versus customers now opting to give space to peers who maybe today, are in a better position to fill that shelf space? Maybe said another way, is it fair to say you are getting punished by customers at this point for lack of a better term?”

In response, management claims that they are not losing share and that the shelf space losses are due to inability to meet demand. Nonetheless, this gives competitors an opening.

Regardless, marketing spend is geared to a world of neverending free money and that world no longer exists. For a while they have some levers to pull that can provide them cash that will permit them to keep the marketing spend rate in tact. However, as marketing efficiency has decreased they need increasingly larger absolute sums to generate incremental revenue gains on a percentage basis as the base continues to grow and efficiency of marketing spend continues to decrease. There is no way these incremental expenditures could be profitable.

Arguably, on a percentage of revenue basis a company like this would spend 2/3 to 1/2 the SG&A it does now. In fact, absent such a reduction in SG&A I see no path to profitability. Cutting back sharply on marketing within SG&A will clearly put downward pressure on sales growth. In the meantime, there are a long list of competitors competing against Oatly. So are other forms of plant based milk. (Pea milk, anyone?)

Here is an amazon search for oat milk. Lots of competiton: https://www.amazon.com/s?k=oatmilk&crid=3N13UH41PXJ5H&sprefix=oatmilk%2Caps%2C156&ref=nb_sb_noss_2

Management provides some country by country revenue breakdown. In Europe, core countries such as home-base Sweden and next door Finland are seeing year over year declines that seem to exceed fx headwind. Certainly those markets are no growth at best. UK, Germany and Netherlands are not far behind .These countries are 87% of their EMEA sales in Q3. The Q3 presentation notes that they have limited presence in the broader EMEA.

While they point this out has an opportunity, and it is, I would point out that it seems to me that breaking in to new markets and taking share is going to require continued outsized losses due to an outsized marketing spend required to take share from existing competitors. In the past, they were part of creating the market. That won’t be the same going forward. They will need to rest share from someone else with marketing and price point. However, as stated, I do not believe the money will be there for this for much longer.

Speaking of price point. In USD their sale price per liter sold dropped from $1.56 in Q3 2021 to $1.45. Their Europe sales, in particular, are impacted negatively by fx and help drag down the whole, but there have also been price increases. The pricing trend is not good as competition picks up. In Europe, in particular, pricing went from $1.39/liter to $1.23/liter, an 11.5% drop. Again, one must factor in fx, but at best it implies little to no pricing power. Asia (mostly China) pricing dropped from $2.01/liter to $1.73/liter. US pricing was up 2.4%. It may be that in 2023 all players will need to raise pricing to cover rising costs and in the process Oatly will benefit, too. Management is signaling more price hikes coming.

The toggle from owned production to hybrid means less capex, but comes at the expense of long term margins. Earlier presentations touted a 20% EBITDA margin target and this was in part based on owning their own production. I don’t believe this was ever going to happen even if they grew their own oats, mixed them with water in their own factories, and delivered it all with their own trucks. That goal was yet another ridiculous bubble era projection of which there is no shortage among recent IPOs and SPACs. EBITDA margin at General Mills is 21%, Kraft-Heinz is 23%, Campbells is 18%, Mondelez 21%.  They sell branded and differentiated products. Oatly is milk and water and there is much competition. At best, I bet margins end up at half the goal.

Ultimately, I suspect Oatly trades for closer to 1x revenue as growth slows, share becomes more widely distributed across peers, and long term margin goals are not fully realized. Should the inevitable pulling of the plug on the unsustainable marketing spend cause growth to halt, then less than 1.0x sales is not out of the question if they can’t get profitable or the profits are meager, or if growth turns negative. But those outcomes are not part of this thesis.

Looking into 2023 I am projecting 13% revenue growth for revenue of $814m. I see the company generating a $50m EBITDA loss, spending $60m on capex, and to be free cash flow negative from operations somewhere in the amount of -$110m. They have some production and capex credits with Ya Ya which will provide some offset to that $110.

Risks:

Management gets to cash flow positive or perhaps can paint a credible picture that cash breakeven is coming. I believe this would require being able to grow or at least maintain sales with a material cut in marketing.

Improving USD fx compares should help as they approach mid-year 2023, assuming stable USD against EUR and GBP. This will not change volume growth but they may get some revenue growth bump as the dollar is off its highs. They do probably get this.

A buy out. The product is nearly a commodity and will be moreso as time passes, but they’ve done a good job building their brand name within the space. The brand may be a good fit with some larger player. Perhaps they are willing to pay more than my 1.3x sales cover price.

Catalyst

I see catalysts as one of two. First would be even if the unsustainable marketing spend continues, it fails to deliver acceptable growth (and more missed guidance). Second catalyst would be that the money that can be applied to endless cash burn runs out. They simply can’t continue to spend even if it continues to generate sales because the cost to generate that loss on each sale is so high that they can’t even make it up on volume.