HelloFresh stock analysis and valuation - One of my largest positions

This week's casual valuation is HelloFresh. I've received many requests to cover it as it is one of the largest positions in my portfolio (13.5%).

In this post, I'll share everything that there's to share from my side, but please do not treat this as financial/investment advice. If you want to make any decision, please do your homework.

The post will be divided into the following segments:

• Introduction
• The business model
• Historical financial performance
• The balance sheet
• The 2025 target (provided by the management)
• Assumptions & valuation
• Valuation based on assumptions different than mine

Introduction

For those who are not familiar, HelloFresh is a company operating in a niche market. It is a direct-to-consumers company, that delivers meal kits & ready-to-eat meals.

A meal kit is a combination of a recipe and all the ingredients required to make the meal. Once a week, the customer can choose the recipes, and everything gets delivered in a box to their doorstep.

A ready-to-eat-meal, is well, pretty much the same, except there's no cooking to be done.

Other than its own brand HelloFresh, it has acquired other smaller companies in the past, such as Factor_, Green Chef, Chef's Plate, and YouFoodz. These are companies that operate in the same industry, and the company uses its know-how to scale them up, by increasing capacity, but also expanding in other countries.

Other than selling meals, it also sells soups, desserts, bakery products, salads, etc.

A tiny portion of their revenue comes in the form of fees for including some marketing material of other companies (offering discounts for example) in the box sent to the final customer. This is not a significant portion, but the margins are 100%. Adding a couple of flyers in a box doesn't take that much space, and other companies would pay to target a certain geographical area for their products/services.

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The business model

The company operates based on a pull model, meaning the first step is done by the customers, choosing the recipes, and placing the order. Between that day, and the delivery (in the Netherlands, the deadline for ordering is Wednesday, and delivery is being done during the weekend), HelloFresh:

• Orders all the ingredients
• Gets all the ingredients delivered to their fulfillment centers
• Orders are being packaged & sorted for delivery

There has been a lot of investment done in automation in advanced assembly lines, so the fulfillment centers are in pretty good shape.

The capex reached its peak in 2022 and is expected to decrease every year over the next 3 years. The main reason for this is the infrastructure that is already in place as it is sufficient to support €10b in revenue (the last twelve months' revenue is €8b).

There are 7.1m customers (assuming 1 customer = 1 household), representing roughly a 2% penetration rate, comparing it against the 322m households in the countries where the company operates. A high penetration rate should not be assumed, as this is a very niche market.

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Historical financial performance

The company has roughly €8b in revenue (vs. €4.3b market cap), with a gross margin of 26%. The direct costs are related to:

• Ingredients
• Packaging
• Delivery

After taking the marketing & G&A expenses into account, the operating margin is around 3%. So, why would I invest in a company of this kind?

I expect the margins, and the free cash flow to grow. Here's my rationale:

If you take a look at the 3 direct costs, it can be argued that ingredients and packaging will grow hand in hand with the more orders the company has, leading to higher gross profit, but same margins.

However, delivery doesn't grow at the same pace. Imagine if one of their vans needs to transport 10 packages to one neighborhood, Now, if the same van has to transport 12 packages, the cost would not increase by 20%. The van has already made the majority of the journey.

This means, the more customers there are in a certain geographical region, the higher the margins are. In the mature markets where the company operates, the operating margin is between 8%-10% (in some, the operating margin is even 12%, but this is too high to use for long-term assumptions).

I am a customer of HelloFresh, this is how I got introduced to this public company. If someone is happy with the product/service, there's no additional marketing expense required to keep them satisfied. Therefore, I expect the marketing expense to decrease as % of revenue over time. The management shared the 2025 targets, and we'll come back to this.

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The balance sheet

The company has almost €0.5b in cash, which is solid, with very low accounts receivable (€17m) which is expected, as the customers pay almost at the same time as the delivery. This means the company has almost no risk of not getting paid.

In addition, as there operate in order cycles, they hold very little inventory (€250m), consisting of fresh ingredients and packaging materials.

On the other side of the balance sheet, it is worth mentioning that they have around €0.7b in debt, including leases, as they lease some of the fulfillment centers in the US, Sweden, Canada, Australia, and the UK.

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The 2025 target

The management shared the 2025 targets, and the summary is as follows:

• Revenue growth to €10b
• Gross profit 26% --> 29%
• Marketing expense (as % of revenue) 18% --> 16%
• Operating profit 3% --> 8%

Today, we have a company with low profitability and high capex (to increase its capacity), and as of 2024/2025, we'll have a company with modest profitability and much lower capex. Based on my assumptions, I expect a significant increase in the free cash flow.

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Assumptions & Valuation

However, only because the management has certain targets, doesn't mean that is exactly what is going to happen.

My assumptions are more conservative:

• Revenue growth of 5% for the next year, reducing to 2.5% over time (the €10b revenue target of the management is hit in 2028)
• Operating margin slowly improving, reaching 8% in 2027
• A discount rate of 8.7%

After adjusting for what is on their balance sheet, as well as the equity options outstanding, the value of HelloFresh is roughly €6b (€34.5/share).

For comparison, the company's market cap is €4.3b (€24.5/share).

Based on my assumptions, the IRR that the company offers is 12.7%.

For those who are interested in multiples, based on my assumptions, at year 10, the terminal value is multiple of the FCF at year 10 x 17.8.

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Valuation based on assumptions different than mine

Of course, the future is uncertain and my assumptions could be significantly wrong. Let's take a look at how the valuation (per share) changes if we use different assumptions related to the revenue 10 years from now as well as the operating margin.

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The €34.5 is the fair value based on my assumptions. If you take a look at the sensitivity, for example, the 6% operating margin column, there's not that much difference if the company grows by 40% over the next decade, or by 100% (€23.0 vs. €27.7).

However, if you take a look at the first row, the valuation changes significantly. As this is a low-margin business, one of the main tasks of the management is to expand margins.

Therefore, the main risk around the company is its margins. If the management doesn't succeed to expand the margins, the impact on the valuation is significant.

My rationale is that as the company gets more customers in the existing geographical regions, the costs per order will decrease. In addition, the reduced marketing expense (as % of revenue) and reduced capex will increase the FCF significantly over the next two years.

I'd love to hear your thoughts and feedback.