In Tematica Investing, we focus on companies that are benefitting from tailwinds associated with our investment themes. As a good institutional portfolio manager knows, avoiding problematic investments is critical as they can sabotage returns to be had from well-positioned ones. In our Tematica lingo, that means avoiding companies that have thematic headwinds bearing down on their businesses and buying companies that are rising the tailwinds.
No need to revisit Blue Apron shares
We’ve been bearish on shares of Blue Apron (APRN) and we’ll try not to pat ourselves too hard on the back as we take a victory lap on that call.
As we saw yesterday, there is a good reason to remain that way as Walmart (WMT) is formally getting into the meal kitting business. While many were expecting Amazon (AMZN) to leverage its Whole Foods Market business with its own meal kitting offering (we still are), Walmart is leveraging its position as the largest grocer to enter the fray. The goal for the brick & mortar retail giant is to help build its digital footprint as well as take share from the restaurant industry, which has been pressured by weak traffic and average ticket pressure. Odds are Walmart is also looking to ride the consumer shift toward healthier eating and snacking that is part of our Food with Integrity theme along with a hefty dose of our Connected Society one.
All in all, this looks like a good extension for Walmart and one that is poised to make an already challenging environment even more so for Blue Apron.
Struggling GNC Holdings looks East
Another company that has been running into a significant thematic headwind is GNC Holdings (GNC). Once a dominant player in the sports performance and nutrition space (otherwise known as body-building), the supplement retailer has been attempting to reposition itself to a wider audience as a seller of “health, wellness and performance products.” As the performance market has moved online and to other sources, GNC has been attempting to capture more women and appeal to the Boomers and their set of nutritional needs, which are far different than the iron clangers in the free weight section of the gym.
To say this stock price chart looks like a one-way roller coaster that only goes down would be an understatement. A better comparison would be an alpine slide that starts extremely high up a mountain, has several twists and turns, but only goes in one direction – down. Since peaking in late 2013 near $60, that’s exactly what we’ve seen with GNC shares as its profits turned to losses despite a comparatively modest dip in revenue over the last few years.
In perusing the company’s latest 10K filing, the company offers up an explanation of sorts: “Prior to 2017, we had been experiencing declining traffic trends leading to decreasing same-store sales in our retail stores. After extensive consumer research and market analysis, we determined that our business model needed to be reimagined.”
Not exactly what a shareholder, existing or prospective one, wants to hear, but at least we can credit the management for not acting like an ostrich with their head in the ground as Amazon rolled into space as did others. The combination of having to “reimagine” its business model as well as fend of competitors led annual Selling, General & Administrative expenses to rise over 2015-2017 as revenue shrank, pushing GNC to deliver bottom-line losses.
Digging into the financials, the company experienced negative same-store sales in every quarter during 2016 and the first two of 2017. Making matters worse, average transaction amount was in negative territory over the last five quarters, and sales at GNC.com sales were falling as well. December 2017 quarterly sales were up 0.2% in company-owned stores vs. down 1.2% in the September 2017 quarter.
Not exactly a recipe for success, but clear signs the company could be in turnaround mode. What makes this potential turnaround interesting is the new partnership with CITIC Capital and Harbin Pharmaceutical Group. As a way of background, CITIC Capital is a global investment firm with a strong position in China and the Harbin Pharmaceutical Group is a joint venture of several China-based pharmaceutical companies. CITIC will invest $300 million in the form of a newly issued convertible perpetual preferred security with a 6.5% coupon payable in cash or in kind and a $5.35 conversion price. GNC will use the funds to repay existing debt and for other general corporate purposes, and on an as-converted basis, CITIC will hold roughly 40% of GNC’s outstanding equity. That’s a significant shareholder and one that will also appoint a total of five members to GNC’s newly expanded 11 member board.
The company expects the transaction to close in the second half of 2018, but it will require regulatory approval in both the U.S. and China. Given the current geopolitical tensions we are reading about almost daily, there could be some speed bumps associated with these approvals. Also too, GNC is ramping marketing associated with its recently launched pricing strategy and loyalty program, One New GNC strategy in the current quarter. This likely means margin pressure is poised to continue.
The bottom line is even though GNC is facing steep competitive domestic pressures, it’s new relationships could pivot its business but there are several hurdles to be overcome. Keyword being “could.” The risk related question I find myself asking is “Yes, I understand what the management team is saying, but what if the pivot or turnaround doesn’t happen as expected?”
We’ve seen many a company that in the face of thematic headwinds and mounting competitive pressures have attempted to reposition their businesses. Few have succeeded. My gut tells me that GNC, much like Blue Apron, Blackberry (BBRY), Angie’s List, GoPro (GPRO), Fitbit (FIT) and others, is on the road to nowhere for investors. But that’s my gut, which means reminding myself to keep an open mind and watch the data as it becomes available.
Recently we shared with Tematica Research Members our perspective on shares of Blue Apron (APRN). In a nutshell, our message was “stay away” from this company as it faced several headwinds. In the last few weeks, APRN shares hit $5.50, well off their initial public offering price of $10, but the shares have since cratered another 13%. For an aggressive trader, that would have been a nice short trade as the S&P 500 rose roughly 0.5% over the same time frame. Candidly, APRN shares were considered as a short trade for our Tematica Options+ service; however shorting stocks in the single digits is fraught with all sorts of issues no matter how tempting it may be.
Tomorrow, November 2, 2017, Blue Apron will report its 3Q 2017 quarterly results before the market open. Given the additional drop in the shares, odds are investors will yet again be contemplating what to do — get involved, leave it alone or perhaps getting even more aggressive to the downside — those are the choices we face.
Before we come to a quick conclusion, let’s remember Blue Apron management just initiated a round of layoffs – not good for a company that has recently become public! The drop in headcount equates to a 6% reduction and comes on the heels of a botched first quarter as a public company. As we learned in that earnings report, not only did Blue Apron deliver a wide miss to the downside vs. expected earnings, but the company also slashed its marketing spend to $30.4 million from $60.6 million in the prior quarter to conserve cash. Because of the June quarter loss per share of $31.6 million or -$0.47 per share, Blue Apron finished the June quarter with $61.6 million in cash down from $81.4 million at the end of 2016. As we pointed out previously, if the company were to simply hit existing EPS expectations for the back half of 2017 it means a most likely painful secondary offering or private investment in a public entity (PIPE) transaction will be needed.
The move to cut marketing spend and conserve cash led to declines in orders per customer and average orders per customer year over year, despite the improved customer count year over year. Now, this is where context and perspective come in handy – yes, Blue Apron’s customer count rose year over year in the June quarter, but it tumbled 9% compared to the March quarter. Ouch!
What this tells us is that Blue Apron is in a difficult situation – it has to carefully manage cash, but for a company that is reliant on marketing to grow its customer base, it means potentially sacrificing growth. And that’s before we consider the threat of Amazon (AMZN), which through Amazon Fresh has partnered with eMeals to take on Blue Apron and others like it. While this is a fairly new initiative, via eMeals Amazon offers gluten-free, paleo, Mediterranean, and other select lifestyle choices. We suspect there will be another salvo fired at Blue Apron as Amazon fully integrates Whole Foods in the coming months.
Even before we tackle September quarter expectations, it’s not looking good for Blue Apron, and what we’ve outlined above explains not only the rise in short interest but also the decline in institutional ownership as the share price collapsed. Generally speaking, the vast majority of institutional investors will not flirt with companies near a $5 stock price.
In terms of what’s expected when it comes to Blue Apron’s 3Q 2017 earnings, the consensus view calls for EPS of -$0.42 on revenue that is forecasted to drop 20% sequentially to $191.47 million. That bottom line loss means the company will burn through even more cash during the quarter. Think of it this way – if the management team was confident in its second half prospects, then why roll heads and introduce a “company-wide realignment”?
What if Blue Apron’s loss for the quarter is less than expected?
While that could pop the stock in the short-term, odds are the company will still be facing stiff competitive headwinds and be in a cash-constrained position. The only real question is will its cost containment efforts buy it another quarter until it hits the cash wall? Any investor will see the blood in the water and factor that into their thinking when it comes time to price the eventual offering the company will need to survive.
Aside from the quarter’s financial metrics, key items to watch inside the quarter’s earnings report will be the sequential trend in orders, customer count, orders per customer and average revenue per customer. Those will set the tone for the company’s updated outlook that if recent history holds will be shared on the 3Q 2017 earnings conference call. For those still intrigued, be sure to see how that outlook meshes with the current consensus view for the December quarter that clocks in at EPS of -$0.22 on revenue of roughly $200 million. The real upside surprise would be if the company moves up expectations for it to be break-even on the bottom line, but given recent headcount cuts and restructuring the odds are very low we will hear such talk.
Stepping back and reviewing the above, we are not expecting the company to throw a life preserver to its stock price. It is possible that 3Q 2017 metrics surprise on the upside, and this could pop the stock, but it doesn’t remove the business environment and cash need challenges Blue Apron’s business will still face. We will be looking at the upcoming pricing of meal kit competitor Hello Fresh’s initial public offering, and with its CEO’s stated goal to “become the clear No. 1 player on the U.S. market in 2018” this likely means, even more, pricing and margin pressure ahead for Blue Apron.
Bottomline, our perspective is this, if Blue Apron’s earnings report is better than expected don’t take the bait. We’ll continue to look for and invest in companies that are well positioned to ride the thematic tailwinds associated with our 17 investment themes and are well capitalized. Investors who have been around the block the time or two have seen situations like this one with Blue Apron before and it rarely ends well.
As Warren Buffett said, “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” We could not agree more.
As the face of retail morphs in response to several of our thematic headwinds, including Connected Society, Rise & Fall of the Middle Class, Food with Integrity and the Fountain of Youth, brick and mortar retailers and mall centers are attempting to innovate and improve their in-store experience. We’d note the following trends that per ISCC’s RECon event appear to be gaining traction:
Grocery Technology to compete against concepts like Blue Apron, Plated and Hello Fresh. Grocerants and restaurants within grocery stores are also becoming more prevalent.
Clicks to Bricks – Showrooms like Bonobos, Rent the Runway and BaubleBar will continue to emerge as online retailers find it as a way to achieve growth through brick and mortar locations.
Personal Fitness – As the trend of group fitness continues to grow, more studios like CycleBar, Soul Cycle, Core Power Yoga, Orange Theory Fitness, Pure Barre and Club Pilates will continue to add to tenant mixes and infiltrate shopping centers as an experiential retailer.
Health Conscious Fast Casual Restaurants – Quick service restaurant options are getting healthier and trendier with salad concepts like Grabbagreen, Chopt and organic/fresh ingredients options like Core Life Eatery, sweetgreen, BibibBob, Taziki’s and Newks.
Food Halls – By 2020, it is expected that there will be 200 food halls in the U.S., which is more than double the number open today. Eataly, the leading food hall developer, has 35 locations alone and plans for several additional food halls in the coming years.