Oatly Group: Sour Milk (NASDAQ:OTLY)

It was the spring of 2021 when I wondered if better-for-you brand Oatly Group AB (NASDAQ:OTLY) was a brand in the making, and whether this made a great investment.

The company has seen consumer adoption across the globe at the time, dominating the niche segment of oat milk, creating a long runway for growth. While I liked the potential, the valuation was far too demanding for me to see a compelling risk-reward situation, as this has painful played out with losses being substantial, now casting a doubt on the future of the business.

The Mission: A Better Food System, For People And The Planet

The header of this paragraph is the mission of Oatly, which believes that a gradual transformation of the food industry is needed in order to address major challenges which relate to the climate, environment and health of consumers. Early adaptors and younger age cohorts seem to understand this, resonating with the brand and its mission.

Oatly aims to disrupt a $600 billion global dairy market, and, in fact, the company has recognized this for a long time, having been founded over 25 years ago. This gave the Swedish-based business a leading market position in milk, ice cream, yogurt, creams, spreads and drinks, all based on oat milk.

The company sells these products through retail, foodservice and e-commerce channels, with products offered in 60,000 retail doors at the time of the offering, on top of this were 30,000 coffee shops and partnerships with the likes of Starbucks, Tesco and Target.

In 2020, the company generated $421 million in sales, of which two-thirds in Europe, including an outsized contribution of home country Sweden, with the U.S. and China driving non-European growth.

The company went public at $17 per share in the spring of 2021, and after shares briefly peaked at $30 in the weeks thereafter, it has all gone downhill. With a 592 million share count at the time of the IPO, the company commanded a $13 billion equity valuation at $22, the price at the end of the first day of trading, although that valuations included an $800 million net cash position. This was a huge valuation for a business which doubled sales in 2020 to $421 million, as operating losses came in at $47 million, up in dollar terms, but marking modest relative operating leverage compared to the previous year.

While a 66% increase in first quarter sales for 2021 to $140 million looked solid, operating losses increased to $28 million, marking some deleveraging ahead of the IPO and typically higher stock-based compensation expenses post the offering. This and the potential of capital rich competitors to start competing were the reasons which stood at the forefront of my cautious take, as the valuation simply felt too exuberant on the prospects of the firm.

Coming Down…

After a successful public offering, at least at the start, shares fell three quarters from their highs to end the year at $8 per share. Poor trends continued in 2022 as shares ended that year at $1 and change, as shares have traded in a $1-$3 range to date in 2023, now trading at $1.70 per share.

The problem is not that of growth (or lack thereof), but mostly that the business is very uneconomical. 2021 revenues ended up growing in a solid fashion to $643 million, yet operating losses of $213 million are unheard of for a food business, as many of these losses are very real, not even caused by outsized stock-based compensation expenses.

2022 was an interesting year, as reported revenues grew by 12% to $722 million, with currencies having a meaningful part of the growth, with sales growing by 20% in constant currency terms. Note that volumes rose by 19%, as prices were up just 1%, indicating that the premium compared to commodity milk and traditional milk-products was coming down in generally an inflationary environment.

On a $722 million revenue number, the company posted a huge $395 million loss, as things were only turning for the worst. The lack of pricing power made that gross profits were only reported at $80 million for the year, resulting in low double digit gross margins, a situation which makes it impossible to become profitable.

The company guided for sequential improvements with 2023 revenues seen up 23-28%, despite a modest currency headwind, with gross margins sequentially improving to the high-twenties in the fourth quarter, and further increases seen in 2024. The issue is that continued losses made that pretty much all the net cash balance were depleted since the offering, a huge burn of course.

Trying to boost liquidity, Oatly resorted to an expensive solution, offering $300 million in convertible bonds which carry a 9.25% interest rate on top of their optionality, which is quite expensive.

…And Coming Down Further

In May, Oatly reported an 18% increase in first quarter sales to $195 million, with growth reported at 23% and change in constant currency terms, as pricing and mix effects were a major driver on top of volume growth this time. As the company posted gross margins of 17% and managed to reduce the absolute net expense base, operating losses narrowed to $71 million. This compares to a $92 million loss in the same quarter last year as these losses are still staggering.

These trends weakened a bit in the second quarter, as released in July with sales up 10% to nearly $196 million. While gross margins improved towards 20% of sales, the company saw a small increase in the other cost base with operating losses increasing to $75 million, making the picture look quite bleak. Moreover, the company sees full year sales now up by 7-12% which after the growth reported in the first half of the year means that growth is seen flattish in the second half of the year. While gross margins accretion is seen, the likely impact is that operating losses will no longer show sequential improvements here.

With the company operating with 593 million shares outstanding, the company actually still commands a roughly billion market valuation here, as net debt comes in at $60 million. The issue is that Oatly Group AB still trades over 1 times sales, but moreover the company is posting huge losses and progress is hard to find.

After all, with operating losses still trending at nearly a million per day, as financing costs only create a bigger hole here, even as the company believes it can become EBITDA profitable in 2024, driven by revenue growth, gross margin expansion and cost savings, all of which requires massive execution. Quite frankly, investors might rightfully be skeptical.

I am skeptical, too, and despite the low optical share price, I see no reason to get involved with Oatly Group AB stock here.