Hellofresh

I have two reasons to write:

1.to provide a foundation for readers to conduct their own research by outlining the current situation of the company. By doing this, I hope to help readers form their own assumptions about its future.

2. to revisit these assumptions in a few years to see how accurate (or wildly off) they were, allowing me to reflect and hopefully refine my thought process in the process.

Not an investment advice. duh

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Content:

1. Equity story

2. Hellofresh offering, business model and simplified income statement

3. Unit economics

4. Unit economics to financial development

5. Financial development to assumptions

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Equity Story

HelloFresh has faced challenges with rising customer acquisition costs (CACs) and declining revenues. The company’s stock crash can be attributed to management’s flawed assumptions about current meal-kit market demand, which they clearly overestimated. For too long, management pursued an ambitious $10 billion revenue target for 2025, only to lower this guidance at the start of 2024. Despite this misstep, HelloFresh has demonstrated strategic discipline since its IPO, achieving a near-monopoly in the global meal-kit market.

After a steep 70% decline following a profit warning, HelloFresh’s stock began recovering from its July lows. However, this rebound was not driven by any significant fundamental changes in the company’s outlook but by short sellers closing their positions. At its lowest, the stock was trading at just 3x adjusted EBITDA.

Since 2021, HelloFresh has faced a significant contraction in valuation multiples. Its EV/sales multiple has dropped sharply from 3.0x in 2021 to just 0.3x by November 2024. Meanwhile, its revenue growth projections have steadily declined since 2022. Compounding the issue, a high fixed cost structure designed for a $10 billion revenue goal continues to weigh heavily on profitability.

Despite the apparent issues, I like Hellofresh for several reasons…

• Abundance of investment opportunitities in the long term

• Founder led and owned

• Near-monopoly status globally

• 1% improvement culture constantly improving the product for the end customer

• Strengthening moat year by year.

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Hellofresh offering, business model and simplified income statement

Business Model. HelloFresh operates as a direct-to-consumer company, offering meal kits, ready-to-eat meals, pet food, and fresh meat through a subscription-based model across 18 countries. The company manages the entire value chain, from ingredient procurement to final delivery, increasingly utilizing its own delivery fleet. With a nearly exclusive focus on private-label products, HelloFresh benefits from significant cost advantages. Each year, the company delivers over one billion meals through approximately 120 million orders.

Profitability. In the past two years, HelloFresh has struggled with profitability as the meal-kit market matured at a lower revenue level than management had anticipated. Management underestimated this shift and continued to invest heavily in marketing and new customer acquisition, despite rising customer acquisition costs (CACs) and a declining lifetime value (LTV) of new customers. Next, we will explore the unit economics in more detail.

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Unit economics

Illustrative only. Unit economics calculated based on LTM figures. Full price is based on Hellofresh meal-kits and 2 person household with a total of 8 meals per week. Hellofresh has multiple brands and pricing varies a lot across different countries and products.

Customer types:

Hellofresh relies highly on discounting and the case is to lower the heavy discount users and hence showcase the true profitability of mature and sticky customer base. The average discount across all brands and products in Hellofresh is around 20%. That doesn't mean every customer is utilizing the discounts, but is the sum of all different customer types, which I will briefly clarify:

• Experimentalist try with + -50% discount and never use again. These are obviously massively unprofitable for Hellofresh

• Deep value - reactive only with decent discount.- I have received multiple reactivation offers with some 30% discounts from Hellofresh Sweden as I have ordered a couple of times visiting Sweden longer periods of time.These offers are likely unprofitable. If marketing costs are excluded, they might be slightly profitable, but this would depend on the contribution margin for HelloFresh’s Swedish operations. Based on the group-level contribution margin figures, these discounts are highly unprofitable.

• The mature sticky customers. These customers pay the full price and order rather frequently. This customer base can post double digit EBIT-margins.

Over the past year, HelloFresh's customer base has shifted toward less profitable segments, as people are less inclined to cook and eat at home compared to the COVID years. The company’s prolonged push for a $10 billion revenue target led to acquiring customers primarily attracted by discounts. This strategy has significantly eroded the group’s margins.

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Unit Economics to group financial development

HelloFresh’s goal of reaching $10 billion in revenue by 2025 is evident in its marketing strategy. Marketing expenses have risen from a low of 12.5% in 2020 to 20% of revenue in the last twelve months (LTM) as of Q3 2024. However, this increased spending has not translated into revenue growth over the past two years, heightening investor concerns about the viability of HelloFresh’s business model.

While the total revenues have remained flat for two years, RTE business has grown rapidly. I’ve estimated that Hellofresh meal-kit revenue has decreased by 15.6%. I’m uncertain where the mature revenue base is for meal-kits, where HFG can generate good profits and cash flows. It has now decreased by 16%, but how much more discount-driven, high churn revenues remain?

Ready-To-Eat revenue has grown by 50% CAGR since the acquisition was made in 2020. I’m uncertain how much of this growth is discount-driven artificial growth and how much will be converted to mature sticky revenue with good profitability. We will see. I would guess HFG won't push for too long for revenue growth if the unit economics turn to worse like they did with meal-kits. I would assume they have learned from their mistakes.

Higher marketing spend has naturally weakened HFG profitability along with lower contribution margin.

Contribution margin development could be the result of two things in my view:

1. in 2020 HFG was able to drive revenues with minimal discounts. While AOV was lower the AOV came with low discounts. As I’ve shown in my unit economics illustration lower marketing converts to better contribution margin. Since 2020 HFG has increased discounting in my view and this has resulted in lower margins. AOV has increased as the basket sizes have increased, but so have the discounts. Contribution margin has decreased from 28% in 2020 to 25% this year.,

2. Overall production inefficiencies in the past two years: HFG has struggled with excess capacity, because the demand for meal-kits was lower than the company had expected and tuned their fixed cost base for. This one is easier to tackle as they right-size the production.

Operating profit margin has declined from 11% to -1% this year (Q3 2024 LTM)

CapEx cycle is behind

HFG invested heavily during the covid years so that they have the capacity to carry the 10B in revenues. If i remember correctly, HFG achieved the capacity for this, but since then they have started to right-size the operations to match the lower demand.

Consequently, this means that the next few years we can see generous cash flows as the capex keep coming down.

FCF has been increasing since the CapEx peak even though the EBIT has been decreasing ever since 2020. When the profitability picks up, the FCF can skyrocket in the next couple of years.

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Financial development to assumptions

Valuation:

I believe the meal-kit revenue will decline by -5% in 2025 and remain flat in 2026. This would mean that the current revenue base is almost fully well profitable. Once the right-sizing of operations is completed, we will see the true nature of the customer base.

RTE revenue will increase by 15% in 2025 and 10% in 2026. I think this assumption is lower than Hellofresh’s own estimates, meaning that the cost base is tuned for higher growth and hence if such low growth were to happen this would lower profitability.

Others segment will grow 70% and 30% in 2025 and 2026, respectively. This growth is from a low revenue base so really doesn’t matter whether it’s 70% or 100% next year.

I expect profitability to improve from here. I expect marketing expenses to decline by 3pp from 2024 to 2030. HelloFresh has clearly communicated they will prioritize profits and FCF generation from here rather than growth. Similarly, I expect lower discounting on average, which should boost both margins to better. In addition, current right-sizing and UK factory ramp-up has further squeezed contribution margins. Once this is all done the contribution margin can once again increase.

Lower capex means more money for us. One of the interesting factors in Hellofresh is the massive capex cycle, which has come to an end. I expect capex to to decline to 180M next year and this year it will be in the low 200Ms as the company has communicated.

Hellofresh has excess capacity and capacity is plenty for growth in the future years. This can allow for growth without any more growth capex, which is appealing. Q3 YTD capex was 131M.

Overall profitability and revenue assumptions

I expect HFG's EBIT margin to improve to 5.8% by 2030, with revenue growing at a 4% CAGR as previously discussed. While the EBIT margin target is ambitious given recent performance, it's not unattainable. The past few years have been particularly challenging for HFG in terms of management’s strategy execution, but improvement is possible. Notably, Hellofresh previously set a long-term target of over 10% AEBITDA margin for 2025, which suggests that achieving a 6% EBIT margin by 2030 should be well within reach.

The profit growth comes with good cash conversion improving owners earnings.

Let’s look at the valuation. Hellofresh enterprise value is around 2.3 billion euros. With that you get revenues of 7700M and negative EBIT of -73m (LTM Q3 2024). Hellofresh is trading at 0.32 x sales, with a somewhat rational assumption of future EBIT margin of around 6%. The valuation looks appealing in sense that we are supposedly at the bottom as far as financial perfomance of HFG.

Let’s assume HFG trades at 12x EBIT in 2030. This would convert to Enterprise value of 6.6 billion euros. The EBIT assumptions seems high, but the past years hasn’t been a good proxy for the true potential of Hellofresh. Let’s look at the IRR potential for HFG with these assumptions:

12x EBIT with an assumption of 550M EBIT in 2030 would derive a share price of 40.9€ or 7.1B market cap.

This is for illustrative purposes only, providing an example of potential outcomes in this scenario. There are numerous uncertainties in HFG's meal-kit business and the growth of the ready-to-eat (RTE) segment, and the results could turn out very differently. RTE revenue might be driven by discounts, leading to low future profits, and the meal-kit business could easily shrink further. This is not investment advice. Please do your own research.

Incap

I have two reasons to write:

1.to provide a foundation for readers to conduct their own research by outlining the current situation of the company. By doing this, I hope to help readers form their own assumptions about its future.

2. to revisit these assumptions in a few years to see how accurate (or wildly off) they were, allowing me to reflect and hopefully refine my thought process in the process.

Not an investment advice. duh

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Content:

1. Equity story

2. Revenue growth drivers

3. Profitability drivers

4. Cash Flow drivers

5. Scenario to returns

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Equity Story

Incap has been on a roller coaster over the past five years. From 2019 to 2022, the company saw rapid growth, largely fueled by increased orders from its largest customer. However, in 2023, the situation shifted dramatically when this customer initiated a massive destocking effort, leading to a 41% drop in sales from them. As a result, the group's overall revenue declined by 17%.

This decline was partially offset by two factors: the acquisition of Pennatronics in the US and 17% organic growth from other customers. Over this five-year period, Incap has reduced its reliance on its largest customer. This shift is due to organic growth from other customers and two acquisitions: AWS in the UK (2020) and Pennatronics in the US (2023).

The share of revenue from Incap’s largest customer has fallen significantly, dropping from a peak of 67% in 2022 to an estimated 40% in 2024.

LTM

While Incap experienced tremendous revenue and profit growth between 2019 and 2022, its cash flows were strained due to a buildup of inventory. During the "shortage" crisis brought on by the COVID-19 pandemic, the company had to stockpile excess inventory to ensure it could meet future delivery demands.

This situation shifted in 2023 as supply chain availability improved, and a destocking phase began. As a result, working capital was freed up, leading to an improvement in free cash flow.

Revenue growth drivers

1. Largest customer’s orders will likely increase in 2025

At the start of 2024, Incap announced that orders would increase quarter by quarter, and that’s exactly what happened. The company’s stock rose by 38% during the year, reflecting a positive outlook and reduced uncertainty about its largest customer’s order activity.

As shown in the chart below, orders from the largest customer have been steadily increasing. I expect this trend to continue gradually in 2025 (all figures are my own estimates and almost certainly somewhat inaccurate). While the largest customer was something of a challenge for investors last year, this year, it is likely one driver of revenue growth starting in 2025.

Incap does not expect order levels to return to their 2022 peak in the near future, but over the longer term, this could happen as the customer continues to grow.

2. Acquisitions

Incap has made a succesful acquisition in July 2023, when they acquired Pennatronics. Incap has communicated that Pennatronics has developed better than expected since the acquisition. This a rare treat and gives confidence that the uncertainty round this acquisition can be left behind. Incap has also communicated that the company is now seen truly global, which I believe will drive organic growth in 2025 and beyond.

Incap has been clear that their primary objective is to find and do acquisitions and with two solid acquisition made in 2020 and 2023, I take this as positive. Incap is strict when it comes to doing acquisitions and I believe thay can find good targets with correct cultural match.

Incap financial health is tuned to acquisitions. Incap currently has a net cash position of EUR 10.4 million and their future capital needs are low. Incap’s operating model is asset and CapEx light and in addition to that their working capital needs are easing. Incap doesn’t need to build up inventory, because their customer order visibility is worsening. So while this is a ‘lower multiple accepting’ factor as it comes with more uncertainty it simultaneously allows for better cash flow conversion in the future.

Incap’s covenants are tied to Interest-bearing debt to EBITDA level of 3.0 which was 1.1 in Q3 2023. Hence, Incap has ample capacity to do more acquisitions.

3. Market growth fuels organic growth

Organic growth from other than the largest customer. Incap has proven itself this year as the organic growth from other than the largest customer is flattish this year, while other EMS companies revenues are declining double-digits organically. This gives me confidence that Incap’s low-hierarchy and flexible organization is able to execute above the market and can at least continue to growth along the market growth.

Summary - revenue growth drivers

I look at the revenue growth from three perspectives: growth from the largest customer, organic growth excl. the largest customer and acquistions.

In summary, I believe the largest customer will modestly continue to grow from the 2024E level. I have input 8% growth from the largest customer in 2025, reaching the same level as in 2023.

I have input 10% growth from Pennatronics in 2025E reflecting the fact that Incap has stated it’s goes better than expected and synergies in sales from that acquisition.

I estimate that the organic growth excl. the largest customer is 10% in 2025, which is above the market growth. I believe the market picks up in 2025 from this year and Incap will be able to capture growth above the market as in this year.

This results in group growth of 9%, which I think is doable, especially against the fact that the market declined this year.

3. Profitability Drivers

Incap has always shown stellar profitability compared to its peer group. This is mainly explained by their Indian manufacturing. 67% of the personnel in Q3 2024 was in India, where the average salaries are lower than that of in western countries. Incap has strict cost control and they currently only have two employees in Finland. The business is pretty much run by the CFO and CEO. All the decision making has been rolled down to country organizations and the culture is based on accountability, responsibility and entrepreneurship in my view. I don’t see any reasons why this can’t continue apart from product-mix led gross margin fluctuations.

I don’t think the market that there is uncertainty about Incap’s profitability development. Incap has shown it can maintain above average profitability even if the top line decreases by double-digits like in 2023. In addition, Incap’s peer Note has been able to post decent margins in 2024 while their revenue is declining some 10% organically. This adds to my confidence about Incap’s future margin potential.

3. Cash Flow Drivers

As mentioned earlier, during the years 2020–2022, when Incap experienced rapid growth, its FCF was nil. This was due to the inventory building in order to secure availability as global supply chain was overloaded. Customers would place orders one year into the future, while normally they place orders to next quarter or so. Subsequently, Incap had to maintain high inventory levels. In order to meet its customers needs. This has now changed. Incap’s management communicated that inventory levels have been decreasing this year as the visibility for customers orders is worsening again. So while this adds uncertainty, it comes with better cash flow.

In the next years I believe cash conversion will improve and reflect the profitability better. This allows for possibly more acquisitions or other investments, while maintaining solid balance sheet. It's worth noting that Incap doesn’t pay dividends.

Scenario to returns.

Incap is a growth company and after the decline in revenue growth in 2023 Incap’s multiples have remained low. I believe that as we go into 2025 Incap is one of the companies to keep an eye on. If the growth picks up there is a chance for multiple expansion in addition to good profitability with improving cash flow profile.

The most important part of this text has been to clarify Incap’s revenue growth drivers. Incap’s valuation is largely dependent on growth estimates and here the largest customer play a big role. if the growth comes, Incap can see its value increasing. I will present the returns that would follow if the growth scenario I have presented here realizes.

Pennatronics acquisition consolidated in group figures since July 2023.

Without multiple expansion, Incap’s next two year IRR is 10% in the scenario I have input in my model. (This is just an illustration how the revenue development in this scenario translates into returns.) If incap is able to post growth rates of 9% and 7% in 2025 and 2026, there is a high possibility of multiple expansion. This would improve the returns up to some 20% IRR for the next two years.