When considering an investment for the Henderson EuroTrust portfolio, we tend not to focus on market noise or any technical factors; the main thing we are doing is trying to establish whether what we are looking at is a good company or not. This is a key part of the research process.
There tend to be many features that most good companies have in common, but there are a myriad of characteristics and features to analyse that will be unique to each and every business. By undertaking detailed analysis of the 50 or 60 companies we have on our radar (a portfolio of ~40 positions and a watch list of 10-20 names) we try to ascertain whether a business is a good business and if so, whether now is the right time to be invested or not.
We have held a position in the German meal-kit company Hellofresh since the second half of 2020. Hellofresh has been a huge success story since its initial public offering (IPO) in late 2017. Since IPO, the business has grown much faster than expected, achieved sustained levels of profitability and has seen its share price increase to over 8 x the original IPO price.
Why has the business model been successful?
There are several long-term structural trends which act as tailwinds for Hellofresh. In the busy modern world that we live in, there is growing emphasis placed on convenience; consumers want to eat well, but don’t want to spend hours shopping, meal-planning and cooking - meal kits tick several boxes in this regard. Consumers are also increasingly diet-conscious. We want to know where our food has come from, how many calories it contains and how much protein it provides us with; meal kits provide a means for consumers to have control over their diet. Another growing trend is the desire to waste less food and to avoid excessive packaging. Meal kits result in far less food waste than supermarket bought groceries and there is also significantly less packaging used across the entire distribution chain. With meal kits, the packaging you receive is just about all the packaging that has been used, whereas with supermarket-bought produce, you only see a small portion of the total packaging that has been used. These structural drivers go a long way to explaining why Hellofresh has managed to grow strongly; simply put, they have seen strong growth in customer numbers, higher average order values and increasing order frequency. Revenues have grown 4 x from 2017 to 2020.
Revenue growth is one thing, but Hellofresh have managed to do what many other fast-growing, tech-enabled businesses have failed to do; generate sustained profitability. When thinking about margins, the starting point has to be that Hellofresh are doing more than selling you a potato, a cut of meat and a few other ingredients; they are selling you a service. This has resulted in gross margins being much higher than those seen for supermarket-sold groceries. Beyond the direct cost of goods sold (COGS) and fulfilment costs, most of Hellofresh’s costs are involved in advertising, marketing and promotion. These cost items are inherently scalable and as the revenue base has grown, these costs have grown much more slowly, leading to natural operational leverage. Hellofresh achieved an earnings before interest, tax, depreciation and amortisation (EBITDA) margin above 13% in 2020. With regards to the competitive environment, the interesting thing is that so far, we have not really seen intense competitive behaviour from other meal kit companies. The reason for this is that the real competitors for these companies are not each other, but instead the supermarkets. The meal kit companies are all gaining market share from the supermarkets and this is likely to continue. So long as this is the case, competitive intensity within the industry is likely to remain under control.
What are the opportunities for further growth?
There is significant scope for Hellofresh to add more customers. To use the US as an example, in 2020, they had just over 2.4 million active customers versus total US households of around 129 million; thus, they have around 2% penetration. Hellofresh are introducing both value and premium offerings alongside their core brand in order to widen their reach. There is also scope for existing customers to increase their reliance on Hellofresh over time by ordering more of their weekly meals through them rather than through their weekly grocery shop. In addition, Hellofresh are present in less than twenty countries globally and they are always looking for new regions to enter.
Hellofresh also have a few avenues to growth outside of their core meal kit offering. For example, they recently bought a business called Factor which sells frozen meals. This part of the market is growing quickly and over time, one can see how this might be cross-sold to Hellofresh’s existing meal-kit customer base. They are also increasing what they call their ‘marketplace’ offering. This is where Hellofresh act as a platform, selling a range of food and non-food related products. Again, the intention over time would be to cross-sell products to existing meal-kit customers to boost share-of-wallet and average basket sizes.
As with many of our favourite growth companies, Hellofresh are never standing still and are always focused on identifying and executing upon potential new growth avenues.
Investment behind the business leading to improving consumer experience
We are reassured to see that, although current margins are healthy, management do not focus too much on short term profitability; they would be very willing to allow shorter term margins to go lower if they needed to spend money improving the long-term competitive standing of the business. We tend to favour management teams who behave in this way. Hellofresh (as with Delivery Hero who we have written about previously) is, in our view, a classic example of a business willing to invest at the expense of short-term profits. This is a powerful attraction to us and symptomatic of a long-term focused management team, who, in the case of Hellofresh, are also significant equity holders in the business.
As with every investment decision we make, there are many other factors that we analyse such as the quality of the management team, the approach to capital allocation, cash flow generation and the management of the balance sheet. For us, Hellofresh ticks all the boxes as a quality, long term focused business worthy of investment.
References made to individual securities should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security. Janus Henderson Investors, one of its affiliated advisor, or its employees, may have a position mentioned in the securities mentioned in the report.