Shares of The Honest Company (HNST -0.33%) fell as much as 30% in early trading on March 25. That's a massive hit, though the stock had pared the loss some by the end of the day. But the really shocking thing is that, since an early pop after the company's initial public offering (IPO) in May 2021, the stock has moved steadily downhill. The stock is now down nearly 80% from its post-IPO high. Recent price action, despite the shocking size, is just a minor blip in the ongoing downtrend.
This is a former Wall Street darling that clearly hasn't lived up to the hype. But how bad is it?
Image source: Getty Images.
The big picture
At its core, The Honest Company is a consumer staples company, making personal care, beauty, baby, and household products. That means marketing is the name of the game, with the company's IPO news release noting that it is focused "on leading the clean lifestyle movement, creating a community for conscious consumers, and seeking to disrupt multiple consumer product categories." Backing that up was a built-in spokesperson in actress Jessica Alba, who founded the company.
So The Honest Company has basically been trying to break into the highly competitive consumer goods space with a sales pitch attuned to current consumer trends. With fourth-quarter 2021 sales of $80.3 million, up 3% from 2020 and 26% from 2019, The Honest Company is a small fry compared to industry giants like Procter & Gamble, which generated $21 billion in sales in just the most recent quarter alone, but it does appear to be gaining a foothold.
What's notable about the 2021, 2020, and 2019 periods, meanwhile, is that they represent the post-COVID shock period, the COVID upheaval period, and the pre-COVID period, respectively. Think of 2019 as a baseline, with a huge amount of 2020's sales growth attributable to a fear-driven, and temporary, shift in consumer purchasing habits. That leaves 2021 as the year when things got back to normal.
Indeed, the fourth quarter witnessed 3% sales growth, but management noted that this outcome was "primarily a result of strong volume growth in our Skin and Personal Care and Diapers and Wipes product categories, mainly within our Digital channel, partially offset by a decline in the Household and Wellness product category due to reduced COVID-19-related consumer demand for sanitizing and disinfecting products."
It's actually impressive that The Honest Company, given its small size (the market cap is only around $400 million or so), didn't see sales fall off a cliff. The company's story is obviously resonating with at least some consumers.
That 2020 demand spike, however, was still showing up in the financial statements when the company held its IPO. The prospectus, for example, proudly highlighted that The Honest Company "grew revenue 27.6% from $235.6 million in 2019 to $300.5 million in 2020." Management also noted that the company was bleeding red ink, but with massive sales growth, investors probably didn't pay much attention to that fact. And then the pandemic-driven demand spike petered out.
For the full year, 2021 sales increased just 6% or so, which isn't nearly as impressive as the previous 27.6%. And yet, for a consumer goods company, 6% would actually be pretty solid growth in most years. Kimberly Clark's sales only increased 2% in 2021, though off of a much larger base. Also add that The Honest Company managed 6% growth in 2021 despite difficult comparisons to the demand spike during COVID. So maybe there's something to The Honest Company's sales pitch.
And yet it continues to lose money, which is not good and clearly isn't sustainable over a long period of time. It isn't shocking for a young, growing company to lose money early on, but there is a very real reason to be concerned about a business in a highly competitive industry that isn't profitable.
This brings the story back to the IPO. Investors who jumped aboard thinking that The Honest Company was going to change the consumer products industry bought into a narrative that hasn't played out -- and isn't likely to play out anytime soon. If that's why you own The Honest Company, you should probably take the loss and try to learn something from the pain you are feeling. Every investor makes mistakes, and it's OK, but the important piece is to learn from them.
Now what?
There's no question that The Honest Company has its work cut out for it if it wants to break into the highly competitive consumer products business in a more material way. Moreover, if it can't get to a point where it turns a profit, it will never be able to gain the kind of traction it needs to scale up. It would probably be better off selling itself to a larger industry player if it can't get the ends to meet, so to speak.
However, if management can turn a profit, there's no reason why The Honest Company couldn't have years of growth ahead leaning on its sales pitch and high-profile founder's image. The key point here is, at what price is the risk of failure worth taking on for investors?
Shortly after the IPO, The Honest Company's price-to-sales ratio was over 6 times, greater than the 4.75 times valuation being afforded to industry bellwether Procter & Gamble at the time. That was clearly too rich a price, and the market has adjusted by taking The Honest Company's stock down a few pegs. Today, The Honest Company's price-to-sales ratio is at 1.2 times, well below that of Procter & Gamble's nearly 5 times and even lower than Kimberly Clark's 2.1 times or so.
HNST PS Ratio data by YCharts
With The Honest Company projecting flat sales in 2022, there are still some problems ahead (thanks at least partly to industrywide inflation and supply chain headwinds). But for contrarian investors, this out-of-favor consumer products player could be worth an exploratory deep dive now that investors have, seemingly, abandoned the stock. At some point, the price could get so cheap that The Honest Company becomes a compelling story again.
