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Introduction

The honest society (NASDAQ: HNST) develops innovative solutions for childcare and beauty products by marketing them in more than 40,000 retailers and on their website. Honest has over $306 million in revenue, and currently maintains a net income loss of $48.8 million. Honest is currently a $308 million company and has significant growth potential. It was originally founded by actress Jessica Alba and floated around a year ago, raising $412.8 million. Since its IPO, Honest has fallen more than 82% to $3.35 per share due to a small cap selloff and disappointing earnings, subsequently presenting a significant opportunity for the year ahead with more than 231% increase. The main factors that contribute to their significant advantage are rapidly expanding margins, continuous expansion of operations, theft of market share and a disgusting valuation.

Investment thesis

Honest has huge potential for its future due to its rapidly expanding consumer segments, phenomenal management team, and relatively low growth valuation. The main reason Honest has fallen significantly from its highs is because analysts’ earnings expectations are missing and it remains unprofitable for longer than analysts expected. Although HNST is currently not profitable, they appear to have enough cash ($78.1 million) to sustain losses and possibly break even by 2023. Their management team, led by Nick Vlahos, owns significant experience in other companies such as Clorox (CLX), Amazon (AMZN) and other cosmetic companies; therefore, I believe they will accelerate growth with Honest due to this prior experience. Additional factors that further propel their growth are:

  • The baby and beauty products industry is growing (5%).
  • An extremely large total addressable market of over $582.7 billion, baby products account for $18.7 billion and the beauty market TAM is $564 billion.

Finally, when considering these multitudes of aspects, using a DCF model, Honest is over 231% upside with a price target of $10.2 at a valuation of just under $1 billion.

Financial analysis

Honest currently has revenue of $306 million, down slightly 1% year-on-year due to extremely high comparables. They are expected to grow revenue another 10% next year, bringing their forward sales to 346 million and a forward P/S ratio of less than 1. Now that multiple isn’t particularly low given their gross margin depressed by only 35%, which is well below the industry average of 58.14%. Fortunately, they make up for their abnormally low gross margin with rapid growth rates. Over the past 3 years, their CAGR was slightly above 30%, while their forecast CAGR is 15% for the next three years. Finally, assuming they can maintain the industry average FCF margin of 12% with growth rates of 25%, 15% and 7.5% over the next ten years, we can produce a DCF model for this phenomenal company giving us a price target of $10.15. with 231% increase.

DCF model using financial alpha research

HNST DCF Model (Hossin Rasoli: Seeking Alpha Financials)

From a budget perspective, it looks like Honest is significantly undervalued at these levels and presents us with potentially monumental returns that will significantly outperform the market if these assumptions materialize. It is also essential to review HNST’s balance sheet to ensure that they are not diluting shareholders or going out of business. Honest currently has over $78 million in cash. Considering they lost $42 million in the TTM and are expected to lose a similar amount again, they should be able to sustain that loss without issuing more shares. It is imperative to note that this coming year, companies such as Honest will be much more motivated to issue equity rather than take on more debt due to the large interest rate hikes that are anticipated. Additionally, HNST has no net debt; therefore, the risk of bankruptcy is extremely low unless an abnormal event occurs. In conclusion, Honest appears to be in a terrific fiscal position, with the only concern being maintaining its substantial growth rate.

Commercial operations

The Honest Company sells a variety of innovative beauty and baby products that are environmentally sustainable and unique in their market. They are present in more than 40,000 retailers in the United States, Canada and Europe while continuing to expand their operations throughout the world. Honest has achieved this success so far thanks to its phenomenal management team led by many people with previous experience at Clorox, Amazon, and countless other companies. They have nurtured an environment that encourages innovation in an ethical method, thereby eclipsing the competition and stealing market share. Finally, the beauty and baby products industries have an extremely large and continuously growing TAM. Considering these factors, it seems that Honest has huge growth potential due to its rapid growth rates and smooth business operations.

cosmetics market growth

US high-end cosmetics market size (grandviewreasearch)

Risk factors

As far as Honest is concerned, due to the smaller nature of their overall business operations compared to their competitors and the industry as a whole, there are many detrimental risks present.

Competition

Some considerable risk factors regarding Honest are that they may lose significant market share and innovative advantage to competitors such as Sephora due to their higher R&D investments. This would significantly reduce their revenue and other net revenue losses. Another aspect to consider is how Honest still suffers somewhat large losses each year. If they suffer these losses for an extended period of time, it can force them to dilute shareholders, which will ultimately destroy shareholder value. The last, and most likely, risk honest shareholders need to consider is their growth rate. Suppose HNST cannot maintain its high growth rate in the coming years. In this case, the stock will most likely deflate at a very rapid rate as its valuation is supported by generous growth estimates for the future.

Difficult macroeconomic climate

Over the past few months, due to the Federal Reserve’s aggressive rate hikes, quantitative tightening and hyperinflation, a potential recession is looming on the horizon for the US economy and this will have a significant impact on Honest Company . Essentially, most of Honest’s revenue comes from the baby products business or the beauty industry. First, their revenues from the baby products sector are expected to remain fairly constant or decline slightly. Baby products tend to have an inelastic demand as they are essential and parents will not give them up as the alternatives are not readily available. Additionally, during economic downturns, we have experienced significant drops in birth rates which will most likely occur once again and hurt Honest. When it comes to the beauty market, a recession will most likely hurt sales because it’s not a core product, but most of Honest’s revenue comes from baby products. Finally, Honest has displayed strong pricing power in the recent inflationary environment and the effect of the Russian-Ukrainian crisis is also having minimal impact on them.

Conclusion

Overall, The Honest Company is phenomenal from a qualitative and fiscal point of view. They expand into many consumer segments, often innovate to beat their competition, and maintain an excellent management team with extensive prior experience at large companies. While there are certain risk factors regarding Honest, if they can weather the tough macro environment and weather the competition, they are phenomenally undervalued at these current levels and have over 231% upside, making it a phenomenal investment.