In my opinion, the Adore Beauty Group Ltd (ASX: ABY) share price is too good to ignore at its current level.
The beauty e-commerce business has seen a very large sell-off – it's down by more than 70% in 2022.
Plenty of ASX growth shares have seen valuation pain amid inflation and interest rate rises.
While higher interest rates do theoretically pull down on asset prices, I think Adore Beauty has been punished too hard.
I believe there's a beautiful opportunity here, not just because of the decline but also due to a number of positives for the company.
Revenue
While revenue isn't the same as profit, I think it's important to recognise that Adore Beauty is processing a lot of online orders these days, particularly after the e-commerce adoption arising from the COVID-19 lockdowns.
In the latest quarter alone (the FY22 third quarter), Adore Beauty achieved $42.7 million of revenue. This was up 9% year on year.
While the growth rate has slowed, it did still achieve good year-on-year growth in my opinion.
There's an argument that Adore Beauty's products could be more defensive than some discretionary spending items. The Adore Beauty CEO Tennealle O'Shannessy said:
Beauty, especially skincare, is unique within the broader retail market and is resilient to economic challenges. Our products are used daily by customers, who consider these items essential and frequently re-purchase. The nature of premium beauty means our customers spend more as they mature on the platform, with returning customers typically contributing more than 70% of total revenue.
Growth initiatives
Over the long term, I think Adore Beauty can continue to grow. It's the potential growth of the business that makes me believe that it's currently undervalued.
Firstly, the number of active customers keeps rising. If it can increase its customer base, retain customers, and encourage them to spend more (on Adore Beauty's website) over a year then that will benefit the ASX share.
In the FY22 third quarter, the company said active customers went up 7% year on year to 880,000, while returning customers increased 47%.
In the FY22 half-year result, annual revenue per active customer rose 5% year on year to $224. I think returning customers spending more will be a key factor for the Adore Beauty share price over time.
Its mobile app now accounts for 10% of revenue and continues to deliver "elevated levels" of engagement, conversion and average order values, according to the company. The launch of its "first" private label products can also help grow, which will hopefully come with higher gross profit margins as well.
The company has a number of podcasts to connect with customers, for a cheaper cost than paid market channels. It also has its own YouTube channel.
Adore Beauty points to successful partnerships with Temple & Webster Group Ltd (ASX: TPW) and 7-Eleven to increase brand awareness.
It's operating in a "large and growing $11 billion market", giving a large addressable market to work with. In 2020, 11.4% of the Australian beauty market was online. That compares to 18.4% in the UK in 2020, so there is potential for a large increase in online adoption.
Increasing scale to help operating leverage
The company is aiming to invest heavily to achieve above-market growth. That's why its earnings before interest, tax, depreciation and amortisation (EBITDA) margin is expected to be between 2% and 4% in the shorter term.
Adore Beauty itself said that:
In the longer-term, as the business grows, scale benefits are expected to increase operating leverage and deliver further EBITDA margin expansion.
In HY22, the business saw its gross profit margin increase 0.6 percentage points to 33.1% thanks to product margin expansion and brand funding.
The company said that as it grows it will be able to slow its investment in fixed costs, it can forge closer relationships with brands to optimise terms and increase brand funding, and it plans to grow its margin-accretive private label.
