When Plastics Capital reported FY Mar2018 results in June, the Industrials division...
Quality is more than skin deep
InnovaDerma (LON:IDP) specialises in the development, manufacture and marketing of clinically proven products in life sciences, beauty, and personal care. The company operates a portfolio of strong innovative brands, reaching customers in the UK and Australia, and increasingly in North America, Asia, and EU.
The company listed on the LSE main board in 2016 and has delivered revenue CAGR (compound annualised growth rate) of 58% and earnings per share (EPS) CAGR of 31% in its first two years (to June 2018e).
InnovaDerma reported full-year results to June 2018 on September 19. These were in line with market expectations, with 21% like-for-like revenue growth. In this report, we focus on the drivers going forward.
A major driver for InnovaDerma’s growth, in our view, has been the two-way integrated growth model – digital direct-to-consumer (DTC) followed by high street retail.
The biggest success for the group so far has been the Skinny Tan range of products, which initially launched through the DTC channel, using accurate targeting through social media, and sales via e-commerce platforms. InnovaDerma has developed a highly cost-effective DTC strategy, delivering 4-for-1 returns on digital marketing spend. Skinny Tan offers a template for how the company will grow its newer brands, and the success of the model is now becoming apparent in the Roots hair care range.
During August and September 2018, InnovaDerma announced new distribution deals for Skinny Tan and Roots, via Boots and Tesco respectively. The Roots product line has been developed entirely in-house, and the rapid uptake by major retailers is particularly encouraging. In this report, we examine some of the ongoing growth drivers for the company, including Skinny Tan, Roots and additional product ranges.
We argue that this is a company with strong brands and excellent distribution, underpinning strong growth prospects.
The share price has rallied in the last three months but remains on undemanding valuation multiples. In this report, we examine the valuation case, as well as catalysts for re-rating.
InnovaDerma operates a multi-brand portfolio of products spanning life sciences, beauty and personal care. These are sold through high-street retailers and through the company’s direct-to-consumer (DTC) internet platform. The following table summarises the product range.
The Skinny Tan range is the furthest commercially advanced of the products, representing an estimated 80% of the company’s revenues for the full year (FY) to end-June 2018. This product line has been the driver of the company’s rapid revenue growth in FY 2017 and 2018.
The Roots hair care range has also been growing very rapidly since its launch in August 2017 and has become a meaningful revenue driver during FY June 2018.
In Life Sciences, the Prolong device launch in May 2018 represents a major new initiative for the company, with potential for a steady build-up of revenue in FY June 2019 and beyond.
The Stevie K and Charles + Lee ranges have both entered commercial distribution; both are still at an early stage but they have growth potential. There is further revenue upside potential from the hair loss system and from potential future product lines that could be developed in-house (like Roots) or acquired externally (as with Skinny Tan).
Overview continued: Drivers of success
The company has delivered rapid revenue growth in its first three years as a listed company (to year-end June 2018). The following chart shows this revenue progression, including our forecast for 2019e.
We identify five main drivers of this success:
Brands – An existing portfolio of brands together with a strong process for identifying new niches and acquiring or creating additional brands.
Distribution – A powerful direct-to-consumer platform, and accurate use of social media-based demographic targeting.
Disciplined Growth – The multi-brand strategy delivers strong growth with a balanced risk profile.
Execution – Financial and operational accuracy.
Management – Highly experienced management team with the necessary breadth of skills in terms of product expertise and commercial knowledge.
Distribution - The DTC platform
We argue that the DTC platform has been particularly important. In the case of the flagship Skinny Tan range, the direct-to-consumer route was the initial vehicle for accelerating revenue growth, using the internet sales platform and a targeted social media campaign to build awareness of the brand. Having gained market acceptance, the brand was then picked up by high street retailers, initially Superdrug.
The DTC route has proved to be highly cost-effective for InnovaDerma, with a 4-for-1 return on online marketing spend, driven by accurate demographic targeting, and a follower base of more than 350k on social media acting as propagators of the brand’s message.
The Roots hair care range was launched via the DTC platform but also in tandem through high street retail outlets, leveraging the relationships that InnovaDerma had established through Skinny Tan. A growing network of retail relationships will allow InnovaDerma to accelerate commercial ramp-up of new brands while continuing to benefit from the direct-to-consumer sales capability.
Some products like the Prolong premature ejaculation treatment technology may be ideally suited to the DTC route without much use of the high street route.
Overview continued: Timeline
During the financial years to June 2016 and June 2017, the major focus of the group was the development of the Skinny Tan brand. During calendar year 2018 we have seen an increasing contribution from the internally developed Roots range as well as from the Prolong, Charles+Lee and Stevie K brands.
The InnovaDerma share price has rallied in the last three months. We believe this is due to the additional distribution deals for Skinny Tan and Roots with Boots and Tesco, following a slower period of revenue growth in the second half of FY June 2018, which had caused some concern for investors. Despite the recent rally, the valuation remains undemanding in terms of price/earnings multiples or enterprise value/sales or other metrics, in our view.
We believe that Skinny Tan has the potential to re-accelerate its revenue growth in FY June 2019, while a full-year revenue contribution from Roots will drop-down to improved earnings before interest and tax (EBIT) margins. We present some details of these factors in the rest of this report, and we argue that these factors could drive an expansion in valuation multiples (see page 7).
Skinny Tan has been a major success for InnovaDerma, growing from sales of £20k per month at the time of its acquisition to over £800k per month (estimated) today. In many ways, Skinny Tan may be seen as a template for InnovaDerma’s strategy to grow the other brands that have been added, more recently, to the portfolio.
Skinny Tan is a range of self-tanning products (artificial tan) that are paraben-free, cruelty-free, and derived from natural ingredients. As well as offering a streak-free tan, the range offers added benefits such as moisturizing and firming, reduction of visibility of cellulite, and a more pleasant fragrance than traditional self-tanning products. The range is currently being expanded to include products such as blemish concealers, establishing Skinny Tan today as a beauty brand rather than purely a bronzing brand.
The brand was acquired by InnovaDerma in 2015 and initially promoted via the DTC channel, using targeted social media campaigns and the e-commerce platform. The major demographic initially was women aged 28-45. The range was then introduced to Superdrug and became the #1 product in its category, and also became a category leader for Boots Ireland. The online presence has been maintained alongside the high-street retail channel, and Skinny Tan now has over 300k followers on Facebook.
The following chart shows the revenue progress of the Skinny Tan range.
The growth in Skinny Tan revenues was slower in FY 2018 than in previous years, particularly in terms of the retail channel. We believe that there is still scope for Skinny Tan to grow its sales through Superdrug, due to the expansion of the product range. Perhaps more importantly, we believe that there is potential for accelerated retail sales through the deal with Boots that was announced on 19 September 2018.
We believe that Skinny Tan is essentially still in the early phase of its growth curve, with significant headroom for further revenues. The growth so far provides a working example of how InnovaDerma’s integrated marketing strategy – DTC and high street – can drive rapid growth for an emerging brand.
Roots is a range of hair care products with proven benefits against hair thinning or dry/damaged hair. The initial target demographic has been women aged 40-60. The products themselves are free from paraben and sulphates, vegan-friendly and cruelty-free.
The Roots range was developed in-house by InnovaDerma and launched initially via the DTC channel from August 2017. This was rapidly followed by the introduction to the high street via Superdrug, leveraging the relationship that existed from Skinny Tan. The following charts show the initial revenue growth trajectory achieved by Roots, compared with the template of Skinny Tan.
Sales of Roots have been growing strongly since its launch in August 2017. The charts show that the ramp-up has been slower than Skinny Tan at the equivalent stage, and we believe that this is to be expected given the “stickier” customer base in hair regeneration products – users are seeking results over an extended timeframe; however, the overall target market for Roots is 10 times larger than the self-tan market, and we believe this represents a very exciting growth driver for the group.
Prolong is the only device for the treatment of premature ejaculation that has been cleared by the US Food & Drug Administration (FDA). The device uses targeted vibration to reduce oversensitivity over a period of weeks, allowing the user to enjoy prolonged sexual activity thereafter without the need for drugs or numbing sprays.
The intellectual property was acquired in May 2017 for £1mln, and we believe that the company will have spent a further £500,000 establishing the marketing platform over the following 12 months, building towards commercial launch in the US and Australia in mid-2018 (calendar year). This represents a large investment compared with Skinny Tan or the other brands.
The potential market is huge, with the initial target markets of the US and Australia having tens of millions of individuals who experience premature ejaculation (PE). The demographic is also broad-based in terms of age, as shown by the following chart.
The study examined the prevalence of PE across all categories of severity, but other studies suggest that between 10-15% of men report PE to an extent that they consider problematic.
This is a market that is ideally suited to the DTC marketing route, allowing users to read about the product, order it, and receive it all in privacy. We believe that Prolong represents a material potential revenue stream from FY 2019 onwards.
The following charts show our revenue forecasts for 2018 and 2019 by product line.
The pace of revenue growth was slower in 2018e than in 2017. We are forecasting an acceleration in FY 2019, with a larger contribution from Roots, and with the new retail channels for Skinny Tan.
The next chart shows our forecasts for gross margins and operating margins for 2019 and 2020.
The decrease in gross margin in 2018 is driven by two factors. Firstly, the increased revenue contribution from Roots comes at a lower margin than Skinny Tan, as we believe that hair care is intrinsically a 40-45% gross margin business compared with 55-65% for bronzing. Secondly, the company repackaged some product lines during the year and sold the old format products at reduced margins. Going forward we believe that InnovaDerma should trend towards 55-60% gross margins as the Life Sciences products start to push the group’s gross margins back upwards.
In terms of operating margins, the 2018 figures are affected by the lower gross margin and by launch costs for Roots and Prolong. In 2019, at a constant gross margin, we expect operating margins to increase based on a higher absolute level of gross profit, with only a moderate increase in operating expenses. Details of this are on page 8. In the longer term, we believe that InnovaDerma can trend towards 15-20% operating margins.
For FY 2018e the company reported a cash outflow of £1.95mln, after investments in product development, compared with £0.7mln in 2017. The increased cash outflow is due to the cash cost of new product launches and also the working capital required to support revenue growth.
The following chart shows all of the various moving parts in InnovaDerma’s cash position over the last few years.
For 2019e, we are forecasting a cash in-flow of £0.4mln, driven by an improved EBITDA margin and the natural phasing of working capital movements.
We believe that the current cash resources are sufficient to fund the company’s growth plans in 2019 and 2020.
InnovaDerma has delivered strong growth in FY 2017 and 2018, and we believe that the company is positioned to deliver further growth in the years to come. This is coming from end markets that have low cyclicality and a company with no leverage on its balance sheet. We argue that this is an attractive balance of growth vs relatively low risk.
However, the valuation multiple has compressed over the last 12 months. The following table summarises the key valuation metrics.
We argue that the current multiples imply that InnovaDerma is running out of headroom for growth. We believe that these multiples leave significant scope for a positive re-rating once the market gets more visibility of the revenue and earnings growth for FY 2019e and thereafter.
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