So what’s going on with Oatly? And does this collapse represent a good chance for me to buy?

What’s behind the falling share price?

To start, it should be noted that growth stocks have performed poorly over the past year and Oatly is relatively young Swedish food company that produces alternatives to dairy products made from oats. The Oprah Winfrey-backed firm is a loss-making company that has invested heavily in growth.

So, you may ask, how can you make a loss manufacturing and selling something as simple as oat milk? Well, expansion costs have been considerable and margins are thin.

At the end of 2021, Oatly had nine production facilities under construction through to 2023 and recently said it would invest in a fleet of five electric trucks to enhance its sustainable transportation operations. Capex costs are expected to come in around $1bn as the company looks to increase its global footprint and production capacity.

Meanwhile, in the first quarter, Oatly’s gross margin narrowed more than 20% to 9.5%, versus 29.9% in January-March 2021.

These negative indicators have been compounded by production issues and a loss of market share. Customers have also moved towards buying cheaper oat milk brands amid rampant inflation.

Prospects

I actually drink oat milk by the gallon, but I never buy Oatly. That’s partially due to taste and partially because they took small British producer Glebe Farm to court over its branding. Thankfully Glebe Farm, who’s product is far superior in my opinion, won.

But looking beyond my own issues with Oatly, I think the fundamentals here are pretty weak.

The group’s trailing 12-month gross profit margin of 19.49% is considerably lower than the industry average of 33.39%. 

Operating losses per quarter have been accelerating too. The firm’s operating income fell to -$89m in the quarter ending December 31, and -$92m in the quarter ending March 31.

It’s also burning through cash during a period when borrowing is becoming increasing expensive. Operating cash flow over the past 12 months is -$253m.

The global dairy product market size was an estimated $481 billion in 2019 and is forecast to reach $586 million by 2027. That’s still 20% growth but with more and more companies entering the market. I’m not sure whether that will translate into more revenue for Oatly.

I also think there are signs that the vegan market isn’t growing as fast as investors expected, although I’m not sure whether that will necessarily apply to the oat milk market.

So, is now the time to buy Oatly shares? Honestly, I don’t think I’ll be buying Oatly shares at all. The margins are weak and the firm appears a long way away from being truly profitable.

Plus, I’m not sure about the long-term profitability of a high-end, international oat milk brand. I say that because of my own buying habits. Personally, I buy in bulk from Amazon, because oat milk doesn’t go out of date, and I choose the cheapest British product — normally Minor Figures or Glebe Farm. And I say British not because I’m a raving nationalist, but because oat milk is supposed to be the sustainable choice, and buying locally fits that narrative.

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So why has Oatly’s share price plummeted? And has this weakness provided a buying opportunity for me?

Why Oatly’s share price has crashed

The main reason for the crash over the last week is that its third-quarter 2021 results were disappointing, posting revenue of $171m, well below analysts’ estimates of $185.5m.

Meanwhile, net loss attributable to shareholders was $41.2m compared to a net loss of $10.4m in the prior year period. Oatly blamed production issues at a Utah factory, restaurant closures in Asia due to new Covid-19 cases, and the truck driver shortage in the UK for the below-par performance.

What really spooked investors here was the guidance for the full year. Previously, Oatly had said it was expecting to generate revenue of $690m for 2021. However, it now expects revenue to “exceed $635m”. That’s a significant cut to guidance.

It’s worth noting that there were some positives in the Q3 results. One was the particularly upbeat tone from management. “Our confidence in the category opportunity and long-term trends and trajectory of our business have never been stronger,” said CEO Toni Petersson.

It’s also worth noting that the Q3 revenue was up 49% year-on-year, which shows the company is still growing at a healthy rate.

However, overall, the market didn’t like the results. On the back of the poor performance, analysts at Bank of America slashed their share price target from $32 to $11.

Should I buy OTLY shares now?

When I covered Oatly after its IPO in May, I said I was impressed with the company’s growth. However, there were several things that concerned me.

One was the valuation. At the time, the company had a market-cap of around $12bn and a price-to sales ratio of about 28. Those figures looked way too high to me. Another was the level of competition the company was facing. I was concerned that competitors could steal market share.

After the recent share price fall, the valuation here now looks far more reasonable. Today, the company has a market-cap of around $6bn and a price-to-sales ratio of 9.4, falling to 4.7 if we plug in next year’s consensus revenue forecast of $1.3bn.

However, I still have some concerns about the level of competition here. There are now a ton of brands operating in the oat-milk space, including the likes of Califia Farms, Innocent, and Chobani. This isn’t ideal from an investment point of view. Oatly may have to lower its prices to maintain market share.

Another concern for me right now is the level of short interest here. At present, around 16.5m Oatly shares are on loan. That represents about 25% of the free float. This tells me that many institutions expect to see the share price fall further.

Given the high level of short interest, I’m going to keep Oatly shares on my watchlist, for now. All things considered, I think there are better growth stocks to buy.

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With such a fall, could now be the time to pick up some Oatly shares for my portfolio?

Why are Oatly shares falling?

The Oatly share price has been sliding since the company’s listing, but yesterday’s dramatic price action was in response to a particular piece of news.

Oatly released its third-quarter results and much of the news was good. But investors zoomed in on a couple of more worrying aspects. The gross profit margin fell from 31% in the same quarter last year to 26.2% this time around. Adjusted earnings before interest, tax, depreciation and amortisation remained in the red — and the loss was bigger than in the same quarter last year. Last year’s losses were $5m, but $27m this time around. The reported loss without exclusions was bigger, at $41m.

The company continued to trumpet its growth story. A lot of the bigger loss was placed at the door of the costs of expanding, from co-packing instead of manufacturing in-house, to higher staff costs as the company scales up.

Is this bad news or good?

Looking at the financial results, the trend is alarming. As the company seeks to grow, its financial performance is worse, not better, on some key metrics. I also think the signalling around performance was poor, which has reduced my confidence in the company’s management.

However, I actually think the results contained significant grounds for optimism. Oatly has done a great job of building demand for its product and indeed the category as a whole. That is why it has had to ramp up production so fast. It also is building a premium brand which should give it long-term pricing power. While margins are weak at the moment, over time that branding should help them improve.

I think there are two key questions for me to ask as a potential investor here. Is there going to be a huge oat drink market in future? Is Oatly going to be well-positioned to capitalise on that profitably? Based on how it is investing in growth opportunities and its marketing efforts, I think the answer to both questions is probably yes.

Is the Oatly share price a bargain?

Based on that, I reckon Oatly could be an attractive buy for my portfolio at current levels. It can do the hard work of building demand and brand recognition now. With a market capitalisation of under $6bn, it could then make a prime acquisition target for a larger company such as Unilever or Coca Cola down the line.

A lot could still go wrong. Continued high costs could mean sustained losses. Other brands may enter the market and eat into Oatly’s market share and revenues. Given the challenges, I don’t see the Oatly share price as a bargain. But I do think it’s more attractively priced than it was last week. I would at least now consider buying some Oatly shares for my portfolio.

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Positive results

Reading through the half-year results for 2021, there were many positives to take away. Most notably, revenues rose nearly 60%, to over $285m, compared to half-year 2020. Q2 revenues also saw a 53% increase compared to 2020. For Q2 2021, revenues sat at $146m. This rise in revenues shows the continuous growth of the oat milk and non-dairy markets. Oatly earlier this year stated that its total addressable market is worth nearly $600bn. If it conquers more of this market, and revenues continue to grow, I think we could see a rise in the price of Oatly shares.

On top of this, other highlights from the results also provided a strong case for buying Oatly shares. April to June was a busy period for the oat-milk producer, it launching in new geographies such as Switzerland and Ireland. It also expanded its presence in China, growing on an existing partnership with McDonald’s, while also launching a new partnership with KFC. The business also saw its exclusive supply agreement with Starbucks in the US account for over a quarter of sales in Q2. As the market expands, Oatly is following suit, showing why now could be a great time for me to buy some shares before we witness a potential rise in price.

Oatly shares issues

My main issue with Oatly is that it is unprofitable. For Q2, net losses were $59.1m. As much as I understand this is more than likely due to expansion, with Oatly hinting at this through highlighting things such as a rise in R&D spending, it still makes me wary about investing. 

Another major issue that surrounds the firm is competition. Oatly finds itself in an expanding market, yet as such, it will face challenges from other firms attempting to capitalise on this. An example is Nestlé, a firm that is continuously expanding the array of non-dairy products it offers.

My verdict

The Q2 and half-year results provide optimism for Oatly. Despite the loss, it shows the firm is pumping money into its expansion. I think long term this will bear fruit. Within Q2, Oatly managed to create an assortment of partnerships, and the large amounts of revenue generated from its Starbucks agreement showed that this can pay off. What worries me is that as the market expands competition will increase. If Oatly fails to gain a solid market share, this will no doubt have an unflattering impact on the price of Oatly shares. With this said, I believe the firm is creating strong foundations through expansion from which it will eventually thrive as a result. As such, now I deem a good time for me to buy shares before we potentially see a large rise in the price.

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Oatly share price: what gives?

It all started so well. The Oatly share price shot out of the gates on 20 May as its stock began trading in the US market. The involvement of celebrities such as Oprah and Hollywood actress Natalie Portman as investors only raised the Swedish company’s profile even higher. Even Starbucks Chairman Howard Schhultz was a backer. 

And who can blame them for wanting to get involved? Last year, Oatly managed to double revenue to $421m as its plant-based milk and other products continued to be adopted in coffee shops all around the world. The nutritional benefits coupled with a ‘right-on’ environmental message proved an intoxicating mix for market participants.

Unfortunately, reality now appears to be biting down on the Oatly share price.

Reality bites

Of course, a drop in the value of a newly-listed stock isn’t all that unusual. It is to be expected that traders would look to profit from the hype surrounding the initial flotation before moving on to the next shiny new thing.

This makes even more sense when it’s remembered that this company doesn’t make a profit. Oatly reported a net loss of $60.4m last year as it invested in marketing its brand and expanding its range.

Now, all this is fine when things are going swimmingly and traders are whistling on their way to work. It’s not quite so comforting when there’s talk of Covid-19 infection rates rising. Big growth stocks also tend to fall out of favour when inflation rears its head.

So, what happens next?

While I’m in danger of comparing apples with oranges here (maybe oat-based milk substitute with meat substitute burgers), I wonder if we can learn anything from the performance of Beyond Meat. 

Tellingly, Beyond Meat’s share price has been all over the place in the last two years. Those buying the stock at the end of July 2019 will still be heavily under water. Those who bought during the March 2020 market crash will be close to trebling their money. With volatility like this, it’s no wonder the company continues to attract the attention of short-sellers.

Problematically, those doubters seem to now be setting their sights on Oatly. One short-seller — Spruce Point Capital — has now broken cover to question the investment case. This includes asking how a company that makes a similar amount of revenue to Beyond Meat can have a market value that is almost 40% higher. It’s a fair point. 

Of course, the presence of a short-seller or two isn’t a reason for me not to buy this company’s stock. However, it may be the beginning of a sustained attack on the company that could send the Oatly share price even lower. 

I’ll pass…for now

As I mentioned when recently commenting on a promising UK small-cap, I’m bullish on the alternative food sector. Even so, the recent performance of Oatly stock and some ‘interesting’ headlines makes me think it might be wise to hold off buying for now. I don’t see an end to the weakness just yet. 

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Here, I’m going to look at what’s behind yesterday’s share price fall. I’ll also give my view on Oatly stock now.

Why did Oatly’s share price fall yesterday?

The reason for the Oatly stock dip was that Spruce Point Capital Management, a prominent short seller, released a scathing report on the stock. It said it’s “assembled significant evidence” that suggests the “walls are collapsing” on Oatly’s ambitions to dominate the oat milk market.

Some of the short seller’s concerns include:

• Oatly’s market share. It believes the company is losing market share in the US and Sweden as a result of low barriers to entry in the industry and a lack of competitive advantage.

• Profitability. It believes Oatly will “never achieve profitability” and that it will “sorely disappoint investors.”

• Financial controls weakness. It believes Oatly has overstated its revenue and gross margin.

• Operational issues. It believes Oatly is set to experience supply challenges created partly through poorly planned production facilities.

• Boardroom issues. It claims both Oatly’s CFO and Audit Chair have obscured their roles in prior corporate accounting scandals.

• The valuation. It points out that Oatly is trading at 17 times FY2021 forecast sales with a $12bn valuation (57% of the 2025 total projected non-dairy milk market). It believes the valuation is “unsustainable” and will end poorly for new investors.

Spruce Point sums up its research by saying it sees 30% to 70% intermediate downside risk to the stock. 

My view on Oatly shares now

Short sellers don’t always get it right. Sometimes they’re way off the mark. I have to say however, I find this Spruce Point report quite interesting because it highlights a few risks I brought up when I covered Oatly shares after the IPO.

One of my main concerns was the low barriers to entry and competition from rivals, such as Alpro and Innocent. Another concern was profitability. I thought it was odd that the company had been operating for 25 years and was still unprofitable. I was also concerned about the company’s valuation. I noted this was much higher than that of Beyond Meat. So, I don’t think this report should be ignored. I believe it has some merit.

Of course, it’s worth looking at the other side of the story. Oatly does operate in a high-growth industry (it believes its total addressable market is nearly $600bn) – so there’s potential for strong growth. It also has a relatively strong brand and dominant positions in a number of markets. It could even be a takeover target in the future if consumer goods giants such as Unilever and PepsiCo move to increase their exposure to plant-based food products.

However, my view is that the risks outweigh the potential rewards here. After the report, I’ll be avoiding Oatly stock.

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The Swedish oat milk producer has yet to make a profit. Nevertheless, the IPO was greeted with enthusiasm across the pond. And the stock was driven up from the $17 per share initial public offering price.

Oat milk’s all the rage

Now, I know there’s a bit of a fad going on these days and people are falling over themselves to buy plant-based milk alternatives. However, as a long-term milk-alternative user myself, I’ve been presented with many options for years when I shop in a supermarket. And the choices for buying milk alternatives keep expanding.

For example, I can easily buy non-dairy milk alternatives such as almond, coconut, soya, hazelnut, oat, rice, hemp and cashew. And others are available, although I’ve yet to come across them, such as pea, peanut, flax, walnut, macadamia, pistachio, pecan and banana.

Not only can I buy those products, but I’m often confronted with different brands offering the same thing. And more recently, the supermarkets have been undercutting the prices the big brands set by selling their own-branded offerings.

I think the whole issue of competition could prove to be Oatly’s Achilles’ heel — the major weakness in its business plan. After all, oat milk is starting to look like a commodity product. Would I be compelled to choose Oatly’s product over a competitor’s because of its brand? In a word, no.

For me, the price is perhaps the most relevant factor. And we all know what happened to the pricing of cow’s milk when the supermarkets monopolised its supply to consumers — it fell through the floor.

However, I do apply other considerations when purchasing. For example, some milk alternatives work better in hot drinks than others. Indeed, some products tend to curdle. And taste is another big factor for me. When I put milk alternatives on breakfast cereal, that’s a big one. I prefer cashew, hemp and coconut…

A long road to profitability?

My guess is Oatly may need to vastly expand its product range if it’s to build a consistently profitable business. After all, the company deals in fast-moving consumer goods. And big, successful names in that sector tend to have big ranges of products and multiple brands. I’m thinking of companies such as Unilever, Reckitt, PZ Cussons and Premier Foods. And it’s hard for me to imagine such an expansion without the company moving into other raw commodities as well as oats.

On top of that, I reckon Oatly may need to produce more complex products with additional added value. That’s perhaps one way the firm could maintain the value of its brand for consumers.

Until Oatly shines a clear light on a path to profitability, I’m avoiding the stock. However, I’m watching with interest. Meanwhile, one potential ‘outer’ for shareholders is the possibility of one of the fast-moving consumer conglomerates making a bid for the company and adding it to its own stable of brands. But I wouldn’t buy the shares just for that slim possibility.

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The Oatly share price soared as high as $29 at one point in the middle of June. However, the US food share has reversed sharply from those highs and closed last week at $23.09 per share. Is now a great dip-buying  opportunity?

Why Oatly’s share price could soar

There are several reasons why I think the Oatly share price could soar again. These include:

#1: The explosion in dairy-free demand. Oatly is perhaps best-known for its line of pourable milk alternatives but it also provides other non-milk products like spreads, yoghurts and ice cream. This is a surging market and The Vegan Society estimates the total non-dairy market will be worth a staggering $41.1bn by 2026. This compares with $16.1bn in 2019.

#2: Strong sales momentum. For the time being at least Oatly is making the most of this ballooning market and sales are rising strongly. In the first three months of 2021, total revenues came in north of $140m. This was up an impressive 66% from 2020’s first quarter.

Cause for concern

Demand for dairy-free is booming as consumers consider issues like animal welfare, carbon footprints and adopting healthier lifestyles in greater numbers. But rocketing sales growth means that amount of competition Oatly faces is also increasing rapidly.

It’s not just other non-dairy specialists like Alpro which this UK share has to worry about. The world’s largest food manufacturers, including Coca-Cola, Mars, Unilever and Danone to name just a handful, are ramping up their dairy-free food ranges. And they have the clout to potentially squash relative tiddlers like Oatly with their colossal R&D budgets and immense marketing spend.

Should I buy Oatly shares?

I also have reservations about Oatly because oat-based products command such a small slice of the overall dairy-free market. Combined, soy milk and almond milk accounts for four-fifths of this niche food sector. So the likes of Oatly may not be able to make the most of the consumer switch to non-animal-based products.

Indeed, Hargreaves Lansdown notes that “more shoppers seem to want an alternative to soya milk, and oat milk is revered for being high in fibre and vitamins.” But the FTSE 100 firm adds that Oatly’s portfolio of products “has higher levels of calories and carbohydrates compared to plant based milk alternatives.”

People who switch from traditional milk products to dairy-free on health grounds might thus be more tempted to buy other plant-based foods.

It’s clear that the Oatly share price has plenty of potential. But, in my opinion, this firm — which isn’t expected to turn a profit for the next few years at least as it embarks on aggressive expansion — also bears lots of risk. I’d rather invest in other US (and UK) shares today.

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Bull case

One factor that fills me with optimism about Oatly shares is the expanding market. It is clear that many people have made the switch to oat milk products, seen in a recent Persistence Market Research study showing an expected CAGR (compound annual growth rate) of 7.4% for the oat milk market. This is seen in the rise in Oatly’s revenues – 106% between 2019 ($204m) and 2020 ($421m). This, in my opinion, places the future of Oatly shares in good stead, as a rapidly expanding market will naturally lead to a rise in demand.

On top of this, Oatly recently stated that its total addressable market is worth nearly $600bn. Even if Oatly manages to conquer a small percentage of this, we could see further growth in its revenues.

Oatly also recently struck a deal with Starbucks, introducing oat milk across all stores in the US. This will should provide consistent demand for Oatly products, leading potentially to a rise in Oatly shares.

Bear case

A major issue for me with Oatly as an investment is the fact that the company is unprofitable. In 2020 it recorded losses of $60m. I understand this may be due to expansion out of its founding country (Sweden), but this does not fill me with hope for Oatly shares and the future. It also does not allow me to gain a true representation of Oatly’s financial performance.

To add to this, as much as the expanding market does provide opportunities, it also comes with challenges. Competition in this sector is natural as many brands adapt to consumer taste. This is already seen through moves by Unilever and Nestle moving into the sector, as detailed by my fellow Fool, Royston Roche.

Oatly is not the only dairy-free producer currently available to consumers. In a market based on a rather new trend, what is to say Oatly will not disappear as quickly as it arrived? This could have a negative effect on Oatly shares.

What I’d do with Oatly shares now

I am aware of the risk associated with buying a stock so recently IPO’d, but with Oatly I do see real potential. The market it is in will continue to grow as people convert to the trend, and as such, I can only see this having a positive effect on Oatly shares.

Mounting environmental pressure continues to increase, and I predict people beginning with small changes such as switching to oat milk. The company has managed to convert many customers already in a small space of time, and this will only grow.

I see solid long-term potential in Oatly shares, currently trading at around $22, for my portfolio.

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The positives

One reason investors have been keen to get their hands on Oatly shares is that the company stands to benefit hugely from the long-term trend towards plant-based milks. The production of oat milk requires 80% lower greenhouse gas emissions than regular cow milk. This makes it an attractive alternative to an increasingly environmentally conscious customer base. Evidence of this is the explosive growth in the consumption of oat milk in recent years. In the US, for example, the consumption of oat milk grew by 203% last year alone. As a result, oat milk is now the most popular alternative milk in nearly all of Oatly’s key markets including the UK, Germany, and Sweden.

This secular trend has helped fuel Oatly’s rapid growth. Last year, the company grew revenues by 107%, far outpacing the 73% growth it was able to achieve the year before. Considering this growth came during a pandemic, these figures are very encouraging for the future.

Oatly also holds a dominant position in its industry. In its home market of Sweden, the company enjoys a 53% market share in the entire alternative milk market. It is also the largest seller of oat milk in the US, Germany, and the UK.

The success of the IPO and the subsequent increase in the Oatly share price is also partially due to the company’s strong brand. By running quirky and unique advertising campaigns, Oatly has successfully created a recognisable brand in a traditionally commoditised industry. This brand power should allow the company to build a competitive advantage helping it to hold onto its large market share. It should also help the company expand its margins. Currently, gross margins stand at just over 30%, which is impressive for such a fast-growing business.

The risks

Despite the strong potential for Oatly, there are some risks associated with the business. One such risk is the potential for competition in the alternative milk market. Large players such as Nestlé are already introducing their own products in this space seeking to compete directly with Oatly.

The biggest drawback for me, however, is that the business is very difficult to value. In order to know what any business is worth, one must have some idea of the cash flows that will be produced in the future. This is extremely difficult with Oatly considering it is still unprofitable and producing negative free cash flow. In fact, as the company has grown revenues, its losses have also risen. Last year, the business reported an operating loss of $47m compared to a $31m loss the year before. As valuing the business is so difficult, it is very hard to tell whether the current Oatly share price is attractive. For this reason, I will not be adding Oatly shares to my portfolio

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