Innovaderma Profit Warning: Shares in beauty specialist Innovaderma (LON:IDP) tumbled 40% in early trade as the company released a profit warning which contained a number of disappointments. The share price has since recovered. In context of the whole year, this has been fairly volatile and still trades at a very small market cap.
On another note, this is the first profit warning of the year to be covered for some time. The reasons are numerous, and of course mostly related to the pandemic. In its immediate aftermath, most companies lost visibility of their earnings and hence withdrew guidance. We still live in a time of significant unknowns. So, although guidance has been restored in many cases it comes with a very wide range. In fact, at present it is far more likely that profit beats are occurring rather than warnings as initial guidance was prudent.
A look at the results page shows that our collection of companies issuing profit warnings is up 10% – some vindication for holding on. Notably this was well down earlier this year, much like the rest of the market.
Innovaderma may be known as one of the story stocks of previous years before the pandemic hit. It featured some boardroom shenanigans with the previous chairman/CEO cashing out all his shares. The largest part of the company is the Skinny Tan range of products, which has achieved some traction and is now featured in many UK high street stores such as Boots and Tesco. This being said, the share price has done nothing for the last couple of years.
What did the Innovaderma profit warning say?
This warning came out as part of a trading statement. There were several parts to this. Unsurprisingly most of it refers to the main part of the company.
The continued impact of COVID-19 and tighter restrictions imposed in the UK over the important festive season has affected our performance.
We get more detail here:
We expect revenue to be c.£4.1m (H1 19: £5.1m). A decline in UK sales (H1 20: £2.9m, down c.32%), was partially offset by encouraging growth in our key international markets (H1 20: US £0.4m, up c.17%; and Australia £0.8m, up c.52%) led by Skinny Tan. Both Retail as well as Direct-to-Consumer (“DTC”) sales have been impacted by a reduction in beauty category consumption, particularly in the tanning category, due to Covid-19. DTC remains our priority channel and represents c.62% of the Company’s sales (H1 19: 60%). We expect the tanning category consumption to significantly improve as Covid-19 restrictions ease, and moreover as we enter the peak tanning season from April to June.
Whilst the lockdown may have shut shops, arguably this would have increased sales across the DTC channels, which merely rely on the post. However, you aren’t seeing anyone, is there a need for a tan?
There was a word on ‘Nuthing’ – the much anticipated new product release. Unsurprisingly, this was affected as well:
Nuthing sales have been subdued as the UK hair removal category is very reliant on physical Retail and has been severely impacted by category consumption decline. The 2020 brand launch coincided with the UK March lockdown and we are therefore planning further instore enhanced visibility over 2021. The Nuthing Black Cherry & Kiwi scented hair removal Wax Strips, our first product in the largest hair removal category, will launch in February 2021 in Superdrug.
More worrying is the cash position of the company:
The cash position of the Company has been materially impacted by COVID-19. The Company has agreed in principle to enter into a loan agreement in the amount of £500,000 with M.Ward, a Non-executive Director and the largest shareholder of the Company. A further announcement will be made shortly providing details of the agreement once it has been signed.
There are other notes which are small but not unimportant: the company is exploring options to strengthen the balance sheet – the realistic option here is equity raise instead of debt. Additionally there will be some impairments to intangible assets, which was overdue.
Another note is a board change:
On 2 December 2020, the Company announced that Joe Bayer will resign as a Director of the Company with effect from 31 January 2021. The Board has now agreed to dismiss Joe Bayer as an employee of the Company with immediate effect and, as such, he will cease to be a Director of the Company with immediate effect.
The word ‘dismiss’ jumps out. This points to some kind of disagreement, and seeing how the firm has had multiple CEOs over the past few years you have to wonder if this is over strategy.
IDP is a good example of accounting policies in action. Their recent revenue reports show that they have been profitable in recent years (taken from Stockopedia)
However, this is a mirage. The company has a policy of capitalising development spend on its products. This is not unusual in itself. Innovaderma goes one step further and capitalises its costs with regard to building customer lists. This part is quite unusual as it may be quite difficult to value what a customer list is worth. But the net effect of this is that these costs are not regarded as expenses and such profit is flattered.
This intangible asset has grown to be rather large, and additionally is not amortised. The real effect of this policy is seen in the cashflow statement:
So whilst the company reports a profit, cash is being consumed for development and intangibles. With the company having £1.2m of cash in June 2020, it is not a surprise that given the current trend cash is going to run out. It is also not a surprise that the company mentions that it will also have to impair some of the intangible assets on the balance sheet. Customer lists are valued at £3m – it seems hard to justify how a collection of names could be worth so much.
In some ways this choice of policy has harmed the company. Reporting profits has given it a bigger buzz with investors. But the generation of profits has also meant that the company has also paid out tax. This asset may be recouped in later times as the impairments will probably ensure a hefty loss this year.
We can see that looking forward, the company is almost all-in on the Skinny Tan and upcoming hair loss products. This represents virtually all of the revenues of the company, and also is highly concentrated in the UK. In turn, the success of Skinny Tan no doubt will lie on its ability to keep being sold in shops. This, as well as a return to normality.
Is the Innovaderma profit warning a buying opportunity?
In my opinion, no. The current trading will no doubt be a disappointment. Unfortunately the company still needs to invest in products ahead of the curve. This will almost certainly mean some kind of placing to raise some cash. At a current market cap of around £8m it seems likely that many shares will have to be issued. Assuming that this summer is a write-off it may be the case that in excess of £2m could be needed to repay the director loan and ensure continued operations. It seems likely that at some point in the future there will be a chance to buy in cheaper.
Another possibility is a takeover. Skinny Tan is not in a poor market position and the new hair removal product also is in a market that is relatively uncontested. However, elevating a brand from zero to mainstream is a tough ask. There are a few companies which incubate small brands such as Brand Architekts (who also warned on profits), and Creightons, both of which are similar small companies trading on modest multiples.
Is there competitive advantage here? The distribution agreements could be a source of it. But this could be argued to be temporary. Product reviews certainly do not signify that the product is technically better than anything else. And it would be easy enough for a big player to simply repurpose of spin-off one of the existing brands. This could put it squarely into competition with Skinny Tan.
So this jumps out as high risk to me. It may succeed to get a placing away and fight for another year. But it is basically a company concentrated in one product, in one country. There may be some good upside, but the downsides appear more likely to me. 2/5.