Hims & Hers (NYSE:HIMS) has experienced booming revenue and gross profit in recent years following a boom and bust cycle in the stock in the 2020-22 period. A lot of excitement has followed the launch of their low-cost compounded version of the GLP-1 drugs, yet I believe underlying trends, unit economics and pattern analogies suggest caution at this level.
Context
Hims & Hers offers a health and wellness e-commerce platform focused on providing access to medications and over-the-counter treatments, particularly for those addressing long-term conditions. These conditions are generally elective, not covered by insurance, and with social sensitivities surrounding them. Hims & Hers focuses on four areas of healthcare: sexual health, men’s and women’s dermatology, mental health, and weight loss.
Their success stemmed largely from meeting the surge in demand for generic alternatives to well-known erectile dysfunction (ED) medications like Viagra and Cialis, in addition to men’s hair loss treatments.
The business model appears particularly commoditized, without significant barriers to entry and faces significant competition including from Ro, Rex MD, Rocket Rx, Lemonaid, Keeps, and online pharmacies, and does not appear to have particular tangible or intangible assets to limit competitive threats. It already had its boom and bust cycle together with its stock, and it’s now approaching all-time highs again at similar levels where it topped in 2021.
In my experience, stocks with these types of boom and bust charts rarely belong to businesses with great long-term prospects and particular caution is needed. They are generally great trading stocks, but the underlying fundamentals of the business involved need particular scrutiny. The stock has been very strong recently on the back of a positive Q1’24 and excitement around the launch of its budget version of GLP-1 drugs.
Large Marketing Expense and Tough Unit Economics
The large marketing expenses are a red flag for the business model in my view. Healthy consumer businesses generally do not need to spend ~50% of revenue on marketing, regardless of their growth level.
How money is spent generally helps identify the nature of a business. You can look at a tech, biotech or medtech player and generally understand something about the quality and sustainability of its business model by looking at whether money goes into R&D, marketing, management bonuses, etc.
Hims & Hers makes this part of the job very easy as the business spends ~5% of its revenue on technology and ~47% on marketing.
High marketing expenses often come with high churn rates, as it's often a sign that businesses need to continuously find new customers to replace the ones who are churning.
Management says the long-term retention rate is ~85% which sounds astonishingly high for this level of marketing expense. Assuming long-term retention is effectively 85%, short-term retention on a one-year basis could be around 90% or more, meaning that only 10% of customers (or less) would churn after one year.
Between Q1’23 and Q1’24 the business added ~500k net subscribers. Total subscribers in Q1’23 were 1.209 million. Assuming a 10% yearly churn, the business has gained 621k gross customers. With a marketing expense of €479.8mm in the twelve months period, it means the business spent an average of ~USD773 per gross customer acquired.
Assuming 96% of marketing expense is for online revenue (consistent with share of revenue), if would mean an average of USD 742 per customer. The business has a very high gross margin of 82.4% as of Q1’24. Assuming wholesale revenue has a lower gross margin but is insignificant as a percentage of revenue, I approximate online revenue gross margin at ~83%. On $55 average monthly revenue per customer, monthly gross profit per customer is $46, or $137 per quarter. The business therefore needs a customer to remain for 5.4 quarters to recover marketing expenses alone. These are difficult economics to make a business able to generate significant long-term margin expansion, especially if tailwinds related to Viagra, Cialis or GLP-1 weaken, or competition intensifies.
However, a precise definition of long-term retention is lacking, and old data from Second Measure indicated HIMS’ retention was below 40% three quarters after joining the platform. Although the data is old, I have never seen a business improve customer retention by this much, let alone without a massive increase in profitability (Hims is still unprofitable on a twelve-month basis), so the actual unit economics might be worse than these.
Economies of scale and margin trends
To complicate matters, economies of scale on the rest of operating costs have been scarce. Despite a lean business with limited capex, R&D at 5-6% of revenue, and total sales above $800m ($1bn+ annualized), EBIT margin expansion has mostly resulted from gross margin expansion rather than economies of scale.
Given the strong reliance on gross margin expansion to generate profitability growth, the signs that gross margin may have topped are an important development. Gross margin peaked in Q3’23-Q4’23 at ~83% before weakening a bit to 82% in Q1’24.
Guidance implies further weakening of margins in the near future. Margin guidance is given on Adjusted EBITDA, which suggests AEBITDA margin might have already peaked for the year. Using the midpoint of the guidance for Q2’24 and FY’24, Q1’24 adjusted EBITDA margin at 11.6% is expected to decline to ~11% (10% to 12% range) in Q2’24, with a full-year level of ~10.5% (10% to 11% range).
Long-term adjusted EBITDA margin guidance is even more interesting, as it implies a future expansion to the 20-30% range despite a decline of gross margin to the mid-70s. In my experience, it’s very difficult to see such a sharp AEBITDA margin expansion with that level of pressure on gross margin, especially for a business that has shown gross margin expansion to be the main driver of overall profitability expansion.
Revenue guidance also potentially implies a sharp deceleration. The revenue range of $1.20 to $1.23bn for the full year with $292m - $297m in Q2’24 implies $642m for the rest of the year. This means a QoQ growth deceleration to ~6% from ~13% in Q1’24, and a similar rate for the rest of the year, with margin contraction.
What if it’s another Boom and Bust?
The business’ TTM EBIT is back to the levels where it topped in 2021 (negative ~8m, despite 3.5x times the revenue and 4x the gross profit. High growth in subscribers of non-personalized products has weakened to ~2.7%, which means annualized growth of ~10%, but I believe that management guidance and focus shift to personalized products suggest this segment might start to contract soon. Personalized products are still booming, with a 31% growth in subscribers in Q1’24, and the firm says they expect this type of customer to account for the vast majority of subscribers in the future. Yet, this trend is not translating into higher revenue per monthly subscriber, which has been in the right range of $53-55 for the past three years.
The expectations of potential margin contraction from here and what appears in my view a very unlikely long-term margin structure make me very cautious. Revenue is expected to post a significant deceleration in the short term with emerging margin weakness despite the business not having shown sustainable profitability on a twelve-month basis yet.
Besides a positive market response to the Q1’24 results, the stock has been recently boosted by excitement around the launch of a budget version of GLP-1 drugs like Ozempic at just $199 per month, a potential 85% discount to Novo Nordisk’s drug.
After the initial boost, interest around the topic (measured by Google Trends) is already weakening.
This has created excitement as well as a peak in interest in the company as measured by Google Trends, which appears to be normalizing very fast.
Regardless of the doubts around the safety profile of compounded GLP-1, on which the FDA has recently issued a warning, the stock added ~$1.3bn market cap (a ~45% rally) since the news, implying a big revenue and profit upgrade. The news came only two weeks following the earnings release with the guidance update, and the wording around what's implied in the guidance is vague.
The wording around the impact of products imminently coming being included in the guidance could mean some of the boost from GLP-1 might be included (since management knew about it and updated guidance just two weeks before the launch). However, assuming the guidance includes no benefit from GLP-1, the stock has already priced in a massive $1.3bn increase in market cap on a product with a highly uncertain level of sales and profitability.
The stock trades at 4x full-year sales (per guidance) and an EV/EBITDA of ~32x per guidance that needs a healthy combination of strong growth and margin expansion to be justified in my view. When assessing valuation and trading multiples investors should also take into account that they faced consistent dilution over time. High stock-based compensation was 7% of revenue in Q1’24, contributing to a ~3% quarterly dilution as of Q1’24.
Technicals
The stock was not too far off the current levels when it peaked in 2021 on a similar EBIT. It’s now in overbought territory, with a momentum divergence similar to what was seen before the decline started in May 2023.
Conclusion
HIMS stock has been booming on the back of revenue growth and, more recently, on the excitement around their low-cost version of GLP-1 drugs.
The underlying business is likely commoditized and has shown a lack of sustainable economies of scale on operating costs, despite revenue and gross profit booming. Guidance implying a revenue deceleration for the rest of the year and margin pressure work particularly against timing on this stock given the high valuation at 32x EV/EBITDA, and technicals look potentially bearish as well.
If excitement around its GLP-1 drug is as short-lived as Google Trends suggests, this becomes a very dangerous stock to hold here given the weakening underlying trends.