The Honest Company (HNST) in Los Angeles is a retail lifestyle company founded by actress Jessica Alba. It is known for its sustainable plant derivative products, which include baby products, non-toxic skincare, personal hygiene items, and supplements.

The company went public through a traditional IPO by listing 28.50 million shares on the Nasdaq Stock Exchange on May 5. HNST raised $412.80 million from the IPO, which is expected to fund its general corporate expenses.

The stock opened at $21.22, up 32.6% on its first trading day, which was above the $16 pre-listing share price. However, the shares have since declined 12.2% to close Friday’s trading session at $10.07.

Here’s what we think could influence HNST’s performance in the near term:

Criticisms

HNST’s products are labeled and advertised as non-toxic and sustainable, which differentiates them from competitors. As stated in the company’s IPO prospectus, the company’s brand is “focused on leading the clean lifestyle movement, creating a community for conscious consumers and seeking to disrupt multiple consumer product categories.”

However, several lawsuits were filed against HNST in 2015 and 2016, alleging false and misleading advertisement claims regarding non-toxic products. Though the company denied such allegations, it ended up settling the class action lawsuits. Furthermore, in 2017, HNST’s hit product, diapers, were recalled due to the presence of mold, which impaired the company’s reputation and , in addition to financial losses.

In fact, HNST has listed degradation of product quality as a potential risk factor in its prospectus. This risk has the potential to  create an adverse effect on HNST’s  business, financial condition, brand reputation, and growth prospects.

Inefficient Operations

Despite being operational for nearly nine years since its launch in 2012, HNST is yet to generate a profit. Because the company expects its expenses to increase in the near term as it reinvests to fund its growth strategies, its ROE is expected to remain negative in the near term. Given the highly competitive nature of the sector, HNST states its negative profitability as a significant risk factor, noting that its inability to generate adequate revenues might prevent the company from achieving or maintaining profitability.

IPO-Related Investigations

Shareholder rights Law Firm Johnson Fistel, LLP is currently investigating HNST for potential violations of federal securities laws. In addition, following its poor second-quarter performance, the law firm is seeking  to discover whether the company’s filings with the SEC contain untrue or omitted statements to mislead investors.

Disappointing Second Quarter Results

HNST’s total revenues increased 3% year-over-year to $74.58 million in its fiscal second quarter (ended June 30), driven by a 16% rise in Skin and Personal Care segment sales. However, its revenues from “Diapers and Wipes” and “Household and Wellness” segments fell 2% and 6%, respectively, from the same period last year. In addition, its sales through digital channels declined by 24%. Its operating expenses increased 74% from their year-ago value to $46.45 million. Its net loss came in at $20.03 million, and its loss per share stood at $0.17, which was higher than the $0.14 consensus estimate.

Recent Rating Downgrade

Poor second-quarter results announced on August 13 made Morgan Stanley analyst Dara Mohsenian downgrade the stock from “Overweight” to “Equal-Weight” due to lower visibility. Mohsenian expects that it will take time for the company to rebuild its credibility and goodwill. He revised HNST’s price target to $11, down 37.1% from the previous target of $17.50.

POWR Ratings Reflect Bleak Prospects

HNST has an overall F rating, which equates to a Strong Sell in our proprietary POWR Ratings system. The POWR Ratings are calculated considering 118 distinct factors, with each factor weighted to an optimal degree.

The stock has a D grade for Momentum and Quality. HNST is currently trading below its 50-day and 200-day moving averages of $14.40 and $15.64, respectively, in sync with the Momentum grade. In addition, the company’s negative profitability justifies the Quality grade.

Of the 73 stocks in the D-rated Consumer Goods industry, HNST is ranked #68.

In addition to the grades highlighted, we have rated HNST for Growth, Value, Sentiment, and Stability. Get all HNST ratings here.

Bottom Line

HNST’s growth prospects are heavily dependent on its founder Jessica Alba’s social media influence rather than its product quality. It plans to expand its operations overseas—to Europe and Asia—by leveraging Alba’s large following, making it a highly risky strategy. Given its tainted market reputation following multiple lawsuits regarding allegedly poor product quality and operational inefficiencies, we think HNST is best avoided now.

How does The Honest Company (HNST) Stack Up Against its Peers?

While HNST has an overall F rating, one might want to consider taking a look at its industry peers Ennis, Inc. (EBF) and Société BIC SA (BICEY), which both have an A (Strong Buy) rating.

HNST shares were trading at $9.96 per share on Monday afternoon, down $0.11 (-1.09%). Year-to-date, HNST has declined -56.70%, versus a 20.10% rise in the benchmark S&P 500 index during the same period.

Aditi is an experienced content developer and financial writer who is passionate about helping investors understand the do’s and don'ts of investing. She has a keen interest in the stock market and has a fundamental approach when analyzing equities.

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