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Blue Apron (NYSE: APRN) helped popularize the U.S. meal-kit industry and enjoyed some early success. The stock went public in June 2017 at a price that was well below its initial IPO target, but enamored traders with its impressive customer growth rates. After the initial excitement, things went downhill fast, however, as the subscriber growth quickly dissipated along with the share price. Quarter after quarter of declining customers trends and a 1 for 15 reverse split later, the stock is now a stuffed shell of its former self.

In recent months, the company has been thrust back into the spotlight due to an uptick in demand during the coronavirus pandemic. People exploring alternative meal options have turned to Blue Apron amid shuttered restaurants and shelter-in-place orders. The company is undoubtedly getting a near-term boost in demand as a result of the nationwide social distancing measures.

Despite the near-term catalyst, Blue Apron is still not a well-run company nor is it a good investment. Will lessons learned from the COVID-19 outbreak lead to a structural shift in American consumer behavior? How much of the company’s current interest can be converted into a loyal, long-term customer base?

Given the uncertain environment it is hard to speculate on the potential permanency of our lifestyle changes. We can only turn to history for which there is little precedence. In the case of Blue Apron it is difficult to deduce that the pattern of financial mismanagement and underperformance will be reversed. It seems much more likely that the company has its quarter or two in the sun, only to resume the slide towards oblivion.

Flawed Underlying Business Model

Putting the debate around the sustainability of COVID-19 demand aside, the basic premise of the Blue Apron short thesis is that it simply does not have a good business model. The concept of delivering partially completed meals, regardless of how fresh the components are, is not that novel and exciting. More importantly, it is never likely to appeal to a critical mass. Customers receive a Blue Apron box on a weekly basis containing fresh ingredients for specific meals along with recipes that still must be prepared and cooked. It appeals to those who after a full day at the office would rather not shop and come up with their own dinner ideas. In the age of Pinterest and free recipes available on many digital channels such as the McCormick app, convenience is the company’s main value proposition.

There is some sort of market for this, but at the core the business is fundamentally flawed. The company’s ‘Signature for 2’ plan with two recipes per week starts at $9.99 per serving plus $7.99 shipping which comes out to $47.95 weekly. It also equates to fast casual meal pricing for food that still requires a time investment to prepare and cook. This is not only not worth most people’s time, but more expensive than grocery shopping even if you tack on the gas money to get there. And although Blue Apron’s ingredients are fresh and the meals are generally healthy, it will be hard to alter the perception of most people’s minds regarding food that’s delivered in a box. At the end of the day it is still just a few steps away from those Hungry Man frozen dinners.

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Source: oldschoolvalue.com

Persistent Fundamental Weakness First let’s take a step back and look at the history of consistent underperformance at Blue Apron. The financial statements are not pretty and it’s doubtful that even the most ardent bulls would argue. Frankly, they reek of low quality.

Profitability is of course non-existent. It’s never a good sign when the past 12 months gross profit ($157.8 million) is well below operating expenses ($224.8 million).

The company has embarked on a quest to optimize operations and exercise fiscal discipline. Both are noble causes, but given the history, it is hard to believe that current priorities like discovering new capabilities and testing new products will lead to anything but shrinking margins. For Blue Apron to experience meaningful growth, it must be able to execute a sustainable increase in revenue or a major pullback in expenses. Management has talked about unwinding marketing expenses, but to do so without sacrificing brand awareness and customer growth will be a big challenge especially in a small niche market. It is hard to envision this company winning an expenses versus revenues tug-of-war.

Aside from the negative bottom line, operating cash flow and free cash flow are negative. This signals a lack of operational efficiency and an inability to convert sales to cash that can be used to reinvest in growth opportunities and enhance shareholder value. Return on assets (ROA) has decreased over time further displaying management’s ineffectiveness and the company’s absence of a competitive advantage. Whether it be the decreasing gross margin, decreasing current ratio, or CROIC, the key metrics continue to point to an unhealthy financial situation.

The risk of bankruptcy is very real. Blue Apron has been burning through cash for years. Relative to its $211.3 million asset base, sales, working capital, and operating earnings are not at comfortable levels. The debt level has come down but is still high at $53.6 million compared to $50.7 million in shareholders’ equity.

First Quarter Results Underwhelming

Just when things seemed to be looking up, on the day of its 2020 first quarter report, Blue Apron filed a shelf registration to issue another $75 million in equity or debt causing a collective groan from investors who have seen this movie before.

While Blue Apron likely only derived a COVID-19 demand benefit toward the tail end of the quarter, it would have been more comforting to see stronger numbers. Instead, we saw a muted revenue figure of $101.9 million which was up 8% sequentially, but 28% lower than Q1 of 2019. The decline related to the latest master plan of reducing marketing spending and targeting “high affinity” customers. The Q1 net loss of $20.1 million decreased sequentially but was nearly quadruple what is was a year ago.

Cost-of-goods-sold (COGS) relative to revenue increased from 58.3% to 59.5% largely due to higher shipping and labor costs. This was understandable and ultimately COGS should trend lower in the wake of the Arlington facility closure and if (a big if) the new marketing strategy bears fruit. Marketing costs increased to $15 million and 14.8% of revenue. New CEO Linda Kozlowski appears hell bent on reducing marketing and other expenses and going after a more focused customer base to improve the bottom line, but it remains to be seen if this can be done without hurting sales and customer growth. Blue Apron has had multiple CEO’s and strategy pivots during its brief history, and it wouldn’t be surprising if the latest strategic shift flames out.

Many of Blue Apron’s costs– ingredients, packaging, shipping– are fixed, and with the company having to pay workers more for the foreseeable future, there are not many corners to cut in this business. Targeting the marketing budget, the very mechanism that attracts customers, is a sign of desperation and suggests the company is circling the drain. Marketing spending is not the issue. Sales and marketing expenses are one-fourth of what they were in 2016. It is just not a good growth business.

After a $8.6 million EBITDA profit in Q1 of 2019, EBITDA swung back to a loss of $5.8 million in the most recent quarter. Blue Apron has had periods of positive EBITDA, but they have coincided with revenue declines. It has not been able to figure out the economics of lowering costs while growing revenue. This is a basic tenant of becoming a profitable business that the local pizza parlor has figured out, but not this company.

Blue Apron Key Customer Metrics as of Q1’20

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Source: Blue Apron Investor Relations

Searching for its Customer Profile

Management noted that it saw continued strength in its key customer metrics in Q1 that was present even prior to the coronavirus outbreak. While this may be the case, let us not lose sight of the fact that 35k customers were lost in Q4 marking the 7th consecutive quarter of subscriber losses. Blue Apron exited 2019 with 454k customers as the initial hype continued to fade from a couple years prior when it had amassed nearly 1 million customers. The rate of customer losses accelerated to 36% in 2019. Customers were up 7% sequentially in Q1, but overall, this hardly feels like continued strength in customer metrics. Call it part of the deliberate shift towards the new marketing strategy if you would prefer, but it seem more like sugar coating an underlying negative trend.

What is the likelihood that the renewed focus on “affinity” consumers is successful? First, this involves shrinking the already small market down even smaller and banking on higher spending levels to make up for the lower customer base. It is doubtful that higher income households will embrace Blue Apron en masse when others have not. This is the same segment of the population that enjoys socializing and spending time at nicer restaurants. And don’t many well-to-do people have personal chefs if they don’t already prefer to do their own cooking? It would also seem that marketing to higher end consumers would be more costly, i.e. gaining exposure to more expensive magazine ads, events, and other costly sales channels.

Not to mention the fact that in shifting to more affluent consumers, Blue Apron is essentially choosing to alienate much of its current customer base. And doing so at an emotionally charged time when perhaps these people were beginning to connect with the company. Retaining these so-called affinity customers while trying to bring on other regular joes at a time when unemployment is at historic highs and household budgets are constrained is a risky approach. Every dollar counts these days and consumers looking for good values are not likely to seek expensive meal-plan kit subscriptions as a staple of their budget.

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Source: USDA Food Plans, March 2020

In Q1 average revenue per consumer (ARPC) was up 5% year-over-year to $271. This means the average customer is spending roughly $90 monthly on Blue Apron meal-kits. In its March 2020 report on food plan guidelines, the USDA estimated that the cost of food for an adult couple ranges from $372 to $776 per month. For a family of four with two children the range is $572 to $1,301. This suggests that Blue Apron customers are spending a small fraction of this recommended food budget at Blue Apron. They certainly are not relying on Blue Apron as their primary meal source. To this end, a Blue Apron subscription would appear to be more of a complementary food source, perhaps a special treat to go with regular grocery shopping; something to try out.

Blue Apron states on its website that “skipping or cancelling is easy”. It may be a little too easy. Customer churn in this business is high and people seldom return. Since Blue Apron allows customers to cancel subscriptions at any time it opens the door for customers to leave as they please. In this way, Blue Apron’s sales model is like that of a cable or phone company. People explore it for a month or two and then once the promotional period ends, they cut ties and move on to something else. The company could try to lock people in for longer periods, say 6- or 12-month contracts, but that would probably just cause customer growth to trend even lower. Customers are hard to obtain in this market and even harder to retain. The meal-kit market as a whole has perhaps one of the least loyal customer bases around. Investors are better off with businesses that have more sticky consumers.

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Little Room for Meaningful Cost Reduction

Let’s take a look at Blue Apron’s margins specifically as they relate to customer lifetime value (LTV). For purposes of this exercise, customer lifespan will be assumed as a generous 12 months, although company data has suggested this figure may be closer to 9 to 10 months. What portion of customer LTV is being spent on things like raw ingredients, shipping, and administrative costs? While the company doesn’t provide detailed data around these specific items, we can examine the three primarily components of operating expenses as outlined in the income statement – cost of good sold (COGS), marketing, and product, technology, general, and administration (PTG&A).

The average revenue per customer on a quarterly basis over the last three years has been $254. This mean that if customers stick around for a year on average, then customer LTV is somewhere around $1,000. COGS per customer, marketing expense per customer, and PTG&A costs per customer have averaged $166, $36, and $78 respectively over the same period. As a percentage of customer LTV these expenses have averaged 16%, 4%, and 8% respectively.

So how have these costs relative to customer LTV, or “inverse margins”, trended over time? COGS has trended lower from a high of 19.6% in Q3 2017 to a low of 14.6% in Q1 2019 to its most recent measure of 14.9% in Q1 of 2020. Marketing expense has trended slightly lower but at 3.7% in Q1 20202 is almost identical to where it was three years ago (3.6%). PTG&A expenses have trended higher over the last three years owing to product development, digital investments, and more recently higher shipping and wage expenses.

For Blue Apron to become sustainably profitable relative to the value of its rather temporary customer base, one or more of these costs will need to come down significantly. COGS is heading in the right direction but capturing savings in things like raw ingredients will be difficult without sacrificing product quality. Food inflation pressures will make this even harder in the near-term. Marketing expenses can always be reduced but doing so while adding customers and growing revenues has proven difficult for this company. Meaningful cost reduction in PTG&A expenses will be similarly tough amid rising wage and shipping costs, new product development initiatives, and the increasing need for businesses to enhance their technological capabilities. Overall, there does not appear to be a whole lot of room for cost reduction and margin improvement in this fundamentally lost-cost business. This challenge seems particularly daunting considering the inherently non-sticky nature of meal-kit subscription customers.

Small, Niche Market with Competitive Threats

The U.S. meal kit market caters to a small segment of the population. While meal kit industry revenue is expected to reach $8.9 billion in revenue by 2025, it will likely never become mainstream. Not that many will want to fork over $10 or more for a partially completed meal service. People don’t want to be part of the meal production assembly line, they just want to eat. Yes, its convenient, but the average cooking time for a Blue Apron meal is still 30 to 40 minutes. Despite the relatively small market opportunity, seemingly everyone wants to get in on the meal-kit game these days. This includes not only similar startup companies, but mega players like Wal-Mart, Amazon, and Kroger, all of whom offer less expensive and more flexible meal-kit programs. They also have the scale and resources to squash the Blue Aprons of the world. Not to mention that regional grocery store chains are buying meal kit companies like they are reaching their expiration date and developing their own private label products. Even more competition exists in the form of companies like Uber Eats which many people prefer because they can spontaneously get restaurant quality meals without having to commit to a subscription.

And while some have jumped into the fray, others like Plated are throwing in the kitchen towel because they have witnessed a market with waning consumer interest. Too many cooks spoil the stew. There are too many players going after too few customers. This is not an industry where there will be a lot of long-term winners. Blue Apron lacks any sort of clear competitive advantage that sets it apart from this crowd. There is no moat whatsoever as evidenced by all the entrants coming at the food delivery/quick meal prep market from all sorts of angles.

The Post-COVID Effect

How our lifestyles and spending habits evolve post-COVID-19 is anyone’s guess. Yet it is reasonable to make the argument that the recent uptick in Blue Apron demand was born out of necessity rather than a change in consumer tastes and dining preferences.

As Americans we value our freedoms and it will be hard to keep us away from our favorite restaurants. We are a very social people and we will be anxious to schedule dinners out with family and friends even if it means adhering to a new set of rules. We will not mind waiting an extra 15-minutes to ensure our food is prepared safely. If anything, restaurants could ultimately benefit despite incurring higher regulatory and labor costs, because we will be willing to sit around, socialize, and order more appetizers and drinks while waiting for our food.

Most people have not been avoiding the grocery stores, they are just buying larger orders. Many have relied on services like Instacart as a workaround. Services like Blue Apron have captured a piece of this demand, but a return to normal shopper capacity at grocery stores is just a matter of time.

In the meantime, we have changed in other ways. We have discovered a newfound appreciation for spending time with family and friends. We have picked up new hobbies, possibly including learning to cook and creating our own recipes. This could very well translate to more people having others over for dinner parties to show off their new cooking skills. We also value having choices and don’t like being limited to things like a slate of weekly Blue Apron entrees. Add in the prevailing stigma that meal-kit plans are expensive, and it would appear to be easy to turn away from that alternative.

There may certainly be some reluctance for consumers to return to restaurants and grocery stores, but over time, but with the appropriate safety measures in place, we will, and especially as the warmer summer months arrive. This timing will add to Blue Apron’s customer retention challenge. The recent re-ramp in marketing at Blue Apron to capitalize on the COVID-19 opportunity makes sense intuitively. But you must wonder if this service was such a no brainer, customer word of mouth so robust, and demand so strong, then would the marketing acceleration be necessary? Could this just lead it back down the path of shrinking margins and back to square one?

Make or Break Q2 Results

Management’s Q2 guidance includes high single digit revenue growth to approximately $130 million. The company expects to be EBITDA positive by at least $5 million, have positive operating cash flow of at least $10 million, and record a net loss of no more than $6 million. Will they deliver or are we being set up for more disappointment? A positive EBITDA is quite possible given the current economic environment, but a path to stable EBITDA growth from there is far less certain. The August 4th Q2 report may be a make or break quarter for the company. You get the feeling that if the results are not special, what few patient Blue Apron investors are left will depart for more promising growth opportunities.

Management stated that it has seen a “sharp increase in consumer demand” and that web traffic and app downloads have been through the roof. First, it would have been nice to see this reflected in stronger Q1 results. Second, we better be in for some amazing Q2 numbers if this is the case. With most states starting to lift shelter-in-place restrictions and restaurants slowly beginning to re-open, Blue Apron may only get a strong April on its books before the subscription cancellations start flowing in.

The Last Word

Are the Q1 revenue bump and the expected near-term boost from COVID-19 demand an inflection point that can lead to sustainable growth, or another Q1 head fake for a company with a decorated history of underperformance? The company has not been able to sustain positive sales momentum since going public and despite the higher interest in its products there is no reason to expect it to.

While our consuming lives will be forever changed by the pandemic, it is hard to fathom that there we will see a structural shift in eating preferences that brings Blue Apron back from the doldrums. For meal kit adoption to truly take off we would need to see something like a worsening pandemic situation, a scare related to grocery store safety, or government regulations eliminating restaurant takeout. We will ultimately find a way to get back to the activities we enjoy which include going out to restaurants and preparing home-cooked meals.

Blue Apron and its speculative investors should enjoy the party while it lasts. The stock could trend upward in the short-term, but over the long haul there are just too many obstacles to overcome. This starts and ends with the business model itself. Sprinkle in a hearty dash of competition, and there is not a sustainable competitive advantage that can drive success. After four years in the business, Blue Apron is still struggling to identify its target market. At the end of the day, much like the price tag and small portions of the meal kits, Blue Apron’s business model is not appetizing.

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    At the end of the day there’s no innovation that APRN can compete on, only cost cutting. Shipping and labor maybe they can squeeze a few percent out. You say they want to cut marketing to the bone? Risky play, don’t see that their brand is strong enough to spread by word of mouth.

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      When I signed up for Blue Apron a while back they didn’t have local facilities so they shipped my food from halfway across the country. No wonder their margins are terrible, they use tech startup logic for traditional business line.

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        Great note, I agree with your conclusion. The company has a very niche target market that doesn’t mind paying casual dining prices for the pleasure of making restaurant quality food at home. The issue is that it hasn’t been able to earn any money servicing that market and it is difficult to expand the market as the basic product isn’t cost effective. Additionally, there are no real barriers to entry and all you need for heightened competitive pressure are a few active VCs ready to back money losing startups.