Oatly stock: ‘Bearish sentiment has peaked’ for the plant-based company, analyst says

Mizuho Analyst John Baumgartner joins Yahoo Finance Live to discuss upgrading Oatly stock to Buy, the plant-based category, and the outlook for Oatly.

Video Transcript

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- Embattled oat maker Oatly getting some applause from analysts at Mizuho. With shares down more than 60% over the past year, the Japanese bank is stepping off the sidelines and upgrading Oatly stock to a buy rating with a price target of $6, and that's a 123% increase from yesterday's close and a level that hasn't been seen since early 2022. Now, for more on this bullish call, let's get to Mizuho Senior Consumer Equity Research Analyst John Baumgartner.

Joined by Yahoo Finance's Brooke DiPalma. Thank you both for joining us. And let me start with you, John. What's behind this upgrade on Oatly?

JOHN BAUMGARTNER: Well, there's really two parts to it. One, we think from a company perspective, we think bearish sentiment has peaked, fundamentals have bottomed. We expect after a pretty tough 2022 where the company was held up by some supply chain constraints, which limited top line growth, commodity inflation, the zero COVID lockdowns in China, in 2023, we expect supply chain acceleration, new distribution growth, acceleration in Asia from the improved COVID situation in China, as well as better commodity costs, and also an improving liquidity trajectory for the company into 2024.

The second component to the call is the category. At this point, just given the hardships Beyond Meat and the plant based meat category have had, investors have really soured on the plant based theme in general. But we think plant based beverages are much different. The category grew 10% in 2022, very limited elasticity. We see significant room for per capita consumption growth in the US over time, as well as further growth outside the US.

BROOKE DIPALMA: So now let's go into that category conversation there. Can you sort of break down, you still have a neutral rating on shares of Beyond Meat. As you noted before, you upgraded Oatly to a buy. Break down exactly what that consumer sentiment is for plant based meat and just how vast it differs from plant based beverages.

JOHN BAUMGARTNER: Well, I mean, we think the category has really had a pull forward of demand with the COVID lockdowns in 2020. Your category goes up 45, 50%. You've seen 24 straight months of consumption declines for plant based meat. We think you've had your first generation of consumers adopt the category and we're waiting now for the next phase of innovation, better quality products to roll out.

So we like the plant based meat category over a 10-15 year period. We continue to see very limited consumption growth for the short term. Now in contrast to that, thinking about plant based beverages, there is many more consumption opportunities. You can use it as a milk replacement in cereal.

You can drink it as a beverage. You can use it as a coffee creamer. You can use it as an ingredient. So for the beverages category, I mean, you can see four or five consumption opportunities per day in some cases for these categories.

It's not a center of plate option, like plant based meat is, where your consumption opportunities and the intensity of consumption are limited. So we think there's a big difference there. You also have the lactose intolerance consumer helping drive the growth of plant based beverages. You don't have the equivalent of that in plant based meat. There's also a much larger service component as well, in coffee shops, in Starbucks, supporting the category growth in beverages you haven't yet really tapped into on the plant based meat side.

- They also benefited from some star investors, even prior to going public. People like Oprah, people like Jay-Z. Where has that kind of petered out at this point? Does it still have that same appeal to consumers to say, oh yeah, I know that there are some big names surrounding Oatly, does that still kind of push a consumer to trade up or buy up to an Oatly versus perhaps some of the other trade down brands in a grocery store?

JOHN BAUMGARTNER: We don't really think so. We think what it really comes down to at the end of the day is price and taste and functionality. And you can argue that for plant based meat, for plant based beverages. As long as the price is competitive on the shelf and the taste and functionality are there, we think that really drives the category.

And what's interesting for plant based beverages, if you look at it on the shelf, organic milk is about 15% share of the category in volume terms and plant based beverages offer more of a mid-priced product between conventional milk and organic milk, which slots in more favorably in a consumer decision set at the shelf. Whereas plant based meat, there really is no real organic product there. So the price premium looks a lot more impactful relative to your conventional meat price, and that's also been a detriment to the plant based meat and a benefit for beverages.

BROOKE DIPALMA: And bringing it back to Oatly. Of course, they recently announced long term partnership with Yaya Foods in North America. What do you think this means for Oatly's bottom line and ultimately growth here in the North America side of operations?

JOHN BAUMGARTNER: We think it's a big change. Dating back to the IPO, Oatly's strategy long term was to increase the share of self manufactured internal volume with the view being that you have better control over the supply chain, you have better operating leverage, which is fine, but it comes at a cost of big CapEx going forward. And that was the issue in 2022. There was about a $500 million cash burn on the cash flow statement before it's all said and done.

Yaya coming in as a hybrid manufacturer now allows Oatly to split CapEx with a partner. So it really reduces CapEx going forward in 2023 and in the out years. We think you could have a CapEx savings of up to $100 million relative to the base case here in 2023. That significantly reduces cash burn, improves liquidity profile going forward. We think that puts a bottom in fundamentals as well.

BROOKE DIPALMA: And last question here. Commodity relief is something that you noted with particularly in relation to oats. This comes as the company raised prices last year. What we're hearing on the street is that here we see higher prices hitting consumers, but lower prices when it comes to commodities. What do you expect that this means for the company's quarterly results coming up?

JOHN BAUMGARTNER: We think in Q4 you're going to see the lagged impact, more pricing coming through playing catch up to the inflation that was probably mid-to-high teens in terms of cost of goods sold in 2022. Looking forward, we're definitely seeing inflections, we're seeing oats prices actually turning deflationary, both in the US and in Canada. We've seen better crops over the past year. So oats and grapeseed oil, those are about 15% of Oatly's total cost of goods sold.

They were most inflationary last year. They should be tailwinds going forward. So for 2023, we still think the company faces inflation but more manageable, probably more high single digit in that respect. And at the retail shelf, what's interesting, when 2022 first started, the jury was out in terms of plant based beverages as a staple versus discretionary product.

And what we found was even with the category raising prices 12%, volume was only down 1%-2%. So in terms of elasticity, plant based beverage is really on par with cow's milk, soft drinks, bottled water. So it really proved itself as a real staple category over the past year.

- John, I've got to hustle to my finish here, but when you think about Beyond Meat, because you also cover this company too, does plant based meat make it through an environment where consumers are bucking higher prices and perhaps even trading down to other meat alternatives?

JOHN BAUMGARTNER: We think it will. And there's about 200 brands that are out there. So we think you're going to see consolidation of these smaller brands, real shelf consolidation at retail. The big brands that are out there, whether it's Beyond Meat, Impossible, Morningstar, we think those remain the big brands going forward. And after this period of consolidation, we expect new entrants to come in over the next few years with next generation R&D, next generation ingredients, processing technologies, to continue to drive the quality experience to improve it over time for the meat category.