Adore Beauty and Freedom Foods among six ‘fallen angel’ stocks worth a second look

As the smoke clears after results season, here’s a selection of stocks that are ready to recover.

Adore Beauty founder Kate Morris. Photo: Eamon Gallagher

One of the trickiest aspects of investing is deciding whether a fallen angel will ever fly again.

If they do regain their wings, the rewards of buying at distressed levels can be enormous. But as they impress on newcomers in MasterChef safety briefings, trying to catch a falling knife can be highly injurious.

As per tradition, the red ink flowed liberally at the tail end of the profit reporting season (especially over the last two permissible reporting days in the week just past).

Amid the outright duds, here are some small to mid-cap plays worth a closer look. Generally speaking, they’ve fallen from favour but are improving at an operational level.

Of course when we say ‘‘worth a closer look”, we mean just that. Investors should do their own homework.

Freedom Foods (FNP)

Looking on the bright side of the specialist food maker’s recent woes, Freedom has ample revenue to play with, recording an 8 per cent increase in full year turnover to $559m.

The net loss from ongoing operations was an ugly $38m, but adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) came in at $22m, compared with a loss of $54m last time around.

Controlled by the Perich dairy family, Freedom came a cropper last year after revealing close to $600m in writedowns and write-offs – and unwanted regulatory attention.

One reason for the accounting hit was that some products were sold “at prices that did not fully recover their costs” – which just goes to show there are no new ways to lose money.

Crucially, the company has reorganised and recapitalised by way of a $265m convertible note issue, which was backed by the Perichs but also included $139m of new money.

Adore Beauty (ABY)

The pure play online beauty has been heading south ever since its overpriced IPO last October, which raised a chunky $270m at $6.75 apiece.

Given the listing resulted from a private equity selldown – Quadrant decreased its holding from 60 per cent to 30 per cent – investors should have been on high alert about over-optimistic valuations.

Adore shares were hit hard in May when the company released an upbeat revenue update, which in reality missed market expectations by 5-10 per cent. Actual revenue for the year was $179m, 48 per cent up year-on-year and just ahead of the revised expectations. Active customers increased by 39 per cent to 818,000.

The pandemic lockdowns are a thing of beauty for the company, with year-to-date revenue up 26 per cent.

Our take on this one was that a tad too much foundation and rouge was applied to the initial valuation, but the subsequent 25 per cent share price haircut probably makes amends.

Cash Converters (CCV)

The consumer lender and pawn shop owner was affected by both positive and negative forces during the pandemic, but emerged an overall winner from the chaos.

Naturally, foot traffic through the pawn shops dried up in lockdown-affected areas, bearing in mind that only about 150 of the group’s circa 700 outlets are in Australia.

Demand has picked up across the company’s consumer and vehicle lending books, with gross loans rising 8 per cent for the year to $178m.

With a $126m market cap and $72m of cash, Cash Converters looks like a pawn shop bargain given its 26 cent share price compares with net tangible assets of 31.25 cents per share.

The stock isn’t everyone’s cup of tea, to put it mildly. Past sins include unconscionable lending practices that resulted in a $42.5m class action payout.

Formerly a payday lender, the company says it is moving from “short-term high-loss products to lower-cost longer-term cash solutions”.

And the company’s new product? Early Wage Access, which loans $200 for up to 60 days for a “single arrangement fee” of 5 per cent.

Sounds pretty short-term to us.

Prospa (PGL)

The specialist lender to small business should be vulnerable to pandemic-related corporate failures, but its bad debt costs declined 48 per cent for the full year to $27m.

Sydney and Melbourne of course are disaster zones for anything to do with hospitality, travel, beauty or the arts, but SMEs elsewhere are largely resilient.

Prospa shares popped 6 per cent after the company reported EBITDA of $375,000, compared with a $15.8m deficit last time around. The net loss improved to $9.5m from a $24.9m shortfall previously.

Put in context, Prospa listed in mid-2019 at $3.78, and with it trading around the $1.05 mark, investors have lost about 70 per cent of their dough.

Humm (HUM)

Formerly known as FlexiGroup, Humm prides itself on being the country’s oldest buy now, pay later (BNPL) operator and perhaps the only profitable one.

It’s also been a giant disappointment for investors: Humm shares have lost almost 60 per cent of their value over the last five years, at a time when other BNPL stocks have gone ballistic.

The name change reflects the consumer and commercial lender’s renunciation of its somewhat stodgier past to a groovy operator appealing to a younger BNPL audience.

Anyway, Humm’s net profit soared 121 per cent to $68m, with BNPL volumes surging 31 per cent to $1.03bn.

Mesoblast (MSB)

The stem cell drug developer continues to bleed cash with only token revenues as it pursues multiple approvals for its flagship asset remestemcel-L.

The full-year loss of $US99m ($135m) follows on from last year’s $US78m deficit.

As of June year end, the company had $US137m in the bank and $US80m of debt, plus $US10m undrawn, which kind of implies that things can’t go on as they are.

The company – which is still worth more than $1bn – has been adept at fundraising in the past and is in chats with its bankers about the loan facility.

Tim Boreham edits The New Criterion.

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