Should we care more about the ‘adjusted’ in THG’s adjusted Ebitda?

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Apologies for writing twice in two days about a small-cap* but an interesting analyst note on THG, the protein-powder-to-mascara retailer, just dropped into our inbox.

The theme is one-offs, such as THG’s failed sponsorship deal with Williams Racing and the mothballed Manchester hotel it has written off. As we noted yesterday, THG last year booked a £14.9mn impairment charge for the hotel and spent £7mn to back out of the Williams deal, which it bundled together with the cost of an HR software rollout that didn’t work.

These kind of adjustments, along with disposals agreed shortly before the year-end, cause quite a gap between THG’s 2024 profit by its preferred measure, adjusted Ebitda (£123mm), the “management adjusted” operating profit metric (£92mn), its statutory operating loss (-£148mn) and the loss figure to be found at the bottom of its income statement (-£326mn).

There’s nothing shady about adjusting earnings to give investors a clearer view of the underlying business. The cause of concern is the regularity with which THG has adjusted earnings, as well as the items it has chosen, says Panmure Liberum analyst Wayne Brown.

In addition to the Williams sponsorship misfire, THG last year adjusted earnings to cover cost inflation it tied to the Israeli–Palestinian conflict. For both 2022 and 2023 it made adjustments for Covid-related supply chain disruption.

“These are arguably part of normal business operations, and their repeated exclusion calls into question the reliability and quality of the company’s reported earnings,” says Brown. “Should such sales associated with these exceptional costs be considered underlying?”

He adds:

Over the past four years, THG has classified £631m of costs as adjusting items—equivalent to 153% of the group’s cumulative adjusted EBITDA (£412m) over the same period. If we break the adjusting items between impairments (which are often linked to disposals and involve accounting judgements) and others, the other adjusting items over the last four years have also added to a material £227m, which still represents a significant 55% of cumulative adjusted EBITDA.

None of this would be of great concern if THG delivered cash. Ebitda is meant to be an approximate measure of cash. But THG’s cash outflow last year was £88mn.

The idea behind its disposal in December of Ingenuity, the loss-making online marketing and logistics division, was to reset the business around its slower-growing but profitable nutrition and cosmetics operations while bringing debt down to manageable levels. However, excluding Ingenuity, 2024 group free cash flow was only just neutral at £400,000.

THG asks investors to also exclude one-offs, which is how it arrives at an underlying-underlying hypothetical remainco cash flow for 2024 of £21.6mn. Problem is, underlying-underlying hypothetical cash flow doesn’t pay the bills, which remain high even by management’s preferred measures: gross debt of £400mn at the 2024 year-end was equivalent to 3.8 times adjusted remainco Ebitda.

Cash flow improvement this year relies largely on whey prices easing. It’s a bit of a gamble.

The performance of nutrition at THG seems to get buffeted by whey costs much more than at Glanbia, a London-listed peer, says Panmure-Liberum’s Brown. Some of that may reflect disruption from a recent rebrand of THG’s Myprotein and some loss of competitiveness in Japan due to sterling’s strength against the yen — though, again, investors may think twice about treating these factors as one-off.

Glanbia’s protein shake division shrugged off record-high input prices in 2024 to deliver a 16.9 per cent margin. THG Nutrition’s margin more than halved to just 6 per cent. That’s in spite of THG products tending to be made with Whey Protein Concentrate, which is less volatile (and cheaper) than Whey Protein Isolate, which Glanbia favours.

Some of the earnings unpredictability is because, unlike Glanbia, THG prefers short-term supply agreements, Brown tells clients:

The situation raises broader questions regarding the strength of the Myprotein brand, the robustness of the company’s revenue management strategies, and the effectiveness of its brand and supply chain management. [?.?.?.?] Notably, despite two major whey price shocks in the past three years, there is little evidence that THG has adjusted its procurement strategy — such as securing longer-term contracts — to better manage input volatility.

He concludes:

The shares trade at 0.6x 12m forward EV/Sales and 9.5x 12m forward EV/EBITDA. On our forecasts, the 2025 FCF yield is still very low at 2.4% but improves to 13% on our 2026E forecasts. While there are a number of positives building, we continue to see risks around the recovery of the Nutrition margins which depend on the timing of new whey capacity landing, and also the group’s exposure to the US where the consumer reaction to inflationary tariffs could derail growth. Given the company’s tract [sic] record of missing expectations, we retain caution and stay at HOLD, but lower our TP to 26p (from 36p) to reflect the increased risks.

A target of 26p is already above the current level, though for anyone thinking that suggests value, the longer-term trend might be worth noting:

* THG joined the FTSE 250 index in March but it’s currently the third-smallest constituent by market cap, and appears to be below the threshold for automatic relegation. We’ll need to see updated share counts but if that remains the case on the next review date, May 28, it’ll drop into the Small Cap index.

Further Reading:
— The magic of adjustments: ebitla-dee-da (FTAV)