Swedish plant-based milk company Oatly (NASDAQ:OTLY) recently had its blockbuster IPO, which saw its valuation skyrocketing over $10 billion. There’s a lot to like about OTLY stock, as it looks to create a more sustainable product and lead the way in the global dairy market worth more than $700 billion. It’s been around for the past 25 years and has become a household name. However, an unclear pathway to profitability, a lofty valuation and considerable competition in the sector all limit its attractiveness.

OTLY stock is trading at remarkable premiums at this point. For instance, it’s trading at 21 times its forward sales, which is over 1,000% more than the sector average. Moreover, its price exceeds its book value by a staggering 38 times. In all fairness, Oatly’s revenue growth has been impressive in the past year, but that hardly justifies its meteoric valuation. Whether it can become a profitable entity and fend off its competition is a big if at this stage.

Company Description

Oatly called itself “the world’s original and largest oatmilk company.” It claims to be a pioneer in the production of retail oat milk products. Moreover, it has been among the most successful alternative dairy brands in markets such as the U.S., the U.K. and Germany.

It earns most of its revenues from the EMEA (Europe, the Middle East, and Africa) geographic segment, followed by the Americas and Asia segments. Surprisingly, the EMEA region is currently the only region that is profitable for Oatly at this point.

The company generated $421 million in revenues last year, which more than double what it produced in the previous year. The world’s plant-based dairy market was valued at $21.4 billion in 2020, and it is forecasted that the industry could grow at a double-digit pace in the years to come.

There is greater awareness about the negative environmental and healthcare impact of cow’s milk.  Plant-based milk accounts for only 9% of dairy milk sales around the world. Hence, there is plenty of room for Oatly to grow in the coming years.

OTLY Stock: Challenging Path To Profitability

Despite the extraordinary revenue growth for the company in the past year, it is not even close to turning a profit. Its gross margins are at only around 30% when its main product comprises low-priced ingredients and is priced far more than standard cow milk. In addition, selling, general and administrative expenses were $168 million in the past year, roughly 40% of revenues.

Moreover, its operating loss totaled a massive $47 million in 2020, and its cash flows from operations were also negative. Nevertheless, despite the negative cash flows, it continues to go all-in on its expansion efforts and plans to spend as much as $1 billion over the next three years.

Furthermore, its recent expansion efforts into mainstream locations are a double-edged sword. Oatly has so far been able to expand into 50,000 locations in 20 countries. However, these countries are subject to inflationary pressures, higher business energy costs and intense competition. Hence, with the level of competition that the company faces, it will not pass on the higher costs to its customers. Therefore, I expect losses to widen further in the long term for Oatly.

The Bottom Line on OTLY Stock

Oatly has seen a successful public debut after coming off its most successful year to date. With the cash generated from its IPO, it will continue to expand its business into new territories and establish its presence as a clear market leader in the sector. However, the tough competition in the industry and its rocky road to profitability are major concerns at this point. The cherry on top is its unreasonable valuation, which further strengthens its bear case.

On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines

Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University.