Three Reasons to Invest in Hansen Natural

Few corporations have managed to consistently increase revenues during the recession of the past eight quarters, given the extent of the systemic shock that the global economy was subject to. This article takes a closer look at one corporation that managed to do so, Hansen Natural (HANS), the maker of the popular Monster energy drinks, and looks at three factors that make the company (and its shares) very attractive to potential shareholders.

1. Revenue growth during the recession

This article focuses primarily on revenue growth as opposed to income growth alone, for the latter could have come from a variety of sources: Layoffs, production cutbacks, one-time gains, or more recently, government doles. The metric that is somewhat less amenable to accounting wizardry is incremental sales, more so when subject to certain constraints such as these:

1. The company must have sold incrementally more products in 2009 over 2008, and more in 2008 than in 2007. This is a critical test of the product's demand during the recession
2. Those companies cannot have compromised their pricing power to make this list. In other words, any increase in revenues should not have resulted from an increase in promotional expenses or discounts.

Now the above rules are rather stringent, but that was by design. The objective was to whittle down the list to as small as possible. Well, mission accomplished. Entire sectors were eliminated - financial services, energy, the auto industry, and housing. Even near-monopolies have had a hiccup or two, including Microsoft (MSFT), Cisco (CSCO), Intel (INTC), Coca Cola (KO), Toyota Motor Corp (TM), PepsiCo (PEP), etc. As a rough guess, the above two rules might perhaps have eliminated about 90% of the companies in the S&P 500 or the Russell 2000 indexes from consideration.

But for a very select few such as the following five, for instance: Wal-Mart (WMT), McDonalds (MCD), P&G (PG) (and others in consumer staples and confectioneries), Google (GOOG), and Apple (AAPL). And HANS makes this select list comfortably, as seen in the graph below.

This recession-era growth is noteworthy given the fact that 88% of its gross sales come from the US market, where almost every other beverage maker has seen volume declines, including Coke, Pepsi, and HANS' primary competitor, Red Bull. Moreover, the company did not have to resort to aggressive discounting during the recession to push its products - Since 2006, promotional expenses have stayed between 12-13% as a proportion of gross sales.

Finally, international growth is expected to start making a sizable contribution to the bottom line starting 2010. Already, the Monster energy drink is the clear number two brand in Canada, France, Sweden and Holland, essentially overtaking long-established brands in those markets in under a year, at a rate that is taking many observers by surprise. The current stock price seems to assume little or no overseas contribution to the bottomline in the near-term, and this might well prove to be a significant oversight.

2. Operational Efficiency

One of the reasons that Hansen Natural vastly outshines its peers in the beverage industry is the high profits that it can churn out relative to capital employed. To highlight its operating efficiency, specifically two other metrics are examined here - net profit margin and net profit per employee, in comparison to the beverage industry giants. For comparison's sake, a few highly profitable tech companies of Silicon Valley have been added to the mix as well, including Apple, Google and an assortment of software companies that are leaders in their respective verticals.

Not only does Hansen hang in there with that tough crowd as far as profit margin is concerned, it comfortably outshines the others in the profits it is able to churn out per employee, trailing only Google in that regard. Moreover, that number for Hansen would have been considerably higher had only full-time employees been taken into account, who comprise less than half of its work force.

Company	Revenues1 in billions	Net Income1 in millions	Employee count2	Profit margin	Profit per employee
Google, Inc	$16.91	$6,000	19,786	35.5%	$303,245
Hansen Natural	$1.13	$212	1,270	18.8%	$166,929
Apple, Inc	$37.06	$5,380	35,000	14.5%	$153,714
Adobe Systems (ADBE)	$3.00	$793	7,335	26.4%	$108,112
Coca Cola	$30.77	$7,100	92,400	23.1%	$76,840
McAfee, Inc (MFE)	$1.91	$378	5,778	19.8%	$65,421
PepsiCo	$43.25	$5,760	198,000	13.3%	$29,091
DrPepper/Snapple (DPS)	$5.56	$492	20,000	8.8%	$24,600
SalesForce.com (CRM)	$1.25	$76	3,566	6.1%	$21,312

1. From 2009 Q1/Q2 earnings reports and 2009 Q3/Q4 consensus estimates. In addition, GAAP estimates were used for Apple and Google, which may be lower than non-GAAP earnings by about 10-15%
2. Employee numbers obtained from 2008 annual reports or recent SEC filings, and includes both full-time and part-time employees

Such efficiency is a direct offshoot of its business model, in which it prefers to outsource both the manufacturing process as well as distribution to third parties, preferring instead to focus on drinks development and marketing strategy. The result is an extremely lean organization that employs only 250 employees in operating roles, which is markedly low for a company that managed over a billion dollars in revenues in 2008.

3. Valuation

At a closing price of $35.31 on Sep 24, 2009, HANS is trading at an December 2009 P/E of 15.9, and at about 14.4 if cash and equivalents are excluded. Given the health of its balance sheet (over $310 million in cash and no debt), operational efficiencies that are seldom seen in the beverage business, a slew of new products introduced in July 2009, and the strength of the Coca Cola distribution network in many overseas markets that gives Hansen's drinks premium shelf space, this valuation is significantly on the lower side. In the near-term, HANS should be able to grow the bottom line in excess of 18-20%, based on international growth opportunities, product expansion and potential acquisitions with its growing cash hoard.

Disclaimer: The author owns shares of HANS, which is the only stock in his portfolio at this time.

Comments

[Marc Gerstein:]

I’m a bit troubled by the disclosure at the bottom of an otherwise fine article: that HANS is the only stock you own. Two points:

I understand your desire to unlearn what they teach in your MBA program (I checked your SA bio) and a lot of the mathematical MPT concepts do, indeed, falter in the real world. But the “diversification” piece of MPT is not the problem. That part of the theory is fine; in fact, it’s downright vital. I agree that HANS is a pretty good company with a reasonably valued stock. But never, never, never, never underestimate the way the world can toss nasty curveballs at any company or stock, no matter how great. Heck, even a one quarter earnings shortfall wherein HANS does spectacularly well, but a teeny bit less spectacular than some analysts had hoped can precipitate a wicked stock plunge. So much the worse if there’s an actual business hiccup which tends to happen pretty-much all the time. I note you’re a Buffett fan. Please do not believe all the nonsense you see written about his so-called love of “focus” portfolios. In truth, he is a big-time diversifier. The list of Buffett holdings you see bandied about are actually only a small portion of the total BRK portfolio. So please, add some diversification to your portfolio. HANS isn’t the only great opportunity out there.

I suppose I should have welcomed you to SA earlier in this comment. Anyway, I do so now. Your reasoning re: HANS is sound and well presented and I expect you’ll write more in the future. But from a reader’s point of view, I will have to tell you that I’ve long ago learned to be suspicious of writers speaking bullishly on the only stock they own. Even if there is nothing shady actually occurring, it still casts a shadow on the overall credibility of what you say. Even the most honorable of investors-authors can find themselves getting too wrapped up in one thing to the point where their objectivity falters. It’s easier to see the full spectrum of issues that surround a topic when you don’t have a full-out 100% stake in how others feel about it. So besides being financially prudent, diversification is also intellectually sound.

Sep 25 11:04 AM

[Graham and ...:]

Mr. Buffett has been know to put as much as 10% of his portfolio in any one position (at cost).

Maybe this author has one 10% position (at cost) in his favorite stock and the balance in cash. Maybe he's a big bear, but thinks this one equity can beat a bear market.


On Sep 25 11:04 AM Marc Gerstein wrote:

> I’m a bit troubled by the disclosure at the bottom of an otherwise
> fine article: that HANS is the only stock you own. Two points:<br/>
>
> I understand your desire to unlearn what they teach in your MBA program
> (I checked your SA bio) and a lot of the mathematical MPT concepts
> do, indeed, falter in the real world. But the “diversification” piece
> of MPT is not the problem. That part of the theory is fine; in fact,
> it’s downright vital. I agree that HANS is a pretty good company
> with a reasonably valued stock. But never, never, never, never underestimate
> the way the world can toss nasty curveballs at any company or stock,
> no matter how great. Heck, even a one quarter earnings shortfall
> wherein HANS does spectacularly well, but a teeny bit less spectacular
> than some analysts had hoped can precipitate a wicked stock plunge.
> So much the worse if there’s an actual business hiccup which tends
> to happen pretty-much all the time. I note you’re a Buffett fan.
> Please do not believe all the nonsense you see written about his
> so-called love of “focus” portfolios. In truth, he is a big-time
> diversifier. The list of Buffett holdings you see bandied about are
> actually only a small portion of the total BRK portfolio. So please,
> add some diversification to your portfolio. HANS isn’t the only great
> opportunity out there.
>
> I suppose I should have welcomed you to SA earlier in this comment.
> Anyway, I do so now. Your reasoning re: HANS is sound and well presented
> and I expect you’ll write more in the future. But from a reader’s
> point of view, I will have to tell you that I’ve long ago learned
> to be suspicious of writers speaking bullishly on the only stock
> they own. Even if there is nothing shady actually occurring, it still
> casts a shadow on the overall credibility of what you say. Even the
> most honorable of investors-authors can find themselves getting too
> wrapped up in one thing to the point where their objectivity falters.
> It’s easier to see the full spectrum of issues that surround a topic
> when you don’t have a full-out 100% stake in how others feel about
> it. So besides being financially prudent, diversification is also
> intellectually sound.

Sep 25 11:49 AM

[poortorich:]

Diversification is ok up to a point. If you want mediocre returns, you can invest in index funds , like the s and p 500. Over a long period, you won't lose money. But keep in mind that about 25% and if you dig deeper, only 10% of the companies in the S and P are responsible for the historical return of the famous index. In other words, 75% of companies will not give you positive returns.

If you can find 15-20 companies that have a sustainable moat and consistently earn high returns oninvested capital, there is no need to diversify any further. You will only dilute your returns.

With regard to Hansen. Is this a company that has a sustainable moat? The answer is no. Is this a company that I have a high degree of certainty will be around the next 20-30 years? Probably not. But will their products be around at the end of this period. The answer is yes.Red bull has been around inn europe for 20+ years. Soft drink brands do not die easily, as long as you take care of them. Think of coca cola, pepsi cola, dr. Pepper etc. These are products that have been around for over a 100 years. Heck, even 7up, RC cola, Tab cola are still around. Compare that to computers, phones, cars etc that need to always rely on innovation. Coke and Pepsi with their endless supply of money could not displace Hansens monster. It is very difficult to displace an established brand in the soft drink business.

These are some of the possiblities for Hans:
1)remain an independent company and continue to grow internationally in which case the current price of hansen is very undervalued
2)get bought out by another company. ie coke.. I think this is the most likely scenario.

The biggest risks to Hansen are
1) lack of distribution system. if they want to remain indenpendent, relying solely on Ko for most of your distribution may not be a good idea
2)government regulation/outcry from the public about the dangers of energy drinks


I own shares of Hans

Sep 25 06:50 PM

[THofler:]

Interesting comments. I believe that at times in the past Mr. Buffett has put roughly 40% or more into a single position like American Express when valued at an extreme discount. But he did a huge amount of homework & even hired investigators before investing. Also, Amex isn't quite the same as HANS is it?

Yes, if you are a really really good investor some large concentrations can be very effective. I'm not that good, and I'm definitely not crazy enough to have a lonely single position. But who knows; maybe its a modest size & Ashwin has a lot of cash or bonds that he is excluding from the count?

Sep 25 08:51 PM

[Ricard:]

Good, convincing analysis.

"Those companies cannot have compromised their pricing power to make this list. In other words, any increase in revenues should not have resulted from an increase in promotional expenses or discounts."

Regarding this above quote, I do not see what the criteria is for 'promotional expenses or discounts'. Apple has certainly discounted the iPhone 3G by $100, and it is reasonable to expect that most soft drink manufacturers have discounted one product or another in their portfolios either to grocery stores or to fountain operators. Despite being an excellent company, Intel will never make your list as long as 'Moore's Law' applies - this will be true for any company in the deflationary consumer electronics sector - I again question why and how Apple made this list.

I would also add CMG, a recent addition to my own portfolio, to your list. I do not know why your screener excluded it - it has posted incrementally higher revenue on incrementally higher pricing ever since going public, to include this entire recession. This very startling example of your 'recession-proof' test is exactly why I bought it. Again, not sure how your screener missed it.

Also, pricing power is paramount to any business strategy, and there are times when this power is manifest via discounting to attack the competition. Well positioned companies with low cost structures will invariably profit against similarly positioned companies with more bloated costs. Intel nearly destroyed AMD by flexing this one particular muscle (although it is not hard to pressure AMD).

Essentially, I question whether or not this metric can ever be measured in an objective fashion. CMG is exceptionally easy to analyse, but I am sure that the stocks on your list are probably the epitome of difficult analysis regarding individual product lines. I do not question the importance of the metric, as I can see the author's point about measuring teflon effectiveness through a recession.

Again, good analysis.

Sep 25 10:21 PM

[Ashwin Bhag...:]

Before I respond any further, I think a full disclosure is in order, to provide some context: I am 100% invested in HANS. Also, I don't own anything else, including bonds.

Marc:
Thanks for the welcome, and appreciate your view points. I have no strong proclivity towards having a highly focused portfolio at the expense of diversification, but it so happens that my investing philosophy precludes owning a large number of companies. I need to be able to understand a business, be able to price it, and make sure it is trading below that appraisal price at the time of my purchase. I have a morbid fear of going anywhere near a business that doesn't meet all three of those criteria.

And it so happens that in the small universe of businesses that I understand and can price (numbering about 25), only one is trading at a price that I like. For sure, risks abound, as with any company ('poortorich' highlighted a couple of risks pertinent to HANS in his comment above). My personal feeling is that the recession still has some steam left in it, so stocks may see another drop yet. Perhaps as much as 30% in Hansen's case. But unless I am convinced that the core business is suffering, I don't concern myself too much with the going price on any given day.

THofler:
The beverage business is not incredibly complicated. For instance, a typical 16 year-old has a better shot at comprehending Hansen's 10k report versus that of American Express. Moreover, people are creatures of habit, so if they have consumed about three billion cans of Hansen's energy drinks in the past three years, I am loath to think that this is a fleeting phenomenon. Will this ever be as big as Coca Cola? I am willing to stick my neck out and confidently say no. But do I need it to be as big as Coke to make money? No, again.

Ricard:
True, now that I think about it, Apple has had to cut prices on at least some models. I stand corrected. Although, most of those discounts happen to be offered for products that are on their last legs in the product life cycle, as newer models are introduced. But still, I have to agree with your assessment that pricing power is a somewhat tricky metric to be measured, and my treatment of that in the above article is somewhat informal.

Sep 27 08:59 PM

[poortorich:]

Good luck to you Ashwin

You have alot of guts. Unless the two risks i mentioned above do not come to fruition, you should be fine with Hansen. If a company has positive free cash flow and no debt, it is extremely hard for it to go bankrupt. This is especially true of Hansen, in light of the addictive nature of its product.

I'm not as courageous as you. The only time I would own only 1 or 2 companies is if something like JNJ or KO all of a sudden dropped in price by 50% and their yield went up to 6-7% (highly unlikely to happen).

Sep 27 09:25 PM