Hain Celestial (HAIN) is a consumer play on healthier living, making it a very interesting long-term investment at a reasonable price. While investors have long believed in the stock, driven by the great growth prospects and continued buyout rumors, they have been shocked following an accounting issue. This warning and the accompanied profit warning triggered a 30% sell-off in the share price of this former darling.
While accounting issues are scary, I believe this storm will pass. What is left is a promising business with a great acquisition track record. While past growth has been very impressive, Hain has some challenges to integrate all the brands, boost branding awareness, cut costs and bolster the organic growth profile.
Given the market-equivalent multiples at which the stock trades, while leverage is modest, there is certainly appeal at current levels if the business stabilizes and recovers. The great organic positioning should theoretically warrant a premium to other food players which often already trade at 20+ times earnings multiples.
A return to levels above $50, therefore, does not seem out of the question in the intermediate term once accounting issues are resolved. If Hain delivers on margin improvements while it manages to accelerate organic growth, investors have the chance to look forward to even greater returns in the years to come.
Hain focuses on organic, natural and better-for-you products. Its diversified portfolio of food, beverage and protein products made it a dominant player in this emerging field. The company derives two-thirds of its sales from grocery products, and the remainder comes from protein, snacks, tea and personal care products. Half of these sales are generated at home in the US, roughly a quarter in the UK, and the remainder in the rest of the world and through the sale of pure protein products.
Since its founding in 1993, the company has relied on acquisitions to drive growth. Revenues four-folded from $100 million in 1998 to $400 million in 2000, when Hain and Celestial merged. Growth has been much more modest in the 2000-2008 period, but a compounded annual growth rate of 13% for that period in terms of sales remains very solid.
Sales stabilized and actually fell slightly during the crisis, given that Hain sells luxury products. Coming out of the crisis, aided by multiple acquisitions, growth returned in a big way from 2010 onwards. Revenues were up by 24% on a compounded average rate between 2010 and 2015, and are expected to approach $3 billion this year.
For 2020, Hain has set an ambitious goal to generate $5 billion in sales. That implies growth of $500 million in sales each year, requiring a significant contribution required by further M&A.
Zooming In On Growth
Over the past decade, Hain has achieved incredible growth, increasing sales by a factor of 4 times to $3 billion by now. While deals have played an important role, the company surely has created a lot of value doing so. Organic growth has been combined with the purchase of smaller competitors at relative attractive multiples, while these businesses as a whole were awarded higher multiples under the ownership of Hain.
The growth strategy has resulted in modest margin gains, having increased from the low single digits to 10-11% of sales. Dealmaking has resulted in the issuance of some shares, as the outstanding share base has increased by 30% over the past decade. Despite this dilution, growth numbers per share remain very impressive.
Acquisition-led growth often results in one-time charges, impairment charges and reorganizations, influencing short-term GAAP earnings results. A rapid pace of acquisitions can also create troubles related to the successful integration of all these moving parts, and given that Hain has been active with dealmaking, it may have contributed to recent accounting issues as well.
Before we investigate those issues, let's take a quick look at the acquisitions pursued by the company. Hain has announced numerous deals over the past decade - too many to individually discuss. What is noticeable is that most deals typically involve an acquisition sum of a few tens of millions, as only a handful of $100 million+ deals have been pursued.
Looking at cash flow statements over the past decade shows that roughly $1.2-1.3 billion has been spent on deals as this number. Note that this only involves the cash portion of these deals. Hain has issued roughly 25 million shares over the past decade, at average prices of roughly $20-30 per share, increasing the total price from these deals to roughly $2 billion.
The question is whether this $2 billion has been well spent. Back in 2006, Hain operated with a net debt load of roughly $100 million. The company had 78 million shares outstanding, valued at $15 at the time. This gave the company a enterprise valuation of nearly $1.3 billion, for a 1.8 times sales multiple given the reported sales of $738 million.
The $1.3 billion enterprise valuation has risen a great deal ever since. Net debt has risen from $100 million to $800 million over the past decade. HAIN now trades at $37 per share, for an equity valuation of roughly $3.8 billion, valuing the entire enterprise at $4.6 billion. As roughly $2 billion of this valuation can be attributed to dealmaking, we are left with a $2.6 billion valuation, which is still double the valuation back in 2006. It seems that deals and organic growth have hereby certainly created a lot of value for shareholders.
With sales expected to approach $3 billion, valuation multiples have been modest. The company now trades at roughly 1.5 times sales after the market awarded Hain a 1.8 times sales multiple back in 2006. One thing should be noted. It is hard for investors to zoom in on the real organic growth performance, as the constant pursuit of acquisitions makes it hard to break down organic and deal-related growth. What is certain is that Hain's brands tend to be rather small, indicating that some brands lack the power, recognition or adoption, being a potential risk for long-term investors.
Shares of Hain plunged on the 15th of August following the announcement that the company will delay the release of its fourth-quarter and full-year results for 2016. The issue relates to concessions being granted to certain distributors within the US. The question is whether revenues being associated with the concessions were accounted for in the correct period. These questions triggered an evaluation of internal control and review by the Audit Committee as well as independent advisors.
Under previous accounting periods, Hain recognized revenues when products were shipped to distributors. The company is now checking whether these revenues should really have been recognized when these distributors sold Hain's products to their end customers. Although it could be the case that revenues will shift if the current accounting practice needs to change, total revenues will not be impacted.
Reading through it, it seems that it is really a timing issue (being rather short-term itself), as revenues and profits should not be impacted. In essence, I believe the storm will pass, as we are not talking about inflating profits, sales or the undue recognition of these.
One thing is for sure: the company did include a profit warning into the release, telling the market that it did not expect to meet the full-year outlook for 2016. While the company did not cite Brexit as a reason for the shortfall, recognize that the UK business makes up 25-30% of total sales. The combination of the accounting issue and profit warning was sufficient to sent shares tumbling.
Valuation Becomes Appealing
Back in May, Hain reported its last available financial statements. Sales came in at $750 million for the quarter, a decent 13% increase in constant currency terms. Growth has entirely been driven by acquisitions as Hain made two large deals back in 2015. This includes the $41.5 million deal to acquire Mona, announced back in July of 2015. The main acquisition this year was the purchase of Orchard House, boosting the presence in the UK for a sum of $116 million.
The company indicates that acquisitions added $93 million to quarterly sales, indicating that organic sales growth remains challenging as total sales rose by $87 million compared to the second quarter of 2015. US sales, which did not benefit from acquisitions, grew by 2.4% in the quarter, marking a big improvement from the second quarter. The domestic business posted a fall in comparable sales, indicating that Hain made real progress during the third quarter, although a 2.4% growth number is still not very inspiring for an organic growth play.
Disappointing was the fact that overall adjusted margins fell by a full point to 10.7% of sales, driven by margin pressure in the key US and UK markets. This margin pressure is concerning, but was compensated by the spectacular top line sales growth, allowing adjusted earnings to increase by 9% to $50.6 million.
The company guided for full-year sales of roughly $2.95 billion for 2016, with adjusted earnings seen at $2.00-2.04 per share. For the first nine months of the year, the discrepancy between GAAP and non-GAAP earnings came in at $0.10 per share, suggesting a GAAP number of $1.90 is forecasted. This guidance was released before the profit warning, indicating that both sales and earnings could disappoint slightly in comparison to these numbers.
Leverage remains reasonable by all means, certainly as Hain does not pay out dividends, allowing it to deleverage in a rather quick way. Net of $125 million in cash, total debt stands at nearly $800 million. With quarterly EBITDA coming in at $98 million, leverage ratios are seen at little above 2 times, although the company has a lot of cash flow generating capacity to deleverage in a quick manner. This is certainly the case if organic growth returns in a meaningful way.
Hain has a lot of issues at hand, including non-impressive organic growth numbers, accounting issues and large operations in the UK, not being helpful following the Brexit vote. While this uncertainty weight and could continue to weigh on the shares, the company's long-term fundamentals remain sound.
A 2 times leverage ratio is not that concerning given the solid cash flow generation and lack of dividends being paid out. That leaves the question what the business could look like in the future. By now Hain is a $3 billion business, supporting operating profits of roughly 10%, and even slightly higher if we back out amortization and acquisition-related charges.
We know that Hain targets sales of $5 billion by 2020, as project Terra should result in cost savings equivalent to roughly 1% of annual sales. While these savings could boost margins, management has already indicated that most of these savings will be used to invest into the brands in order to boost the organic growth profile of the business. Given the current troubles, I believe M&A might slow down, and that poses risks to the $5 billion number for 2020, as I see revenues growing to $4.5 billion that year in a more conservative scenario. That still translates into average growth of 10% per year.
I assume margins of 11% for 2020, allowing Hain to report operating earnings of $500 million under my scenario, as EBITDA is likely seen around $600 million. I furthermore assume that growth will be split 50/50 in terms of acquisitions and organic growth. In order for Hain to add $750 million in sales through M&A, it likely requires $1 billion+ in funds to pursue such deals. I recognize that the company will likely generate these funds through retained earnings, with earnings now running at $200 million per year.
As EBITDA continues to rise, Hain should have enough capacity to finance both internal and external growth without diluting the shareholder base. For that reason, I assume a net debt load of $1 billion by 2020. Assuming a 4% cost of debt, interest expenses come in around $40 million per year. With a 30% effective tax rate, given the large overseas assets, earnings should be able to comfortably surpass the $300 million mark for earnings of at least $3 per share in 2020.
In a world in which almost every food player trades at a 20+ times multiple, given the low interest rate environment, a $60 target seems warranted on the back of these results at the time. If organic growth accelerates to mid-single digits, a higher multiple might even applied to that earnings per share number.
The big development in the industry has been the acquisition of WhiteWave Foods (WWAV), of course. This deal was executed at a 3+ times sales multiple, warranting a $100 per share number for Hain if that multiple would be applicable on the projected 2020 revenues. If we use a similar 25 times adjusted EBITDA number, potential valuations would be even higher.
The reality is that Hain has some troubles, while WhiteWave posts much stronger organic growth numbers. Hain has an excellent track record, but growth appears to have been driven by acquisitions in recent times and not by organic growth. Additional concerns include, of course, the accounting issues and Brexit.
If I value Hain at a 2.0-2.5 times sales multiple based on the 2020 prediction, and a 12-16 times EBITDA multiple, valuations range anywhere between $60 and $100 per share, but this valuation only applies in 2020. With shares now trading at $37, upside is anywhere between 60% and 170% under these assumptions, for annual returns of 12% to 28% per annum.
Risks include accounting worries, and they can be scary. Fortunately, the issues appear manageable and not manipulative, but of course, one can always be proven wrong. Other concerns include the reliance on relative smaller brands, which could be a concern with regard to effective cost leverage, marketing budgets and recognition.
Despite the concerns, I do believe the long-term trends outweigh these concerns. A stabilization of the business, return to growth or perhaps even a sale of the entire business act as reasons for my long-term optimism.
Disclosure: I am/we are long HAIN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Adding to my position on further dips.