Market Ignores Big Picture: Punishes Hansen on Gross Margins

On 2/28/08, Hansen Natural Corp. (HANS) reported its 4Q and fiscal 2007 results.

4Q 2007 Highlights

** Gross sales up 61.5% to $277.3 million from $171.7 million in 4Q 2006
** Net sales up 63% to $246.6 million from $151.3 million in 4Q 2006
** Cost of sales $120.9 million from $70.92 million in 4Q 2006
** Gross margin down to 51% from 53.1% in 4Q 2006

** Net income up 103.1% to $45.1 million ($0.45 per share) from $22.2 million ($0.23 per share) in 4Q 2006
** Profit margin 18.29% from 14.67% in 4Q 2006
** Diluted share count 99,512,000

** Cash and cash equivalents $75.57 million
** No debt

** Cash flow from operating activities $45.35 million from $11.86 million in 4Q 2006
** Cash flow from investing activities -$94.63 million from -$20.75 million in 4Q 2006
** Cash flow from financing activities $2.64 million from $90K in 4Q 2006

Fiscal 2007 Highlights

** Gross sales up 47.3% to $1.03 billion from $696.3 million in fiscal 2006
** Net sales up 49.3% to $904.5 million from $605.8 million in fiscal 2006
** Cost of sales $436.45 million from $289.18 million in fiscal 2006
** Gross margin down to 51.7% from 52.3% in fiscal 2006

** Net income up 52.5% to $149.4 million ($1.51 per share) from $97.9 million ($0.99 per share) in fiscal 2006
** Profit margin 16.52% from 16.17% in fiscal 2006
** Diluted share count 98,874,000

** Cash flow from operating activities $135.45 million from $76.41 million in fiscal 2006
** Cash flow from investing activities -$194.73 million from -$95.23 million in fiscal 2006
** Cash flow from financing activities $36.59 million from -$7.71 million in fiscal 2006

• Press Release

Analysts were on average expecting an EPS of $0.38 on sales of $212.2 million. Hansen managed to smash both of these estimates by a decent margin, but investors are spooked by the lower gross margins (which is a result of pricing pressures), sending the stock down more 6% Friday. While I won't say that this isn't a legitimate worry, there is no doubt in my mind that the market is overdoing it and completely ignoring the other aspects of the company. Isn't the bottom line what truly matters? If so, the market should be extremely pleased with these results, given the fact that Hansen put up earnings numbers not too far off from its high flying, Wall Street darling days of just 2-3 years ago. Hansen's bottom line efficiency is greatly growing.

Of course higher prices will impact gross margin and cost of sales. But a truly great company will be able to work past that and increase efficiency. That is essentially what Hansen did this quarter and investors should realize that. That isn't to say higher costs aren't worth worrying about, all I'm saying is Hansen is in extremely dedicated and experienced hands and they've shown time and time again that they can work the company through tough times. I believe there is a very good chance prices will continue to rise this year, but I am not the least bit worried due to the fact that Hansen is simply in the right hands with its own management team as well as the backing of Anheuser-Busch and PepsiCo Canada with distribution. Really what the market is worried about here is whether or not Hansen can continue to sell drinks with a shaky and potentially far more volatile economic situation. This comes down to whether or not Hansen has much pricing power left in it.

My opinion on Hansen's pricing power is that Hansen has a good deal of it, more than any other major energy drink out there at the current time. I say this because Monster is hands down winning the energy drink market now and it will only be a matter of time before it is ahead of Red Bull in market share. I just got back from a road trip down to Mexico and in all of the gas stations we stopped at (in the U.S. of course) Monster had prime shelf placing and often 2-3 rows of products. Monster is becoming the preferred energy drink and Hansen has Anheuser-Busch to really push distribution forward and gain the most and top shelf placement it can get.

Hansen has been working on and releasing a bunch of terrific new products in the past several months and I can't help but think they will be big once distribution with them picks up. The Java Monster drinks are in a wonderful position because it gives people a quality energy drink option from the normal, carbonated ones people are used to. I really believe Hansen is both expanding the bottled coffee market but also creating something pretty big with the coffee energy market. Just as Starbucks redefined the bottled coffee market 15 or so years ago, I believe Hansen is redefining the energy drink market with Monster. With the expansion of the Monster and Java Monster brands, Hansen has created something that will be much more than a one time fling with consumers.

Back to this quarter's results. Cash flow production, as usual, has been fully ignored by Mr. Market. Cash flow production quadrupled in the 4Q, ho-hum. Nothing exciting there. In all seriousness, I believe this symbolizes more of what we'll see in fiscal 2008. For the better part of last year Hansen was slowed by the options investigation all while developing the partnerships with Anheuser-Busch and PepsiCo Canada. Hansen now has the investigation completely behind it, the partnerships are at or close to full throttle, and the company has a fresh batch of awesome new products that should help boost results and market share. Pricing pressures will stay and there is a good chance will increase. But I believe Monster has more pricing power if that ends up being what the company needs. In short, I believe we're in for a great, exciting year, and as long as Hansen continues to report results like this the market won't be far behind.

For the coming 1Q 2008, analysts are on average expecting an EPS of $0.36 on sales of $219.98 million.

Disclosure: Long HANS

Comments

[rizal1509:]

Hansen's 4Q07 result announced was remarkable considering the recent and current market environment. Investors failed to looked at the big picture and as you said, get spooked by the slight decreaed in margin. Any experienced company will know how to manage the increase in costs of production and I am sure Hansen is capable of doing that. Some of its new products are just making their way in the market and this would surely help to boost up the sales volume for Hansen especially with the 2 partnerships.

2008 Mar 02 09:38 PM

[Blenderboy:]

I totally agree with your analysis. What food or drink maker won't see cost input pressure? The fact that they dropped more earnings to the bottom line on a percentage basis is the real story.

Keep in mind that everyone got killed on Friday and that the market is going to be tough for a while, but the operating momentum and market opportunity HANS has going forward makes it an extremely good buy at these prices. I'll take 50% growth at a forward 20 times earnings with no debt everytime. Isn't HANS a stock Peter Lynch would love?

2008 Mar 03 12:34 AM

[GH:]

The margin "issue" is a non-issue; it's directly a result of the slightly lower margins already known and expected for the Java Monster drink, as it ramps up from relatively lower volumes. This is straight out of business operations 101, but apparently the idiot Lezard analyst who sounded an alarm about margins didn't take that course.

David, you have it exactly right, HANS is about to return to the "Darling Days" when shorts got murdered for betting against this company... only now the valuation has been reset to the KO and PEP level, so there is no excuse for being short. 11 million short shares are about to be deeply underwater.

2008 Mar 03 09:04 AM

[btr0037:]

do you think investors should consider that $227m is locked up in illiquid auction rate securites and another $63m is invested in munis? This is over 70% of the company's net worth..........

2008 Mar 28 10:25 AM