On September 25th, I wrote an article about why I believed Annie's (BNNY) stock was significantly overpriced and bound to drop. At the time I wrote the article, the stock traded at $46.64. In the last five weeks, Annie's stock has declined $7.14, or 15.3%, to close at $39.50 last Friday (October 26). Annie's stock has fallen much greater than the broader market, which is not surprisingly given how overvalued Annie's stock was and continues to be.
On Tuesday, October 30th, Annie's released its Q2 fiscal year 2013 financial results for the quarter ended September 30. In this post I analyze the company's the Q2 results compared to the prior year's quarter and Wall Streets' estimates. I also re-visit Annie's valuation and discuss why the stock still has downside potential of 28-37%.
Q2 Fiscal 2013 Results vs. Prior Year (Q2 Fiscal 2012)
According to Annie's press release, the company reported net sales of $46.7 million for the second quarter of fiscal 2013, an increase of 20.1% over the second quarter of fiscal 2012. Gross profit was $17.9 million, an increase of 26.6% over the second quarter of fiscal 2012. Gross margin in the latest quarter was 38.3%, a 1.9% increase over gross margin of 36.4% in the second quarter of fiscal 2012. The more favorable gross margin was more than offset by higher SG&A expense which grew from $8.1 million in Q2 2012 (20.7% of net sales) to $11.5 million in the latest quarter (24.7% of net sales). Operating margin declined from 15.6% in Q2 fiscal 2012 to 13.6% in Q2 fiscal 2013. Adjusted EBITDA was $7.6 million (16.3% margin) in the latest quarter versus $6.4 million (16.4% margin) in Q2 2012. Finally, adjusted EPS was $0.24 in the latest quarter, an increase of 9.1% over Q2 2012 EPS of $0.22.
These results are mixed (see my comparison chart of Q2 2013 versus Q2 2012). Annie's is growing its net sales and profitability in an absolute sense, but the company's margins (EBITDA, Operating Income and Net Income) were all worse compared to the prior year. Yet these results cannot be evaluated in an absolute sense in a vacuum. The results must also be compared relative to the market's performance expectations, specifically Wall Street's estimates.
Q2 Fiscal 2013 Results vs. Wall Street Estimates
In evaluating Annie's Q2 financial results, I compiled estimates from six Wall Street banks that publish research on the stock. My compilation shows estimates from net sales down to earnings/EPS, including margin projections.
Wall Streets' consensus forecast for net sales was $46.0 million, and Annie's came in slightly better than consensus at $46.7 million, or 1.5% better. Wall Streets' consensus forecast for adjusted EBITDA was $7.6 million, and the company came in on top of consensus estimates, although it missed on margin (16.3% adjusted EBITDA margin versus consensus estimate of 16.6%). Wall Street consensus forecast for Annie's operating margin was 15.9% (a slight improvement versus prior year), but the company disappointed with operating margin of 13.6%. Annie's also missed bottom-line profitability by generating adjusted net income of $4.2 million (9.0% margin) versus consensus estimate of $4.4 million (9.5% margin). Similarly, the Street was looking for adjusted EPS of $0.25 per share, whereas Annie's earned $0.24 per share for a one penny miss. The bottom-line miss was driven by substantially higher SG&A expenses (the Street forecast $10.4 million of SG&A, or 22.7% of net sales, whereas the company actually spent $11.5 million, or 24.7% of net sales) and a modestly higher tax rate. The accompanying chart shows a comparison of Q2 actual performance versus Wall Street consensus estimates and highlights where Annie's over- or underperformed. As shown, Annie's slightly over-performed on top-line sales and gross profit, but underperformed in nearly every other aspect, including Operating Income, Net Income, EPS, and every margin category.
According to my calculations, Annie's is currently trading at 4.4x net sales, 30x adjusted EBITDA and 73x adjusted earnings. Based on forecasts for fiscal 2013 (1-year forward), the company is trading at 27x adjusted EBITDA and 48x adjusted earnings. In an absolute sense, these valuation levels are in nosebleed territory and are completely unsustainable in the long-run. In a relative sense, Annie's valuation must be evaluated relative to its peer "comparable" group, such as Hain Celestial Group (HAIN), Whole Foods Market (WFM) and other companies in the natural and organic food category. Peer "comparable" companies are trading around 14x 1-year forward EBITDA and 25x 1-year forward earnings, or roughly half the level of Annie's. Thus, based on a comparison of these substantially larger and better capitalized companies operating in the same industry, Annie's appears considerably overvalued.
As I've written in several comments, investing is a two-step process. The first step is finding good companies. The second step - the one most overlooked by investors - is paying a fair price for those good companies. Simplistically, here are the formulas that investors can use:
- Good company + fair (or undervalued) price = good investment
- Good company + overvalued price = bad investment
- Bad company + any valuation = really bad investment
Overpaying for a good company is simply NOT a good investment. Benjamin Graham, Warren Buffet and countless other value investors can attest to this fact. I think Annie's is a good company, and won't try and argue otherwise (I already admitted in my first article that I buy their food). Unfortunately Annie's is NOT a good investment, because of its stratospheric valuation.
So what's a reasonable valuation for Annie's, and where should the stock trade? In my analysis, I start with Annie's adjusted EBITDA for fiscal 2014 of $32.7 million (Wall Street consensus estimate). Note that this 2-year forward EBITDA estimate is roughly 44% higher than the company's trailing twelve month adjusted EBITDA of $22.7 million. Said another way, Annie's must deliver another 2 years of growth at 20% per annum to achieve EBITDA of $32.7 million by fiscal 2014. Next, I apply a range of multiples (13-15x, in line with Annie's peer group) to arrive at a Total Enterprise Value of $425-490 million. Add the cash on balance sheet and the implied Market Capitalization is $440-505 million, or $24.80-28.50 per share. In my view, Annie's stock must fall another 28-37% to reach fair value. Thus, I continue to recommend that investors short Annie's stock or buy put options to take advantage of an eventual price correction.