Hain Celestial's Valuation Already Incorporates Strong Expectations

By Stephen D. Simpson, CFA | August 22, 2013 AAA

Even as someone who isn't all that interested in the “healthy lifestyle” trends of today, I find it interesting to see the sort of visceral reactions that stocks like Hain Celestial (Nasdaq:HAIN), White Wave (Nasdaq:WWAV), and Annie's (Nasdaq:BNNY) provoke in investors/readers. In particular, there appears to be a very vocal percentage out there that are just incensed over the valuation and attention these stocks get and absolutely insistent that healthy/organic eating is just a fad.

Whether it's a fad or not (I happen to lean toward “not”, even though I don't participate), there's no question that these stocks have generated some sizable expectations on the Street. As one of the veterans of the sector, Hain Celestial is a good case in point – today's valuation already more than incorporates assumptions that Hain will significantly outgrow the packaged food sector and generate above-average long-term profits. So much so, in fact, that I find it hard to see how the company can live up to (or grow into) these expectations.

Strong Results Clearly Don't Hurt
Hain Celestial did no harm to the stock's cause with fiscal four quarter earnings that slightly exceeded both top and bottom line expectations.

Revenue rose 32% as reported, good for a small (2%) beat versus the average of Street estimates. U.S. sales rose almost 18%, while acquisitions helped U.K. sales to more than double. Rest of World revenue increased 11% for the period. Stripping out acquisitions, management indicated that organic revenue growth was in “high single digits”, a figure that broadly meshes with the Nielsen data from the quarter.

Hain's margins were better, but still need to improve further. Gross margin rose 40bp on an adjusted basis, while adjusted operating income rose 37% and the adjusted operating margin rose 40bp. These numbers looked slightly below expectation, though, and Hain Celestial beat the bottom-line EPS estimate with the help of a lower than expected tax rate.

Growth Versus Operating Leverage
Hain Celestial has been a strong grower for a while now, as a combination of internally-driven organic growth (both product introductions and expanded distribution) and serial acquisitions have led to nearly 14% compound annual revenue growth over the past decade. With that, company brands like Arrowhead Mills, Terra Chips, and Greek Gods can be found in most retailers, including Whole Foods (NYSE:WFM) as well as Wal-Mart (NYSE:WMT), Target (NYSE:TGT), and Kroger (NYSE:KR).

SEE: How To Eat Healthy Food And Save Money

While the growth has been respectable, the company still has work to do on the margins. The company's return on invested capital has never grown past the mid-single digits, free cash flow growth has lagged sales growth, and the company's gross and operating margins are still below established grocery players like Kraft (Nasdaq:KRFT) and Kellogg (NYSE:K). It's all well and good to talk about the above-average growth potential of natural/organic packaged foods, but that enhanced growth is literally not worth much if the margins are always going to lag.

It's also worth noting that natural and organic foods have increasingly attracted the attention of larger established packaged goods company. Smucker (NYSE:SJM) recently announced the acquisition of another natural/organic company (Enray), and others like Kellogg, PepsiCo (NYSE: PEP), Campbell Soup (NYSE:CPB), and General Mills (NYSE:GIS) own organic brands as well – and can often use their existing manufacturing and distribution capabilities to good effect.

The Bottom Line
I don't believe Hain Celestial has to worry about being outmaneuvered by established packaged food companies so much as whether management can drive enough growth and margin improvement to satisfy the expectations already factored into the stock's valuation. At today's price, Hain Celestrial already needs to grow cash flow at a high teens rate just to be “fairly valued”, and that doesn't leave much room for error. With that, it's hard for me to be all that positive on the shares, though I won't be surprised if strong revenue growth keeps the margin concerns at bay for at least a little while longer.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

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