With MJN catching two Old Wall downgrades in two days, it made sense for us to start poking around for reasons to get more constructive, rather than follow the crowd and drive while looking in the rear-view mirror.
MJN is set to report Q4 2012 EPS on January 31st, and this looks to be one of the more closely scrutinized EPS announcements of the upcoming reporting period. MJN is coming off two substandard EPS results associated with market share, pricing and distribution issues in China. While we have longer-term concerns regarding the sustainability of the margin structure in China, we believe the issues in China that have been the catalysts for recent, negative EPS revisions to be shorter-term in nature and now largely in the past. We prefer to look at a potential tailwind that is emerging in a market that has likely been left for dead by investors – the good ole’ USA.
The company’s margins in the mature markets of North America and Europe have declined from 32.62% at the end of ’09 to 19.76% in the most recently reported quarter. Low birth rates, broader economic issues and increases in breastfeeding rates have forced manufacturers to aggressively pursue share in a declining volume environment. Drafting off of some of the consistently excellent work done by our Healthcare vertical, we can see reasons why the issues of low birth rates and breastfeeding might move from a headwind to tailwind.
Increases in breastfeeding rates have been a headwind in the United States – some of that is secular, some cyclical. The secular component is a well-documented and often times aggressive (I say that as a relatively newly-minted father within the past five years) campaign on the part of various public and private health care organizations regarding the health benefits associated with breastfeeding. The cyclical component is less obvious, but no less important – intuitively, unemployed women are more likely to initiate breastfeeding and women who work full time are more likely to terminate breastfeeding earlier. Therefore, improvements in female employment trends would be a benefit to the infant nutrition sector.
Our healthcare team has done great work to show that maternity should accelerate, as outlined in the chart below. It estimates that “the drop in births since 2007 has led to a backlog of upwards of 700,000 to 1,500,000 maternity cases, which is significant when compared to an annual rate of 4M annual births. Additionally, the best macro indicator is the employment of women between the ages of 20 and 34. A growing demographic and the backlog in births should lead to accelerating births in the US over the coming quarters and years.”
Additionally, increases in birth rates among women in the age group of 30-45 years old has been constructive as older, more financially stable parents are presumably able to spend on children at a higher rate than younger, first time parents.
We have some concerns about how the market reacts to the company’s initial 2013 earnings guidance (historically provided on the Q4 conference call). Consensus currently contemplates $3.37 in 2013 vs. $3.04 in 2012 (one quarter remaining, and Q4 may be too high as currently modeled by consensus). This represents 10.9% growth. For perspective, the company has never guided to double digit EPS growth at the midpoint of the range with its initial guidance– 5.4% 2010 vs. 2009, 7.4% 2011 vs. 2010 and 9.3% 2012 vs. 2011. Sales growth guidance has historically been at least 7% (7-9% was the initial guide for 2012, the most aggressive the company has been). Consensus is looking for 8% sales growth. We view management as a reasonable, conservative “guider” and would be surprised if the leopard decided to change its spots.
Assuming a base of $3.00 in 2013, 9% EPS growth at the mid-point would represent $3.27 – consensus is $3.37. Under more normal circumstances, we suspect that a guide below consensus would be largely shrugged off by investors – it’s unclear to us that would be the case, particularly if coupled with a below consensus result as we are modeling. Investors are justifiably a little shaken given some hiccups over the past year, so the benefit of the doubt may be in short supply, even if history suggests it is warranted. Ultimately, we don’t see consensus for 2013 as being unreasonable – we are at $3.35. We recognize that Q3 provides some easy comparisons as we move through next year, but we don’t think management will guide that way.
Looking at all this, we are going to stay on the sidelines as we approach the company’s earnings release with the stock hovering close to the $70 mark, preferring, if our math and thinking are correct, to wait for an opportunity lower. Closer to or below $60 per share, with consensus presumably corrected, we think the name makes sense as we move through 2013. At $60 per share, MJN would be trading at 18.0x our EPS estimate for next year, which in our view would make it a far more compelling investment than names like CLX (17.3x ’13), KMB (16.5x ’13), HNZ (16.6x ’13), or CL (18.5x ’13) that do not share as compelling a growth profile as MJN.
HEDGEYE RISK MANAGEMENT, LLC