HAIN remains on the Hedgeye Best Ideas list as a short.
On the surface, HAIN reported a strong quarter and the stock responded nicely, trading up ~11% on the day. 4Q14 adjusted earnings from continuing operations were $0.90 compared to $0.65 in 4Q13, good for a 35% increase year-over-year. On the call, management reported a strong 7.5% organic growth rate for 4Q14 and 8.5% for FY14. Guidance for organic growth remains in the mid-single digit to high-single digit range for FY15.
The adjustments made to continuing operations are a list of recurring and non-recurring items that, in our view, lower the quality of the reported number. Notably, these adjustments are getting bigger each quarter. In 4Q14 the adjustments to net income totaled $0.15, 50% greater than the $0.10 of adjustments in 4Q13.
The current adjustments to net income of $10.3 million are principally from:
- $6 million related to the voluntary recall
- Start-up cost of $3.8 million primarily related to Project Castle (the chilled desserts facility in the UK)
- $2.9 million of acquisition related fees and expenses, including integration costs from Tilda and Rudi’s
- $2.2 million non-cash valuation reserve on net operating losses incurred along with the start-up of the non-dairy facility in Europe
It’s amazing to see that a company can get away with adjusting earnings for growth related innovation and operating costs that are desperately needed to grow organic revenues. The company also reported $4 million of non-recurring income including a true-up of contingent consideration earn outs, unrealized currency gains and gains from the sale of shares.
On top of that, the company continues to push SG&A lower in order to drive operating margins. In 4Q14, SG&A on an “adjusted” basis (excl. amortization of acquired intangible assets) was 14.4% of net sales, a 110 bps improvement versus last year.
Therefore, despite higher commodity costs, HAIN “effectively managed operating expenses” to report a 49% increase in “adjusted” operating income to $73.9 million and a 200 bps improvement in operating margin to 12.7%. We continue to view the steady, significant reduction in SG&A as a competitive long-term disadvantage. In fact, we’d go as far as to say that the company’s margin structure is highly unsustainable and, as a result, it is currently over-earning in an increasingly competitive environment.
One of the core tenets of our short call was the lack of leverage in the business model. Despite a 200 bps improvement in operating margins, the company only reported “adjusted” EBITDA of $79.5 million or 13.6% of net sales versus 13.5% last year. It’s clear to us that the management is far away from hitting its objective of delivering long-term growth EBITDA of 15% to 18% of net sales.
The company’s inability to leverage its cost structure is clearly illustrated in the chart below.
The biggest risk to our short thesis was the strong revenue growth the organic sector is seeing. But, as you can see below, sales trends are expected to continue to slow at HAIN. In order to sustain its past level of growth, management will need to acquire more brands in FY15.
Net sales guidance for FY15 is between $2.7 billion to $2.8 billion, with approximately two-thirds of growth coming from acquisitions and one-third coming from organic sales. If this plays out, HAIN expects to deliver FY15 EPS within the guided range of $3.72 to $3.90.
While today is painful, we are sticking with our short thesis.
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