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HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected)

Takeaway: The sum of the parts analysis has been updated to reflect better math!

HAIN in on the HEDGEYE Best Ideas as a SHORT!


Being short HAIN has been the pain trade for me. 

 

That being said, the FY15 financial performance (negative earnings revisions and declining margins) over the past 12 months does not warrant a multiple expansion.  Unfortunately, over the past 12-months the NTM EV/EBITDA multiple expanded from 13.6x to 16.8x today.  At the time of our SHORT call we argued the company was overvalued because the international business (UK) was a slow growing, low margin food business that did not deserve to trade at a U.S. Organic food company multiple.

 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 1 

 

The exact opposite happened!

 

To that end, our thesis has not changed but has strengthened over the past six months.  The company continues to provide little evidence that they have a sustainable business model, additionally management does not disclose the basic information analysts need to understand what the real organic growth rate is.  We believe that there are structural impediments to future margin improvement, making the bull case even more suspect.  The biggest impediments to margin expansion are:  

  • Global geographic diversification put pressure on margins
  • The two most recent acquisitions are low margin protein businesses
  • The limited supply of global Organic ingredients is hurting gross margins
  • Increased trade spending will lower gross margins

According to the current sell-side models the HAIN business model will look very different in FY16 versus the past four years.  Frankly, I have no explanation for the change in the sell-side logic other than they need to be bullish on the stock due to its Natural & Organic attributes.

 

The key components to the changes are:

  • Gross margins will expand in FY16 after declining for the past four years
  • The company will not be cutting SG&A any more
  • Operating margins will expand in FY16 after declining in FY15

The following is a look at why the current models are too aggressive in FY16:


GLOBAL DIVERSIFICATION LEADS TO LOWER MARGINS

Over the course of six quarters (to establish its international business), HAIN bought four international businesses for a total of $600 million. 

  1. October 29, 2012 (2Q FY13) HAIN acquired Premier Food and Jams for $315.8 million. 
  2. On April 27, 2012 (4Q FY12) HAIN acquired Cully & Sully Ltd. for $19.8 million. 
  3. On October 25, 2011 (2Q FY12) HAIN acquired Singapore Food Industries Ltd. from SATS Ltd., for $254.5 million.
  4. On October 5, 2011 (2Q FY12) HAIN acquired Europe's Best, Inc. from The J. M. Smucker Co.

Importantly, none of these businesses are organic or all-natural.  This is in direct conflict to the U.S. business which is primarily Organic and the reason why the UK business should trade at a lower multiple. 

 

Collectively HAIN’s new international businesses are producing low single digit operating margins, while the U.S. is running at 17%.  Going forward, with the company now seeing 20% of its revenues coming from international with 1/3 of the margins and another ~12.3% from its latest protein acquisitions with mid-single digit margins it will be hard to grow overall margins.  To summarize, HAIN can’t cut G&A to offset the gravitational pull of lower margins or it will sacrifice performance in other areas of the company.   

 

GROSS MARGIN PRESSURE

For the past three years HAIN gross margins have been declining at a fairly steady rate.  Since 2Q FY11 the company’s adjusted gross margins have declined from 29.3% to 26.6%, or 270bps.  Gross margins are under significant pressure from commodity headwinds, mix shift and increased trade spending.  We don’t see these issues abating in FY16.  The current consensus sees a dramatic shift in HAIN’s gross margins in 1Q FY16.  What has changed in order for management to guide to better gross margins in FY16? 

 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 2 

 

MASSIVE CUTS IN G&A ARE CRITICAL AND UNSUSTAINABLE

Can any company cut G&A at the rate HAIN has and sustain critical mass?  Does outsourcing G&A functions create sustainable long term advantage?  I feel this is a big risk to the HAIN business model!

 

Prior to making the series of international acquisition in FY12 HAIN had not relied on G&A cuts to drive margin expansion.  Obviously, when they acquired lower margin business they need to cut significant amounts of G&A to prevent the overall margin structure of the company from collapsing.  Until FY15 they have achieved the intended goal.

 

Prior to 2QFY12, over the previous five quarters HAIN had only cut G&A by 9bps.  Since 2QFY12 the need to cut significant amounts of G&A has become critical to the overall story.  From 2QFY12 to 3QFY15 the company has experienced on average 132bps reduction in G&A.  Over that same time G&A has gone from 18.7% to 13.45%, or 496bps. 

 

Over the past 12 months HAIN’s G&A has run has 13.75% of sales, as compared to 20% for most of HAIN non-organic companies and 23% for the biggest organic companies.  Either HAIN has figured out a better mouse trap or this company is structurally set up to fail.    

        

Now the company is in a very difficult position, the margins internationally have stopped improving and there is incremental pressure on the margins in the U.S. business.  HAIN can’t cut G&A and be a company that is built to last. 

 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 3

 

OPERATING MARGINS HAVE PEAKED

Looking forward into FY16 the street consensus has HAIN returning to growth in operating margins.  The improvement is entirely coming from improved gross margins, which seem counter intuitive to what is happening in the market place.    

HAINS LTM EBIT margins have gone from 9.5% in 4QFY11 to 11.6% in FY4Q15.  In FY15 LTM EBIT margins have gone from 11.8% to 11.6%.  FY15 will represent the first time in 4 years that the company has not shown margin improvement.  Why will the trajectory change in FY16? 

 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 4 

 

Our bottom line for HAIN is that the margin story is over!

 

When the music stops it's going to be real ugly!

 

SUM OF THE PARTS

The following charts are a look at the top line growth rate for the HAIN’s important regions.  As you can see the two most important markets U.S. and UK are showing a significant slowdown in revenue growth.  Importantly, the UK business revenue growth is estimated to slow 1% over the balance of FY16.  What is the organic growth rate of a company with 1% revenue growth?  And why should it trade at a premium multiple?  Even the U.S. business is slowing to the mid-single digits.  Again, the company organic growth will not be in the high-single digits in FY16.  

 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 5 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 6 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 7 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 13 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 9 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 10 

 

What do you pay for a company that is seeing a significant slowdown in revenues and can only grow margins by cutting massive amounts of G&A? 

 

I understand that my bearishness on HAIN ignores the roll-up story and all the hype surrounding the growth taking place in the organic market.  At best the UK business is seeing low single digit organic growth of 1-2 and high single digit operating margins.  We believe the UK business should trade at a significantly lower multiple than the U.S. business.

 

Our sum of the parts table is below:

 

HAIN – THE OPERATING MARGIN STORY IS OVER (Corrected) - Hain Chart 14

 


Cartoon of the Day: Mario "Answers" Reporter's Question

Cartoon of the Day: Mario "Answers" Reporter's Question - Euro cartoon 05.18.2015

The ECB will not stop short in rolling out its trillion-euro-plus money printing scheme, its president Mario Draghi said last week, playing down fears that QE could blow price bubbles.


Keith's Macro Notebook 5/18: USD | Gold | Europe

 

Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.


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Dollar Getting Smoked

The U.S. Dollar was smoked on that bad Retail Sales report last Wednesday. It proceeded to close the week on its lows (down -1.8% week over week and -5.3% in the last month).

 

We’re staying with the counter-TREND call (Down Dollar, Up Commodities) until we get through what should be a dovish June 17th FOMC meeting.

 

On a related note … Lower-for-longer on rates being priced in – Hilsenrath’s WSJ article reiterating the same this morning.

 

Dollar Getting Smoked - z 44 05.18.15 chart

 

***This is an excerpt from our morning research. Click here to learn more about what we offer and how you can subscribe.


LEISURE LETTER (5/18/2015)

Tickers:  27.HK

headline news 

Macau government only approves 150 of the 400 casino tables requested by Galaxy. Galaxy will have to move tables from other casinos under the group’s umbrella to the new casino grounds of Galaxy Phase 2.

ARTICLE HERE

Takeaway: While there hasn't been an official announcement, this media source has been credible in the past.  150 is exactly in line with our expectations. 

COMPANY NEWS  

Bid for BWIN - 

  • 888 Holdings has submitted a proposal regarding the acquisition of bwin.party, comprising of cash and 888 shares.
    • The proposed transaction will require the approval of 888 shareholders
    • 888 shareholders representing ~59% of 888's share capital have irrevocably committed, subject to customary conditions, to vote in favour of the proposed transaction
  • Earlier reports indicated that a merged 888-Bwin Party business could be worth over GBP 1 billion

  • Bwin Party has been on the sales block since last November 

ARTICLE HERE

Takeaway: A bidding war among 888, GVC, and Amaya

 

Viking - Newly launched Viking Ocean Cruises is the first cruise line in several years to not include noncommissionable fees (NCFs) as part of the cruise commission structure. The line made its official debut on May 17 with the naming of its first ship, the Viking Star, in Bergen, Norway.

 

From the start, Viking Chairman Torstein Hagen has made “no nickel and diming” one of the cornerstones of the new line. For passengers, that translates into benefits like unlimited free Internet access and complimentary wine and beer with lunch and dinner.

 

For agents, it means the line items that other cruise lines designate as “noncommissionable,” such as port charges and taxes, are included in the amount on which commissions are calculated. Viking is hoping that this will help distinguish it from other lines in the small-ship, upper-premium category. Several agents said that the policy is welcome, and that if their clients are otherwise qualified for Viking, they would recommend it as a good business move.

ARTICLE HERE

Takeaway: A move by Viking to lure agents as they enter the ocean cruising industry.

INDUSTRY NEWS

Macau hotel promotions - Galaxy is introducing hotel promotions to mark the new property openings, while Sands China offers discounts of up to 50%. 

ARTICLE HERE

Takeaway: Pressure on ADR

 

Macau hotel pipeline -  As of March 31, 2015, Macau saw 18 hotel projects under construction and 25 hotel projects undergoing government approval, which could provide about 25,600 new hotel rooms in total, the latest data released by the Bureau of Land, Public Works and Transport (DSSOPT) shows.

 

The January to March period saw seven fewer hotel projects under construction than the previous quarter. For the 18 projects under construction, most of the over 9,800 hotel room inventory is earmarked for Cotai: five hotel projects were being built in Cotai during the period, which could release over 7,500 rooms.

 

On the Macau Peninsula 10 hotel projects were being built in the first quarter that could potentially provide over 1,000 rooms; in Taipa, the official data stated that two hotel projects were being built in the period, which could put over another 1,000 rooms in the pipeline. The ongoing construction of a hotel project in Coloane could supply about 200 rooms.

 

Meanwhile, some 25 hotel projects are in the planning stage and are undergoing government approvals, which could release more than 15,700 rooms to the market, according to DSSOPT data.

 

While the number of operating hotel rooms by March is almost level that of the same period last year, the occupancy rate declined by 8% points to 79.3% in 1Q 2015 – a time when the number of hotel guests has also declined by 11.6% to about 2.3 million. The last time that the hotel occupancy rate here was below 80% was the first quarter of 2013.

 

A separate set of data provided by the Macau Hotel Association  shows the occupancy rate in the 5-star hotels was 82.72%, almost 9% points lower than the same period last year; the occupancy rate of 4-star hotels was 80.76%, representing an 8.5% points YoY drop.

ARTICLE HERE

Takeaway: Lots of hotel supply coming, not just on Cotai in the face of rapidly declining occupancy rates. 

 

Manila Bay Resorts - Tiger Resort, Leisure and Entertainment Inc – a firm controlled by Kazuo Okada that is developing the Manila Bay Resorts casino property in the Philippines  said via email to GGRAsia, "Given that we have submitted a request for extension of our provisional licence for the first quarter for 2017, we are actively targeting to open the property by 2016. Our Phase 1 spans across our hotel, casino, nightclub and the iconic fountain with a variety of…restaurants...”  “Tiger Resort is currently in review with Pagcor regarding extension of our project implementation plan. Having already committed approximately US$750 million into the project, with a further US$1 billion pending, and having completed more than 50 percent of the construction we believe we are in compliance with the terms of the provisional licence," the company added.

 

But Tiger Resort has not yet announced a local real estate partner for the scheme. Local media have reported that the need for a local development partner relates to a requirement under the country’s constitution and public land laws that only Filipinos, or entities owned at least 60% by Filipino citizens, are allowed to own land. That restricts Mr Okada and his majority-owned companies to just 40% ownership of the land on which the resort is located.

ARTICLE HERE

 

 

MACRO

Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.


MACAU WEEKLY ANALYSIS (MAY 11-17, 2015)

CALL TO ACTION

Another bad data point – we’d really like to bring good news, a positive pivot, a reason for hope, a catalyst on the horizon, but not today. Following a stronger sequential week due to the May holidays, table revenues are back to bad, and down 40% YoY. Our forecast for the full month of gaming revenues is not quite as bad, owing to easier weekly upcoming comps, but nobody should rejoice over a down 35-38% month. Our concern remains with the base mass where we see the biggest negative delta from Street expectations. Indeed, visitation and floor activity looks weak in May as well.

 

 

Please see our detailed note: 

http://docs.hedgeye.com/HE_Macau_5.18.15.pdf


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