HAIN | SOMETHING NEW UNDER THE SUN?

Hain Celestial (HAIN) is on the Hedgeye Consumer Staples Best Ideas list as a SHORT.

 

It might be a stretch to draw similarities between Valeant (VRX) and HAIN, but we see some very eerie similarities relative to their respective industries.  The centerpiece of the SHORT call on both companies is focused on that fact that roll-up models carry big risks and rarely work over the long run.   

 

Our Healthcare team used the following quote when they wrote the SHORT presentation on VRX last summer:

“That which has been is that which will be, and that which has been done is that which will be done. So there is nothing new under the sun.” -Ecclesiastes 1:9

 

The SHORT story was centered on Valeant operating an unsustainable business model of “serial acquisitions and underinvestment, fueled by debt that will continue to lead to deterioration in the ongoing business.”  While the VRX story is just now coming to light and some smart money owns the name, there are now some very serious questions being asked about the company’s business model. 

 

In our view, HAIN is essentially no different.  HAIN is operating an unsustainable business model of serial acquisitions and underinvestment in its brands that will continue to lead to deterioration in the ongoing business.  In addition, the recently acquired businesses carry lower margins and overall returns.  One difference would be that HAIN’s balance sheet is not overly leveraged.

 

Like VRX trying to change the pharmaceutical business model, HAIN is trying to redefine how a typical food manufacturer operates a traditional business and that carries significant unquantifiable risks.  These risks will ultimately lead to the company trading at a discounted multiple over time.   

 

COMPANY GROWTH STRATEGIES

In the case of VRX, the company purchases innovation through serial acquisitions, exchanging R&D costs for interest payments and integration and restructuring costs (R&D spending at acquired companies is dramatically reduced).  In the case of HAIN, HAIN purchases “new brands” through serial acquisitions; exchanging G&A costs for interest payments (higher share count) and integration / restructuring costs (G&A spending is nearly eliminated at acquired companies over 12 months following the acquisition.)  HAIN further complicates its strategy by diversifying into new “organic” categories in which they are not part of the core competency of the company.    

 

THE RISKS

The short case for Valeant’s “new model” carries new and underappreciated risks.  We now know what some of those unappreciated risks are for VRX.  For HAIN, the street is just learning about some of the underappreciated risks.  In our last note on HAIN, we outlined one of those risks that we see as being underappreciated by the market – outsourcing key brand related functions.    

   

One of our biggest issues with HAIN is the secular decline in gross margins.  As the environment for “better-for-you” products in the U.S. gets more competitive, HAIN will not be able to defend brands or market position.  To that end HAIN, like VRX, does not invest much in R&D.  In FY2015, HAIN incurred approximately $10.3 million in company-sponsored (less than 0.5% of sales) in R&D, up only from $10.0 million in 2014.  Given how competitive this market is, spending 50% less on R&D than their competitors, is a long term issue for the company.  In addition, HAIN like all other consumer staples companies does not report the spending incurred by co-packers and suppliers on R&D, which does benefit the company.  That being said, outsourcing a critical function like R&D is an unquantifiable business risk. 

 

As we see it, the only weapon the company has to defend itself from a secular decline in gross margins is to make massive cuts in G&A.  Cutting G&A is never a long term winning proposition, and cutting too deep can put the long-term business model at risk.  In 4Q15, it looks as if they are cutting into the muscle of the company.  With the current G&A cuts announced for 2016, HAIN is now taking a big risk with their most important distribution channel. 

 

In 4Q15, HAIN announced that they were moving their natural channel sales/merchandising team to Advantage Sales & Marketing to “drive SG&A productivity.” Advantage is a third party national sales and marketing company that works with many companies within the consumer packaged goods space.

 

This is just the latest move by HAIN to reduce costs, saving them roughly 20-25% per year. Advantage is used by some of the big players to supplement their sales and marketing in the natural & organic channel, specifically on slower moving sku’s. The problem with HAIN’s use of this company is its sole dependence on it, as they said they moved their entire natural channel merchandising team to Advantage.

 

Transferring the entire operation out of HAIN is strategically a very risky idea and could lead to a loss of brand expertise at the company.  HAIN will effectively go from managing their brands first hand to having a third party manage them, depending on how their contract is structured (dedicated resources or not) will be a pivotal factor.  The biggest advantage of an internal sales force is, share of mind, you want your employees pitching your products. How do you know the third party will be representing your brands in the best light? 

 

These risks will only be known over time as selected brands begin to show slowing organic growth.    Unfortunately, the street will never know that until it is too late, because the company lives in a culture of no bad news and does not disclose key metrics that allows investors to understand how the business is truly performing.  Knowing they have something to hide, management has never consistently given the street historical context on:

  • Organic sales growth by segment
  • Non-organic sales growth by segment
  • Volume growth by segment
  • Price/mix by segment
  • Shipment vs consumption timing
  • Quarterly tone of business by region

 

Getting past the obvious similarities of roll up stories, HAIN is overvalued on its own merits.  Nearly 40% of the operating profits of its UK business come from private label brands.  In addition, most of the owned brands are not “organic” yet the company trades at a premium multiple relative to other mature food manufactures and/or private label business.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

    


Cartoon of the Day: 'Biggest Tax Cut Ever'

President Donald Trump's economic team unveiled what he called last week, "the biggest tax cut we’ve ever had.” Before you get too excited about that hang on a sec. "Trump Tax Reform ain’t gettin’ done anytime soon," Hedgeye CEO Keith McCullough wrote in today's Early Look.

read more

Neurofinance: The Psychology Behind When To Sell A Bull Market

"Most momentum investors stay invested too long, under-reacting and holding tight after truly bad news finally arrives to break the trend," writes MarketPsych's Richard Peterson.

read more

Energy Stocks: Time to Buy the Dip? | $XLE

What the heck is happening in the Energy sector (XLE)? Energy stocks have trailed the S&P 500 by a whopping 15% in 2017. Before you buy the dip, here's what you need to know.

read more

Cartoon of the Day: Hard-Headed Bears

How's this for "hard data"? So far, 107 of 497 S&P 500 companies have reported aggregate sales and earnings growth of 4.4% and 13.2% respectively.

read more

Premium insight

McCullough [Uncensored]: When People Say ‘Everyone is Bullish, That’s Bulls@#t’

“You wonder why the performance of the hedge fund indices is so horrendous,” says Hedgeye CEO Keith McCullough, “they’re all doing the same thing, after the market moves. You shouldn’t be paid for that.”

read more

SECTOR SPOTLIGHT Replay | Healthcare Analyst Tom Tobin Today at 2:30PM ET

Tune in to this edition of Sector Spotlight with Healthcare analyst Tom Tobin and Healthcare Policy analyst Emily Evans.

read more

Ouchy!! Wall Street Consensus Hit By Epic Short Squeeze

In the latest example of what not to do with your portfolio, we have Wall Street consensus positioning...

read more

Cartoon of the Day: Bulls Leading the People

Investors rejoiced as centrist Emmanuel Macron edged out far-right Marine Le Pen in France's election day voting. European equities were up as much as 4.7% on the news.

read more

McCullough: ‘This Crazy Stat Drives Stock Market Bears Nuts’

If you’re short the stock market today, and your boss asks why is the Nasdaq at an all-time high, here’s the only honest answer: So far, Nasdaq company earnings are up 46% year-over-year.

read more

Who's Right? The Stock Market or the Bond Market?

"As I see it, bonds look like they have further to fall, while stocks look tenuous at these levels," writes Peter Atwater, founder of Financial Insyghts.

read more

Poll of the Day: If You Could Have Lunch with One Fed Chair...

What do you think? Cast your vote. Let us know.

read more

Are Millennials Actually Lazy, Narcissists? An Interview with Neil Howe (Part 2)

An interview with Neil Howe on why Boomers and Xers get it all wrong.

read more