After the close on Friday, Hain Celestial Group (HAIN) issued a press release that said, "The SEC has issued a formal order of investigation and, pursuant to such order, the SEC issued a subpoena to the Company seeking relevant documents. The Company is in the process of responding to the SEC's requests for information and intends to cooperate fully with the SEC."
As a reminder, the last time HAIN reported financials was for their 3Q16 ended March 31, 2016, on May 4, 2016, which is now roughly nine months ago! Since the company's announcement of accounting irregularities in 8/16, the stock is only down 23% and consensus estimates have only come down marginally. Therefore, the company is trading at a stale NTM EBITDA multiple of 11.8x. As we have done in the past, we will make the case that HAIN is a great SHORT because the company's business model is broken and management can't be trusted with their words.
Operational Challenges
Whatever they found under the hood, whether illegal or not, will likely not be good news for the company and will likely cause restatements of the financials retrospectively. Who knows what the trends will look like once these changes are made and we actually get to look at the financials? One thing is for sure: the lack of investment that HAIN has made in their corporate infrastructure (accounting, finance, IT, etc.) has come back to hurt them. Going forward, the "strengthening of internal controls," as Irwin put it, will undoubtedly cost HAIN more money and bring operating margins down.
During this period of darkness, short interest has declined from 10.4% to 6.3%, while the sell-side has gotten increasingly cautious: hold ratings have increased from 33% to 53% and sell ratings are a paltry 13%. We often ask ourselves: do people actually believe in the story, or do people just not care about HAIN anymore? In our opinion, HAIN is uninvestable given the lack of financials, but we believe there is great opportunity in shorting the stock here, especially as it scraps around $40.
Let's think about what has transpired over the course of the last nine months. United Natural Foods (UNFI), their largest customer (represents 12% of sales), has experienced a slowdown in their business, missing consensus top line expectations the last five quarters, which has partially been driven by deflation. Whole Foods (WFM), a big customer and the natural channel more broadly, has also underperformed, driven by the proliferation of natural & organic products across all channels. Additionally, many bigger branded packaged food players have brought down top-line growth expectations due to industry dynamics. And this is just the USA!
Their international business, which represented 41% of sales in 2015, is also under pressure due to industry dynamics. UK grocers (28% of sales in 2015) have continued to push out more private label products. Just this week, McCormick stated during their earnings call in regard to private label in the UK:
In Europe, the big customer in the UK, this is part of a deflationary environment in the UK. The customer has, that particular customer, again, has a particular [private label] strategy that goes well beyond spices and herbs, but that did impact us, and it was a drag on our performance in the EMEA."
That spells trouble for HAIN's below par UK business.
Reading Between The Lines - The Verbal Deception Is Real
As part of our original SHORT thesis, we enlisted the services of ex-U.S. Marshal Mark McClish, who is trained in statement analysis, to dig into HAIN's earnings call transcripts to find signs of deception. It took Mark about an hour to point out where management was less than truthful with their spoken words. We recently asked Mark to look at the latest HAIN press releases to get to the bottom of what HAIN is actually saying. We believe it's clear from Mark's comments that the HAIN management team is hiding something and the fact that they can't get out historical financials is very telling.
Below are Mark's key takeaways in bold:
Hain Celestial Announces Completion of Independent Audit Committee Review
LAKE SUCCESS, N.Y., Nov. 16, 2016 /PRNewswire/ -- The Hain Celestial Group, Inc., a leading organic and natural products company with operations in North America, Europe and India providing consumers with A Healthier Way of Life™, announced today that the Audit Committee of the Company's Board of Directors has concluded its independent review with external counsel into concessions with respect to certain distributors in the United States.
We see that the company's Board of Directors Audit Committee is the one that conducted the review. Based on this statement, the review was done internally.
Hain Celestial had previously announced on August 15, 2016, that during the fourth quarter of fiscal year 2016 it had identified concessions that were granted to certain distributors in the United States and that the Audit Committee had retained independent counsel to assist in its independent review of such matter.
The Audit Committee did hire an independent counsel. The independent counsel did not conduct an independent review. They only assisted with the review.
The word "its" is tricky. They probably want us to believe the word "its" refers to the independent counsel and their review. However, based on the first sentence of their press release, "The Audit Committee... has concluded its independent review" it appears the word "its" refers to the Audit Committee and not the independent counsel.
The review, which was extensive, found no evidence of intentionalwrongdoing in connection with the Company's financial statements. Hain Celestial has begun to implement a remediation plan to strengthen its internal controls and organization.
The key word is "intentional." A better statement would have been to say, "Found no evidence of wrongdoing." However, that is probably a false statement so they added the word "intentional."
Saying they are implementing a remediation plan indicates that something was wrong and they are now fixing it.
The Audit Committee is pleased to conclude our thorough review with independent counsel," said Andrew R. Heyer, Chairman of the Audit Committee of Hain Celestial. "The Board of Directors believes this is an important step toward releasing the Company's financial results."
The word "with" always indicates distance. We see the distance in that the Audit Committee is at the beginning of the sentence and the independent counsel is at the end of the sentence. This shows us that the Audit Committee is the one primarily responsible for the review. A better statement would have been to say that the "Audit Committee AND the independent counsel is pleased to conclude..."
Hain Celestial is committed to transparency of our financial reporting, and we are taking concrete measures to remediate as well asstrengthen our internal controls. We are extremely pleased that the Company can now move forward with its reporting process as we put these challenges behind us," said Irwin D. Simon, Founder, President and Chief Executive Officer of Hain Celestial. "Our business is uniquely aligned with consumer habits and lifestyles, and we are excited about the fiscal year 2017 launch of our five new core platforms for growth."
In taking about their financial reporting, they used the word "remediate." The word "remediate" means "The act or process of remedying something that is undesirable or deficient."
They also talk about strengthening their internal controls. It sounds as if they are having financial problems.
Hain Celestial will not be in a position to release financial results until the completion of the Company's internal accounting review and the audit process. The Company is working diligently on this matter and will,as soon as reasonably practicable, make a further announcement regarding the timing of the release of its financial results.
"As soon as reasonably practicable" sounds as if it will happen soon. However, it could be years. Only the company knows what time frame they are talking about.
It sounds to me like they are having financial problems. They did an internal review and found some things that were wrong but not intentionally wrong. They brought in an independent counsel to give the review some legitimacy. However, it appears the independent counsel played a small role in the review. It will probably be a while before they release their financial records.
Timeline Of The Press Releases
For purposes of this exercise, we are going to ignore the various product launch announcements and partnerships created in India because we believe the sole purpose of those have been to distract investors into thinking everything is fine. We are in the camp of believing it is a smokescreen to levitate the stock so the CEO can get paid.
8.15.16 - HAIN Announced Delay of 4Q and Full-Year Results (Stock Performance: Down -26% on the day)
"The company noted they identified concessions that were granted to certain distributors in the United States. The Audit Committee of the Company's Board of Directors is conducting an independent review of these matters and has retained independent counsel to assist in that review. Previously, the Company has recognized revenue pertaining to the sale of its products to certain distributors at the time the products are shipped to such distributors. The Company isevaluating whether the revenue associated with the concessions granted to certain distributors should instead have been recognized at the time the products sell through its distributors to the end customers."
11.03.16 - NASDAQ Granted HAIN an extension through February 27, 2017 (Stock Performance: Down 33% since announcement of delay, down 3% on day of this announcement)
"The Company is currently evaluating whether the revenue associated with those concessions was accounted for in the correct period and is also currently evaluating its internal control over financial reporting."
11.16.16 - HAIN Announced Completion of Independent Audit Committee Review (Stock Performance: Down 35% since announcement of delay, flat on the day of this announcement.)
More details on this statement above.
"The review, which was extensive, found no evidence of intentional wrongdoing in connection with the Company's financial statements. Hain Celestial has begun to implement a remediation plan to strengthen its internal controls and organization."
12.07.16 - Announced Executive Changes (Stock Performance: Down 29% since announcement of delay.)
It's interesting to point out that Stephen Smith, ex-CFO of HAIN, who left HAIN in September 2015 to "pursue other opportunities," is still, as written on his LinkedIn page, "seeking new opportunities." Stephen Smith was previously a partner at PWC for 20 years. Did he see something in his two years at HAIN he didn't like? Likely no one will ever know, but it is odd timing/circumstances nonetheless.
What Is The Stock Worth?
Our base case sees 31% downside based on $350 million in EBITDA, but who knows what they are going to earn? That being said $320 million is a real possibility, putting the potential downside at 50%.
Editor's Note:
This is an institutional research note written by Hedgeye Consumer Staples analyst Howard Penney. To read more institutional research ping sales@hedgeye.com.