Growth slump looks over for Hain

Update May 24. On May 4 natural and organic foods producer Hain Celestial Group (HAIN) announced fiscal third quarter 2016 earnings of 49 cents a share, in line with Wall Street projections. Revenue of $749.86 million, up 13.1% year over year, beat projections by $16.69 million. The company told Wall Street to expect slightly (and I mean slightly) better than expected revenue and earnings for the full fiscal year: $2.95 billion to $2.97 billion, up from the consensus of $2.94 billion and earnings of $2.00 to $2.04 a share, above the current $2.02 consensus. That seemingly mildly positive report has sent the shares up 18.2% from the May 3 close of $41.09 to the close today, May 24, at $48.56. That continues a great run in the shares from the January 25, 2016 low of $33.46 and Hain is now up 20.2% for 2016 to date. (Unfortunately I added Hain to my Jubak’s Picks portfolio back on March 26,2015 and that position is still underwater to the tune of 23.2%.) So why the strong positive reaction to a mild revenue beat and a slight uptick in guidance? Two reasons, I think. First, Wall Street analysts have decided that the slump in the company’s growth is over. Revenue climbed 13% year over year and earnings per share climbed 9% year over year. Second, the company said it is looking at cutting costs so that more of that revenue growth turns into earnings growth. To take the two points one at a time. First, the growth slump had raised fears that the company was falling victim to increased competition in the very hot healthy, natural and organic foods market. As revenue has increased for that segment conventional grocers and big box retailers such as Target (TGT) and Wal-Mart Stores (WMT) have all moved to grab a slice of the pie. That has posed problems for healthy, natural and organics grocer Whole Foods Market (WFM)–more competition has meant pressure on margins–and there was certainly reason to think that the same phenomenon would hurt Hain Celestial Group. However, it increasingly looks like analysts and investors who pointed out that Hain Celestial operated a different business model than Whole Foods had a good point. Hain Celestial is a company that sells its branded healthy, natural and organic products through distribution channels that include conventional grocers (55% of sales) and big box retailers–as well as through Whole Foods and similar retailers. Hain Celestial has focused on building distribution in those channels so that it can capture growth no matter what channel it comes from. Margins are indeed lower in the conventional and big box channels but by capturing the growth in those new channels Hain Celestial keeps the ability improve margins by cutting costs in its own hands as revenue grows. And thats why, second, the plan to cut costs is so important. If Hain Celestial can increase efficiency as it grows revenue, then the increased competition (and higher sales) in the segment from conventional and big box retailers actually can work to the company’s benefit. Talk about cost cutting is always just talk until the results show up (or not) on a company’s bottom line, but Hain Celestial has a good record of managing costs and increasing efficiency at the smaller companies it has acquired over the years. For example, SG&A expenses have fallen as a percentage of sales each year since 2010. I think this commitment to cut costs has a good chance of being more than just talk. In the aftermath of the quarterly earnings announcement (and indeed in the weeks leading up to it) Wall Street analysts raised their target prices on the stock–something I always like to see after a stock has climbed 20% or so. Jefferies raised its target price to $55 from $50, for example. Oppenheimer had earlier raised its target price to $44 from $38. Morningstar, which has set its own target price at $47, forecasts 11% compounded average annual growth in revenue through 2020 and sees operating margins climbing 250 basis points to 13.5% from 2016 to 2020. The big punishment dished out to Hain Celestrial in 2015, when the stock fell 31%, means shares are still reasonably priced at 24 times projected earnings for fiscal 2016. (Over the last five years Hain Celestial has traded at an average price to earnings ratio of 32.6) As of May 24, I’m reducing my target price from an overly aggressive (for a modestly growing U.S. economy, which accounts for 51% of company sales) $72 a share to $60. That’s still roughly 20% above the current share price.