Update August 16. All the traders who had jumped into shares of Hain Celestial Group (HAIN) on a bet that the company would be the next in the organic food space to be sold at a huge premium abandoned ship today on a warning by the company that it would delay reporting its fiscal 2016 results while it investigates accounting issues. The company was due to report on Wednesday.
The shares, which had suffered through a brutal 2015 as management seemed to lose control of costs, had recovered nicely in 2016–going to $55.13 on August 11 from $33.46% on January 16, on news that Danone would acquire WhiteWave Foods (WWAV) for $10.2 billion. That seemed to continue the trend of larger food companies buying smaller players in the organic and natural foods market begun with the purchase of Annie’s by General Mills (GIS) two years ago. There aren’t a whole lot of potential buyout candidates in the space and traders put Hain Celestial on their short list. (I added Hain Celestial to my Jubak Picks portfolio on March 26, 2015 at $63.20. The position is down 37.7% as of the close on August 16.)
I understand the logic behind dumping the stock if you are a trader betting on a quick buyout. Until Hain reports the results of its accounting investigation these issues will hang over the stock like a black cloud. Who will want to buy Hain Celestial when these issues cloud the state of the company’s business? The fear seems to be that the premium in any acquisition will be much lower because of these accounting problems and that any sale will be significantly delayed. In the meantime, traders and investors who worried that management had lost its ability to run the company effectively have received plenty of additional reason to worry.
We don’t know how bad the accounting problems are. It seems, from the company’s limited statements so far, to be a revenue recognition problem with issues in how and when concessions granted to some distributors in the United States were accounted for. In short it looks like the company may have been recording revenue when product was shipped to these distributors instead of when the product was actually sold. If this is simply a timing question, then all we’re looking at is revenue being shifted from one quarter to another (and from the current fiscal year to the next.) If the concession accounting resulted in the inflation of revenue numbers, the problem is more serious. Especially if the accounting issues go back for a large number of quarters. The market decided today that the company’s decision to delay the scheduled Wednesday report for the fiscal year argues for the worst–in reality it just says that the company has found significant accounting issues that it can’t resolve in order to release the report on schedule. (Which does legitimately add to worries about management competency.) The company’s additional statement that it would not meet previous guidance certainly don’t make anyone, myself including, feel all warm and fuzzy, but again a shift in when revenue should be recognized would move revenue from one fiscal year to another and with a big effect on guidance.
Wall Street analysts pretty uniformly downgraded the stock and marked it down as a sell today. The general take was to sell on uncertainty and then maybe re-buy when the results of the accounting investigation are clear. A research note from Barclays was typical of this stance: After downgrading the stock and cutting its target price to $43 from $51, Barclays added, “That said, we recognize that there is no guarantee that the outcome of the review will be materially unfavorable and it could simply reflect timing,” the note said. “As such we would revisit our rating once additional clarity is provided.” Most of the cuts in price targets seem to be to the vicinity of $40 or so–which indicates that analysts are basically following the trend in the market price.
The uncertainty in the stock has certainly been ratcheted up by today’s news. Hang on–or maybe even buy on the 26.3% drop–and you risk getting clobbered if the accounting problems turn out to be huge. Sell on the possibility that accounting problems will be large enough to cut into the value of the company’s assets and you risk missing a quick and big pop if accounting issues turn out to be relatively minor.
From my point of view, the big question is how these accounting issues will wind up depressing the value of the brands owned by Hain Celestial. Certainly a potential acquirer would offer less if the accounting issues reveal that the company has significantly inflated revenue and earnings. Given that the company has struggled to show growth in recent quarters, it doesn’t look like to me Hain Celestial has systematically cooked the books. The books would, simply, have looked better if the company were intentionally cheating. Management, if you chose to believe them, has said that these accounting issues over revenue recognition will not change the total amount of revenue recognized by the company and that the accounting issues do not reflect questions about the validity of underlying transactions.
If that’s the case, we’re looking at issues that certainly undermine faith in current management, but that do not significantly change the value of Hain Celestial to any potential acquirer–although they certainly do delay any potential acquisition.