HWKN - Hawkins Inc: Thanks For The Ride But I'm Out

2023-06-12 17:02:01 ET

Summary

• I am taking profits on Hawkins Inc. shares due to concerns about valuations and the stock no longer being objectively cheap.
• Hawkins Inc. has shown strong financial performance, but the current stock price suggests the market is assuming a 7.5% growth rate in earnings, which I find fairly optimistic.
• I believe taking on more risk via stock ownership while receiving less income than the risk-free rate is not an optimal strategy.

I have come by my nickname "Granny Doyle" honestly. I often refuse to buy shares when they're overpriced, even if the crowd is inclined to drive them higher in price. I also often take profits prematurely, when I've reached my target return. It's a little frustrating to see shares go on to do well after I do this, but I'd rather take some chips off the table than risk turning a gain into a loss. It's with all of this in mind that I feel the need to write about Hawkins, Inc. ( HWKN ) again.

It's been a little over a year since I turned bullish on this stock, and in that time, the shares are up about 47% against a gain of about 6.2% for the S&P 500. At this point, this gain feels good because it feeds my very fragile ego, but it also puts me on the horns of a dilemma. A stock trading at $51 is, by definition, way more risky an investment than the same stock when it's trading at $35, so I need to decide whether or not to continue to hold or take profits at this point. I'll make that determination by looking at the most recent financial performance, and by comparing that to the valuation.

Although I've heard it said that we have more leisure time now than at any time in our history, we feel more pressed for time than ever. I want to do my bit to try to relieve some of the time pressure my readers may feel by putting all of my thoughts together in a "thesis statement" paragraph. This gives you all of the "juice" of my insights without imposing the tiresome "squeeze" of an entire article from me. The thought that I'm making your life just a little bit easier is the only thanks I need. I'm going to be taking profits in Hawkins today. Although I consider it to be a wonderfully profitable business in many ways, I am worried about valuations. The shares are no longer objectively cheap. If the overall market tumbles, which it may very well do, I think the shares are at risk of losing some of the gains they've made for me over the past year. Additionally, investors here are receiving over 400 basis points less in income than the risk-free rate. Taking on more risk via stock ownership while being paid over 4% less for the effort seems to me a poor strategy, and for that reason, I would strongly recommend against employing it. Given the above, I'll be selling the shares. I may lose out on future gains at this point, but I'm reminded of that old investing adage: bulls make money, bears make money and pigs get slaughtered. It's never good to be greedy, and it's particularly ill-advised at the moment, in my view.

Financial Snapshot

The company has recently posted annual results, and they were very good in my estimation. Revenue, net income, and dividends per share were all up nicely. The top line was higher by about 21%, and profits increased by about 16.5%. This improvement happened in spite of the 31% uptick in the cost of sales, a 2% uptick in SG&A, and a whopping $3.8 million, or 272% uptick in interest expenses. Additionally, 2022 was an excellent year relative to any time in the past, as you can imagine. For instance, when compared to the pre-pandemic era, revenue, and net income in 2022 were higher by 73% and 112% respectively. Over the past decade, revenue has grown at a CAGR of about 10.3%, so I think we can now safely call this a "growth" company.

The balance sheet has also improved nicely, with long-term debt down by about $13.9 million, or 11%, while cash increased by about $4 million, or 116%. This is good in my view, because interest expense spiked in 2022, and paying down debt is an obvious solution to this problem.

With a payout ratio of only about 20%, I consider this to be a rock solid business that I would happily buy more of at the right price.

The Stock

Unless you have the resources to take a public company private, you don't buy a company, you buy a stock. The company sells industrial chemicals, for instance. The stock, on the other hand, is a "play" on the crowd's ever-changing views about the company. The stock is often a poor proxy for what's going on at the company. The crowd can be capricious, and changes its views on a dime, careening from being too optimistic to being too pessimistic in a very short span of time. Additionally, the market for the shares of a particular company can be taken up or down by changes in the demand for "stocks" as an asset class. This volatility can be cumbersome, but it can also be a great source of profits. In my experience, the only way to successfully trade stocks is by spotting the discrepancies between what the crowd thinks about the future, and what actually transpires. I also think it's best when the crowd is particularly pessimistic about a stock and drives its price lower, because lower-priced stocks offer superior risk-adjusted returns. They offer great potential returns because any good news can drive the shares higher, and they offer limited risk because all of the bad news is already "priced in."

I measure the cheapness of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like sales, earnings, free cash, and the like. On that score, I like to see the shares trading at a low relative to both the overall market and their own history. When I last reviewed Hawkins, the shares were trading at a price-to-sales ratio of 0.97 and a PE ratio of 14.5. Today, the shares are between 18% and 20% more expensive. Additionally, the dividend yield is now firmly below the risk-free rate by over 400 basis points. It's also on the low side for this company, per the following:

Source: YCharts

Source: YCharts

Source: YCharts

None of this fills me with gladness, though I'll admit that the PE ratio is still lower than the overall market.

Given that I am of the view that we want to buy when the market has low expectations, and sell when the market has high expectations, I think it's worth reviewing expectations. The way I try to work out the assumptions embedded in the current stock price is by turning to works like Penman's "Accounting for Value" and Mauboussin and Rappaport's "Expectations Investing." The approach taken in both of these tomes is to treat stock price itself as a great source of information about what the market is currently "thinking." This exercise involves a bit of high school algebra, where the "g" (growth) variable is isolated in a standard finance formula. Applying this approach to Hawkins, at the moment, suggests the market is assuming that earnings will grow at a rate of about 7.5% from current levels. I consider that to be fairly optimistic.

I'll be taking profits on Hawkins today for a few reasons. First, I think the valuation is either "middling" to "excessive." At the very least, it's far less compelling as it was when I bought back in. Additionally, an investor can receive far more income at far less risk by buying the risk-free rate. Taking on more risk via stock ownership, and receiving less income for your troubles, doesn't seem like an optimal strategy in my estimation. For those reasons, I'm selling today. I may miss out on some further upside from here, but I won't regret that, as I've met my target return for this stock. If the shares continue higher from here, I'll remember that what the market can giveth, the market can taketh awayeth.

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