HWKN - Hawkins: Portfolio Expansion Resulting In Cash Flow Stability

2023-09-26 02:49:27 ET

Summary

• Hawkins has seen significant growth in earnings but is currently overvalued according to DCF figures.
• The company operates in specialized chemical and ingredients sectors, with three key business divisions.
• HWKN has a strong balance sheet, robust cash flows, and a potential for future growth in earnings.

Hawkins, Inc. ( HWKN ) has seen significant growth within the past year due to outperformance in earnings which will improve future cash flows. I believe that Hawkins is currently a hold because even though the firm has seen excellent growth, a solid balance sheet, and portfolio optimization to stabilize cash flows, the firm is currently overvalued assuming my DCF figures.

Business Overview

Hawkins, Inc. is a specialized chemical and ingredients company operating primarily in the United States. Three key business divisions make up the organization: industrial, water treatment, and health and nutrition. The Industrial division offers agricultural products, different food-grade and medicinal products, industrial chemicals, products, and services, including sodium hypochlorite, to a wide range of industries. Additionally, it oversees the distribution, repackaging, and storage of a variety of chemicals. For various water treatment requirements, ranging from drinkable water to industrial effluent, the Water Treatment segment offers a full range of chemicals, equipment, and services. The Health and Nutrition section, which includes minerals, vitamins, amino acids, botanicals, and more, focuses on ingredient distribution, processing, and formulation solutions for businesses in the health and wellness sector.

Financials

Hawkins is valued at a market capitalization of $1.25 billion, showcasing a noteworthy return on invested capital of 13%. Presently, the stock is trading at $59.15, slightly under its 52-week peak of $63.21. The company's P/E GAAP is at 19.49, surpassing some of its industry counterparts, implying a potential premium in its stock price and suggesting a state of relative overvaluation.

Hawkins also pays a dividend of 1.08% representing a payout ratio of 19.75%. This demonstrates Hawkins' ability to provide safe and stable income to shareholders to create value in the long term. This small payout ratio also enables the firm to utilize its 13% ROIC to expand upon its core business model which shows that the dividend may increase as the ROIC begins to decline as the firm's size continues to grow. With a recent increase in the dividend , I believe that this source of income will continue to grow as cash flows grow.

Earnings

Hawkins posted robust Q1 2023 earnings, exceeding expectations both in terms of earnings per share and revenue. EPS outpaced estimates by a notable margin, reaching $1.12, surpassing predictions by $0.51, while revenues exceeded projections by $9.1 million, totaling $251.1 million and showing a 1.8% year-over-year increase. This performance underscores Hawkins' capacity to enhance its profit margins beyond anticipated levels, indicating its adeptness in mitigating the effects of macroeconomic challenges. Anticipated growth in earnings for 2024 further reinforces the company's potential to enhance its cash flow capabilities. This, coupled with a strong return on invested capital, positions Hawkins favorably to manage debt reduction, thereby reducing leverage even amidst challenging macroeconomic conditions.

Performance Compared to the Broader Market

In the past 10 years, Hawkins has outperformed the S&P 500 when adjusting for dividends. This demonstrates the firm's ability to create shareholder value through multiple avenues while also strengthening profitability through core business improvements.

Analyst Consensus

Over the past 3 months, Hawkins is currently rated as a "buy" with a 1-year price target of $62 demonstrating a potential 5.5% upside. This demonstrates that although Hawkins has had strong price action in the last year, analysts still see some upside potential due to Hawkins' strong performance.

Balance Sheet

Hawkins boasts a robust balance sheet, showcasing a remarkable 47% reduction in debt over the past year, coinciding with a surge in operating income. The interest coverage ratio stands solid at 17.64, indicating substantial income to both service debt and sustain robust cash flows, even in a high-interest rate scenario. Solvency-wise, Hawkins maintains a Current Ratio of 2.4 and an Altman-Z-Score of 5.83, reaffirming its capacity to stay financially sound in the short to medium term.

Valuation

In order to find an accurate fair value for Hawkins, I decided to find the firm's Cost of Equity to establish an appropriate discount rate. Assuming a risk-free rate of 4.44% based on the 10-year treasury yield, I calculated a Cost of Equity of 8.66%.

Using the previous calculation as my discount rate, I decided to use a 5-year Equity Model DCF using net income to find Hawkins' fair value. Using analyst expectations for my revenues and margins, I found that Hawkins is currently overvalued by ~13%, with a fair value of ~$51.3.

Portfolio Expansion Resulting in Cash Flow Stability

By actively pursuing a product portfolio expansion plan, Hawkins, Inc. has been able to expand its offers and penetrate new markets. Their entry into the nutraceutical and functional food industries is one such example. They expanded their product line to include substances used in nutraceuticals and functional foods in response to the increasing demand for health and wellness goods. With this change, they were able to serve a wider range of customers and enter a market that showed great promise for future growth.

Hawkins, Inc. expanded its product line with a variety of minerals, vitamins, amino acids, and other necessary elements necessary for the creation of dietary supplements and functional foods through strategic acquisitions and partnerships. The company wanted to take advantage of the rising consumer knowledge of health and nutrition by matching its portfolio with evolving health trends and consumer preferences.

With this growth, Hawkins, Inc. was able to diversify its revenue sources as well as position itself as a more complete solutions provider for the chemical and components sector. It was a calculated attempt to maintain relevancy and competition in a market environment that was rapidly changing.

I believe that this diversification will enable Hawkins to allocate FCF more effectively and enable the firm to scale its growth in multiple ways thus mitigating cyclical downturns which stabilizes cash flows. This will also create further safety in regards to Hawkins' balance sheet and dividend as the firm is able to leverage more freely without the worry of significant margin compression due to segment volume decline.

Risks

Supply Chain Disruptions: Hawkins is susceptible to supply chain disruptions such as a lack of raw materials, problems with the transportation system, or production difficulties. Its capacity to meet client demand may be impacted, as well as its financial performance.

Regulatory Compliance and Environmental Risks: As a member of the chemical sector, Hawkins is subject to a number of legal and ethical requirements. Regulation changes or inadequate compliance may result in fines, legal problems, or adjustments to the production process that may increase costs.

Conclusion

To summarize, I believe that Hawkins is currently a hold because even though the firm has seen excellent growth, a solid balance sheet, and portfolio optimization to stabilize cash flows, the firm is currently overvalued assuming my DCF figures.

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