MKC:CC - The Hain Celestial Group: Things Don't Look So Bad

Summary

• There are signs of stabilization after a long time of revenue declines.
• The company managed to divest the less profitable business units, but inflationary pressures are now affecting margins again.
• The company has enough resources to resist a recession for a while.
• The management performed aggressive buybacks since 2020.
• This could represent a good time to acquire shares, as their price fell by 75% from all-time highs.

Investment thesis

The last time I wrote about The Hain Celestial Group ( HAIN ), I was left with a bad feeling about the future of the company, especially in the medium term. This was so because the company was paying down its debt pile through divestitures and the future seemed very uncertain at the time due to low margins and declining revenues, especially considering that we were going through the Coronavirus crisis at the time. Since then, the share price has declined by ~43% while the S&P 500 has changed by a positive ~25%, but despite this, I believe that the company's current projection shows signs that offer much more optimism than before.

Net sales seem to be stabilizing and should slightly increase in the short term thanks to the acquisition of two major brands, and margins have also increased considerably. More recently, there is the ongoing risk of a world recession, which poses a serious risk to the company's operations as its products compete with much cheaper options and private labels, and although Hain Celestial supplies private labels, these often offer tighter margins. In this scenario, we have a better situation in the company's operations but also very worrying uncertainties, but at the same time, a new CEO has arrived with the aim of correctly integrating past acquisitions into the company's business model and reach again the growth path, and therefore, it will be necessary to assess the diverse variables that surround Hain Celestial at the present time to assess where the balance leans taking into account the current share price.

A brief overview of the company

The Hain Celestial Group is a consumer goods company whose objective is to offer healthier alternative food products for consumers with a greater awareness of the health benefits of the food they consume. It offers snacks, meat and dairy alternatives, seasonings, and other food products, as well as personal care products. The company was founded in 1993 and has operations in North America, Europe, Asia, and the Middle East. Its market cap currently stands at ~$1.45 billion and employs over 3,000 workers worldwide.

The company has been built over the years through continuous acquisitions and has recently undergone a transformation through the divestment of those less profitable areas and the acquisition of two major brands as profit margins were somewhat unsustainable for the long term. Furthermore, the CEO who has governed the company for four years has just been replaced by a new CEO who could offer the keys to successfully integrating these two acquisitions into the company's operations as well as finding synergies in past acquisitions.

Currently, shares trade at $17.25, which represents a 75.41% decline from all-time highs of $70.15 on August 5, 2015. This represents a sharp decline that forces us to carefully evaluate the recent evolution of the company's operations because although the share price is suggesting that this could be a good opportunity to acquire shares at low prices, said fall is accompanied by serious headwinds and risks at a time when the company finds itself in a transformation phase, and part of this can be explained by the recent M&A moves that have taken place.

Recent acquisitions and divestitures show a sizable transformation

Over the years, Hain Celestial has managed to grow its business through an aggressive acquisition strategy, which has increased its net debt until it surpassed the $700 million mark in 2014. With the company delivering disappointing results in 2017 and failing to turn around in 2018 and 2019, the company began divesting previously acquired parts of its business in order to reduce its debt load, including Plainville Farms, WestSoy, Hain Pure Protein Corporation, Tilda, Arrowhead Mills, SunSpire, Casbah, Danival, Orchard House, Dream, and Westbrae Natural.

On the other hand, in December 2021, the company acquired ParmCrisps and Thinsters from Clearlake Capital Group, two fast-growing brands offering simple and delicious, better-for-you snacks in a variety of flavors, for ~$259 million. The acquired brands generated trailing twelve months' net sales of $108 million in September 2021.

Net sales keep declining, but there are signs of stabilization

Everything seemed to be going well until 2016 as the company had been posting double-digit growth rates boosted by an aggressive M&A strategy, but as we have seen, disappointing results, especially related to profit margins, forced it to divest parts of its business in order to reduce the debt incurred during the acquisition period.

After two negative fiscal years in terms of revenues (-4.07% year over year during fiscal 2021 and -3.98% during fiscal 2022), it seems that sales are stabilizing as trailing twelve months' revenue has only declined by 0.82%. A recent surge in the dollar value vs. the U.K. pound is also affecting revenues as revenues coming from U.K. operations have less value in dollars. Also, the company has recently reduced its marketing efforts due to supply chain issues. From this moment on, sales are expected to return to the path of growth boosted by the recent acquisition of ParmCrisps and Thinsters, although it is still too early to draw conclusions before seeing how both brands benefit the company's operations. On the other hand, the management is seeking new private label contracts in order to adapt to the new macroeconomic context marked by lower consumer purchasing power.

But despite these revenue growth expectations, the drop in the share price derived from the delicate situation in which the company finds itself (declining sales and uncertain margins), together with the uncertainties stemming from inflationary pressures and the high risks of an upcoming recession in a large part of the world's economy as a result of tight monetary policies marked by rising interest rates in order to combat the current unsustainable inflation rates continue to sink the price of the company's sales, driving the P/S ratio to levels similar to those of 2019.

In this sense, the P/S ratio currently stands at 0.840, which is 51.24% lower than the average of the past decade and 69.88% lower than the highest point reached in 2015. This means the company generates revenues of $1.19 annually for each dollar held in shares by investors. This ratio reflects a very high pessimism on the part of investors, since in some ways a loss of consumer purchasing power due to current inflationary pressures, as well as a potential recession, seriously increases the risk of consumers opting for more affordable food options, especially store brands, against which the company must constantly compete, a very considerable risk especially in U.K. operations due to its very high inflation issues and political turmoil. It is true that the company supplies private labels, but these typically offer lower margins.

Using fiscal 2022 as a reference, 55% of revenues are generated within the United States, whereas 26% are provided by operations in the United Kingdom, and 19% from the rest of the world. In this sense, the company has a certain geographical diversification, although this is limited especially to the United States and the United Kingdom.

Leadership changes should not be underestimated

In November 2022, the company named Wendy P. Davidson the new CEO of Hain Celestial, who will be responsible for the next stage of growth, which has been named the 3.0 strategy , after four years of the government of Mark Schiller. Before joining Hain Celestial, Wendy served at Glanbia Performance Nutrition, managing the integration of a set of acquired brands into a single business model, just what Hain Celestial has needed in the past few years. She also worked in executive positions for Kellogg Company ( K ), McCormick & Co. ( MKC ), and Tyson Foods (TSN), and works in parallel as a director at First Horizon Corporation (FHN).

At this point, and considering the evolution of the company during the past few years, I consider that it is very positive to bring new blood to the helm of Hain Celestial, and therefore, this represents an enormous opportunity to improve the company's outcomes when it comes to finding synergies in the companies acquired through its M&A strategy.

Margins have improved significantly, but inflationary pressures start to be noticed

The main factor that failed in the M&A strategy carried out before the problems began after 2016 is that the growth in sales was made at the expense of a decline in the gross profit margin, which fell below 20%. This decline was especially felt in the EBITDA margin, which was close to 0% in 2019.

Since then, by which time the company began to divest a big part of its business, profit margins began to rise, suggesting that the management was successful at getting rid of those businesses that were not generating actual profits for the company. The stock price, thanks to this, rose by a whopping ~200% consistently from the worst moments of 2019 to November 2021, but a recent decline in margins despite strong efforts to optimize operations is raising the alarm bells again, especially given the current complex macroeconomic context. In this sense, the company reported a gross profit margin of 21.47% during the first fiscal quarter of 2023, and an EBITDA margin of 6.73%, both below the current trailing twelve months' margins of 22.19% and 8.28% in the gross profit margin and the EBITDA margin, respectively, and this has caused a sharp drop in the company's capacity to convert revenues into actual cash.

In this sense, trailing twelve months' cash from operations currently stands at $37.5 million, but inventories increased by $35.7 million in the same period, and accounts payable declined by $14.8 million while accounts receivable declined by just $8.3 million. These numbers allow the company to more than cover its interest expenses, which should stabilize at ~$30 million considering interest expense was $7.28 million during the first quarter of fiscal 2023.

During the first quarter of fiscal 2023, the company posted cash from operations of -$5.1 million, but inventories increased by $7.9 million to $315.9 million and accounts receivable by $2 million while accounts payable declined by $16.9 million. In this sense, the company's operations continue to be virtually sustainable, but to a much lesser extent than in 2021, when it reached trailing twelve months' cash from operations of $244.2 million during the second fiscal quarter. To solve this problem, the management is currently taking pricing actions with which to pass on part of the increased production costs to customers, a process that will likely take some time to fully materialize, especially considering that inflationary pressures continue to be a reality.

The company depends on cash generation to face its current debt pile

Thanks to the company's divestitures in recent years, the long-term debt was reduced dramatically from almost $900 million in 2016 to ~$250 million in 2021. After this period, the company re-indebted at levels similar to those of 2016 to make the major acquisition of ParmCrisps and Thinsters, with which the company's medium-term performance will strongly depend on the results of both brands, especially in terms of profit margins and sales growth.

But this is not the whole picture as the current long-term debt of $890 million is not only the result of the acquisition of ParmCrisps and Thinsters in December 2022 but also the result of an aggressive share buyback initiative that began during the coronavirus pandemic crisis back in 2020.

Share repurchases took place at a very sensitive time

The company spent around $600 million in share buybacks since 2020 in order to reduce the total number of shares outstanding by 11.25%, which means that each share now accounts for a larger slice of the company. This may seem like a positive for shareholders, as per-share metrics improve as a result of total results being divided into fewer shares, but in my opinion, this is a highly risky initiative at this time.

In this sense, the company has used debt to carry out share buybacks at the height of a transformation, with very high inflationary pressures, and on the verge of a potential recession in order to take advantage of shareholder pessimism to considerably reduce the number of shares outstanding and thus stabilize the price of shares, having the option to reissue them at a higher price later once the macroeconomic context improves and optimism returns to investors. In my opinion, there were better uses of that cash, which will be much needed in the coming quarters.

Risks worth mentioning

Here is a summary of the major risks that I think an investor should be aware of at this time.

• The recent acquisition of ParmCrisps and Thinsters may not return the expected results. Since the company paid $259 million and sales of both brands add up to $108 million annually, profit margins, as well as growth rates, should be decent for the acquisition to be considered a success.
• 74% of the company's revenue is generated by operations in the United States and the United Kingdom, and therefore, the company's operations depend to a large extent on the evolution of both economies since it does not have much geographical diversification.
• A sufficiently deep recession could considerably change the consumption habits of consumers, who could switch to private labels or even less healthy options to compensate for their purchasing power loss. The company could fail to secure enough private label supply contracts to offset such a headwind and the profit margins achieved through this change could be considerably lower than current ones.
• The current debt has an interest cost of approximately $30 million per year, which will limit the company's ability to continue acquiring new businesses or invest in growth initiatives. Furthermore, if the company fails to cover interest expenses, it could be forced to use more debt to do so.

Conclusion

Despite the fact that the stock price is at such low levels, there are, in my opinion, still many reasons to remain optimistic when it comes to Hain Celestial. Ongoing pricing actions should stabilize profit margins and boost sales in the coming quarters, to which we must add the upcoming contribution of the operations of the recently acquired brands ParmCrisps and Thinsters. Also, profit margins improved significantly during the period of divestitures that took place since 2019, suggesting that the less profitable parts of the company are no longer part of it. To this, we must not forget that the previous CEO has been recently replaced.

The company has cash on hand of $65.51 million and inventories of $315.9 million, so it still has the resources to face a potential recession for a while. It also has the possibility of reissuing the shares bought back during the 2020-2022 period, which would be a painful measure for investors but which also represents a bullet that is in the chamber in case of necessity in the event of a worsening of the current macroeconomic context or a long enough recession.

Such scenarios are partly reflected in the share price as shown by the recent ~60% drop from the peak of 2021, so I consider this a good opportunity to buy Hain Celestial shares as the recent changes are rather positive while the company has enough resources to withstand a relatively long period of recession.

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