Margin Squeeze Ahead for Hain?

 | Aug 07, 2014 | 10:00 AM EDT
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I wrote about Hain Celestial (HAIN) around this time last year -- at which time, I thought the stock was overvalued.

I said that Hain was a classic roll-up that grows by making rapid-fire acquisitions. A year later, it looks like I was right. The stock is up less than 3% since my last column (Aug. 22, 2013-Aug. 6, 2014).

The company reports its fourth-quarter 2014 earnings on Wednesday, Aug. 20, and I wanted to preview the quarter and next year's forecasts.

Hain has been riding the shift toward organic foods. According to the Organic Trade Association, organic food sales increased 10.2% in 2012, compared with 3.7% for conventional food. Between 2013 and 2018, the market for organic food is expected to increase at a compound annual growth rate of 14%.

While more people may be eating organic food, the trend is not necessarily translating into stock performance. During the last year, the organic space has not been a tranquil place. Just one glance at the sector and you'll want to puke all over your yoga mat.

Annie's (BNNY), a company that makes over 145 organic products, has collapsed. For the one-year period, Annie's shares are down over 31%. Boulder Brands (BDBD), another organic maker, has seen its stock slide 29%. Organic food retailer Whole Foods (WFM) has had its own share of problems, and that stock is down 31%.

The only organic name I can find that is up for the year is WhiteWave Foods (WWAV). WhiteWave is up 57%, mostly on strong sales of its Silk brand (soy milk, almond milk, coconut milk, etc.). First quarter sales of Silk rose 52%.

With the exception of WhiteWave, the organic sector has gone lower because margins are being squeezed. In my opinion, it all starts at Whole Foods. Whole Foods slowed its new-store expansion. Same-store sales slowed. Customer traffic slowed. Supermarkets became more competitive. New competitors such as General Mills (GIS) entered the space. And, recently, consumers became more sensitive to price.

Organic food makers have seen dramatic commodity price increases. For example, the price of organic eggs is up almost 26% year over year. Whole wheat has seen tight inventories and rising prices because of widespread drought and poor crop yields.

How can Hain escape these trends? I don't think that it can. For the last year, Annie's has complained that its largest customer (i.e., Whole Foods) has been reducing its inventory of Annie's products. If Whole Foods is refiguring its inventory, won't Hain be affected at some point?

Analysts are forecasting fourth-quarter sales of $578 million, up 24.8%. For fiscal 2014, Hain is expected to deliver revenue of $2,147.89 billion, up 24%, and earnings of $3.16 per share. Next year, the Street is looking for 15% revenue growth and 18% EPS growth.

Investors are pinning their hopes on continued margin expansion. Hain is expected to end the year with gross margins of 27.25%, and 27.5% is expected in fiscal 2015.

The consensus is carrying a $102 share price target on Hain. Analysts argue that the company carries so many products that it will be insulated from commodity cost pressures. They also argue that it's such a large vendor that Whole Foods can't push it around as easily it can push around Annie's.

Really? I'm not so sure. I think at some point Hain's margin expansion plans will disappoint. If I'm right, I think the stock will see $65 before it sees $102.

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