Mead Johnson From the Inside

 | Nov 02, 2012 | 1:25 PM EDT
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James Cornelius, chairman of the board at Mead Johnson Nutrition (MJN), directly purchased 10,000 shares of the company's stock on Oct. 31st at an average price of $61.75 per share, according to a filing with the Securities and Exchange Commission

Mead Johnson Nutrition is a $13 billion market-cap company that manufactures infant formula and other milk products. According to our database of filings regarding insider purchases and sales, Cornelius has bought shares of Mead Johnson at various points since its spinout from Bristol-Myers Squibb (BMY) in February 2009. Since then, the stock has risen a total of 137% while the S&P 500 has roughly doubled. But the stock is down since Cornelius's three previous buys (research Cornelius's insider purchasing activity). After this purchase, he owns almost 100,000 shares of the company.

Mead Johnson's sales were about flat in the third quarter of 2012 compared with the same period last year, halting the revenue growth that occurred in the first half of the year. Earnings were down 5% as increases in advertising and other expenses offset cuts to SGA. Earnings before interest and taxes was down sharply in the Europe/North America segment, with the Asia/Latin America geography (which is responsible for the majority of Mead Johnson's business) seeing a much smaller decline.

Considering that the company is struggling to maintain its current level of activity, it's a bit surprising to see it trading at 24x trailing earnings -- higher than what we see at a number of other packaged goods companies. True, Mead Johnson does have relatively high margins for a company in that business, but it requires significant earnings growth to avoid being overvalued. Sell-side analyst projections for 2013 have it trading at 19x forward earnings estimates, which we would still consider high. While it does have a fairly low beta of 0.6, its dividend yield is only 1.9% and we believe many general food companies would be better defensive picks as well.

Renaissance Technologies, founded by billionaire Jim Simons, increased its stake in Mead Johnson by 31% in the second quarter of 2012 to a total of 2 million shares (find more stocks that Renaissance Technologies bought). Billionaire Steven Cohen's SAC Capital Advisors also liked the stock, with that fund increasing its own position by 63% over the course of the quarter and owning 1.9 million shares at the end of June (see more of billionaire Steven Cohen's stock picks).

We would compare Mead Johnson to starch and sweetener company Ingredion (INGR), Campbell Soup (CPB), Kellogg (K), and J.M. Smucker (SJM), which provides Folgers coffee but also a variety of baking ingredients and fruit and peanut spreads. Our view is that all of these peers produce basic food staples as a core part of their businesses. Campbell and Kellogg offer lower betas than Mead Johnson, and a dividend yield above 3% as well, and they'd be better for income investors or those who are generally bearish on the market. At forward price-to-earnings multiples of 13 and 15, respectively, we also believe that they are better values; Campbell even reported earnings growth in its most recent quarter over the same period in 2011.

Ingredion is another cheap company: its trailing and forward PEs are in the 11 to12 range, even though in the third quarter of 2012 its net income was up 29% from its levels in the third quarter 2011. We believe that it's undervalued at those prices, and a much better deal for investors than Mead Johnson. A pair trade may even be something to consider, given how wide the spread between their PE multiples is. Smucker is priced the closest to Mead Johnson; for example, it trades at 21x trailing earnings and that company was unable to convert a double-digit revenue growth rate in its most recent quarter versus a year earlier into higher earnings. We don't think that it is a good buy.

Investors probably shouldn't imitate this insider purchase. It looks like Mead Johnson depends on stronger growth than it has been delivering recently, and also stronger growth than analysts are expecting, in order to be well priced. Peers such as Campbell and Ingredion look much better from a value perspective.

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