Hain Celestial, A Pure Play in the Organic Market

I've noticed recently that people like my family members, who for years have scoffed at consumers of organic products (calling them hippies and idiots), have started buying various organic goods. My mom, for example, a long time critic of organics, now uses organic shampoo and occasionally eats organic produce.

Demand for organic food and personal care products has been growing at a phenomenal rate. Over the past 10 to 15 years, demand has increased at a rate of 15 to 20%. In 2006, for example, American consumers spent around $16.7 billion on organic food. This was a 126% increase over the previous five years, according to the Organic Trade Association. With organic food holding around a 2.8% share of the US market, demand is expected to continue to grow at high single digit rates for at least the next half decade. While health food stores and supermarkets like Whole Foods (WFMI) have been selling organic products for some time, regular grocers and big wigs like Wal Mart (WMT) are getting into the game.

Hain Celestial Group (HAIN) is based in Melville, NY, and has sales in North America and Europe. With around 1,500 branded items, most of which are organic, it is well positioned to benefit from recent trends. Among its more prominent products are Celestial Seasonings teas and coffee, and various personal care goods marketed under such brands as JASON (which holds leading market share). Hain participates in almost all natural food categories, including the growing vegan and vegetarian food and beverage market. For instance, veggie burger patties used at McDonald's (MCD) are made by Hain in some markets.

Hain's last quarterly report, in March 2008, showed earnings per share growth of around 20% year over year on a sales increase of about 11%. Price increases of 3 to 5% on many of its products helped offset rising costs. The 11% increase does not reflect about $5 million of discontinued products because of a newly implemented SKU rationalization program. If the discontinued products were included, sales would have increased 14% year over year. Considering the high commodity cost environment, Hain did well internationally too. European sales were up 20%, and sales in Canada grew by 40%.

Hain's SKU rationalization for its personal care products division is expected to weed out between 30 and 40% of its least profitable products. The firm hopes to boost operating efficiencies and margins, expecting to add about 1% to its gross margin. Management expects a total savings of almost $0.07 per share by the end of 2009.

The company's long term growth strategy has been aggressive acquisitions, and it has been on a buying spree of late. Recent purchases include non-dairy beverage maker Imagine Foods, the Linda McCartney frozen food brand, and baby products maker TenderCare International. While its debt to equity ratio is still quite low, this may change if the pace of acquisitions continues. Some recent acquisitions outside Hain's core food competency have been regarded as spreading the company's product portfolio too thin.

Hain's share price has stagnated over the last year, currently trading slightly below January 2007 levels. It is also well off its 52 week high.

This is a reflection of the tough operating environment Hain, like most food companies, faces. Food commodity prices are going up, and price increases are expected to continue. Transportation and refrigeration costs are growing as well. It is difficult to gauge whether Hain's customers would accept additional price increases for its products, especially with the current stagnant economy. Sales may slow, or margins may shrink as cash strapped consumers may switch to cheaper, and perhaps non-organic products.

A big risk faced by Hain is that there are practically no barriers to entry into the organic market. Competition from food processing giants like Kraft (KFT) and Dean Foods (DF) is increasing. Hain also faces competition from the very grocers that sell its products. Kroger, Safeway, Trader Joes, and Whole Foods all have organic in-store brands that often sell at discounted prices.

Another risk in investing in Hain is that over half of its annual sales come from goods made by other vendors. Eight suppliers account for over two thirds of these outsourced products. Contract disputes, production problems, and the like could severely hurt Hain.

Recently, the California Attorney General has initiated a lawsuit against several companies for not warning consumers of a potentially carcinogenic chemical, 1.4-dioxane, in their soaps. One of the companies being sued is Avalon, a subsidiary of Hain.

Dividend investors should note that Hain does not pay dividends.

If you're looking for a pure play on the organic market, Hain is it. As long as demand for organic products does not wane, its success will depend on how management deals with mounting cost pressures and competition, and what new products the company develops. Recent successes include the growingly popular Celestial Seasonings Coffee brand.

Hain's fiscal year ends in June. I would wait until the next earnings report before deciding whether to buy.

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