Mead Johnson Nutrition (MJN), a global leader in pediatric nutrition, has long been a well-respected company and favorite of Wall Street. The firm, with a worldwide leading brand franchise in infant formula, has seen its stock rise from around $29 per share to over $80 since a 2009 spin-off from Bristol-Myers. But as good as its pedigree is, there are a couple of reasons why investor sentiment might start to turn more bearish.
Dependence on a hostile China
Mead has become increasingly reliant on foreign sales for growth. Its Asia/Latin American business segment grew 11% in 2012 and now accounts for around 70% of total revenue. At the same time, North America and European sales declined 4%. The company’s Chinese market is especially important as it generates roughly 30% of sales.
In its 10-K filing, Mead specifically notes, “A significant portion of our revenue and profit is derived from sales in China. Consequently, our overall financial results are dependent on this market, and our business is exposed to risks there.”
A recent event may demonstrate the level of risk involved. China's National Development and Reform Commission reported it was investigating five foreign companies, including Mead Johnson, and one Chinese company for allegedly forcing retailers to sell infant formula at inflated prices. Though the authorities have not accused direct collusion, they were clearly perturbed about the formula’s rising cost, which some have estimated jumped as much as 30%.
Nestle, a major foreign producer, said it would cut infant formula prices by an average of 11% in response. Some Nestle products will be cut by up to 20% and the savings will be maintained through 2014.
The government scrutiny and competitor response clearly sours Mead’s growth plans in China. While still a premium supplier, the formula maker likely faces intense pricing pressure and increased competition from both foreign and domestic foes. It’s not surprising that analysts, fearing the uncertainty, pulled back on Mead Johnson shares. Goldman Sachs downgraded the company to “neutral” from “conviction buy” and Wells Fargo rated Mead Johnson “market perform,” down from “outperform.”
Priced for continued good times
The uncertainty surrounding China comes at a time when Mead Johnson shares look fully priced in expectation of a very robust future. Any hiccup in sales or earnings growth may engender further anxiety on the Street.
Sales came in at $1.0 billion in the company’s latest quarter, an increase of 5% from a year earlier. The rise was driven by 7% growth in the Asia/Latin America business segment. In a disturbing sign relative to the Chinese investigation, the growth came from a 6% gain due to pricing increases and 1% from greater volumes. Regardless, the solid quarterly results allowed Mead to confirm full-year 2013 adjusted earnings expectations in a range of $3.22 to $3.30 per share.
The formula-maker’s shares look enthusiastically priced based upon the high end of this forecast, released before news of the Chinese investigation. Using a cash earnings times market capitalization multiple valuation method with expected revenue of around $4.2 billion and cash earnings of $568 million at a 13.9% profit margin, Mead’s current market multiple is a hefty 24 times. This aggressive multiple implies the company has a well-known, almost iconic consumer name and rock solid growth. Other comparable consumer-product names that have these attributes are discussed below.
Sweets and spirits
Hershey is the largest producer of quality chocolate in North America and a recognized name worldwide. With foreign sales accounting for less than 20% of total revenue, the company's stable U.S. business is a big competitive advantage. Hershey announced first quarter 2013 sales of $1.8 billion and earnings of $1.06 per share compared to $1.7 billion in sales and $0.87 in earnings per share for the comparable period of 2012. Results were boosted by quarterly volume increases of 5.3% and little changes in pricing. The chocolate maker expects continued good times with 2013 full-year sales growth of 5% to 7% and adjusted earnings per share growth of about 12%.
Interestingly, Hershey is also attempting to expand into China's $1.2 billion candy market with its recent release of a new milk-based offering called "Lancaster." The candy, specifically made for the Chinese consumer, is the company’s first new brand launch outside the U.S. in nearly 120 years and could have significant growth potential.
Hershey’s share price looks to have adequately discounted all the positive news. Based upon anticipated revenue of $7.1 billion and cash earnings of $860 million at a 12.1% profit margin, the stock trades at a reasonably deserving 23 times multiple.
Beam, is another highly valued iconic consumer name. It is one of the world’s leading premium-spirits companies with well-known brands such as Jim Beam Bourbon, Canadian Club Whisky, and Courvoisier Cognac. The company reported sales of $577.7 million in its latest quarter, up 8% from the prior year. North America sales were up 7%, generating over 60% of all revenue. Operating income jumped 37%, benefiting from a favorable product mix, and adjusted earnings per share increased 21% to $0.64.
The good quarterly results helped Beam reaffirm its expectation for high-single-digit growth in 2013 adjusted earnings per share.
Beam share’s sport a premium multiple of roughly 24 times based on estimated revenue of around $2.7 billion and average cash earnings of $418 million at a 15.5% profit margin. Since most spirits-related companies trade at higher-than- average multiples anyway, and Beam has a platinum reputation, the lofty valuation is probably justified.
On the other hand, Mead Johnson’s current valuation may be hard to support. Lower profits from a price drop in China and a lower multiple due to reduced growth expectations could be tough to overcome. If one anticipates just a 2% drop in cash earnings, to around $556 million, and a reduced but still premium 20 times multiple, the company’s fair business value looks closer to $55 per share than its current bid.
Mead Johnson Nutrition is a well-respected company and has long held a premium stock market value. But a recent setback in China, one of its key markets, might begin to chip away at the company’s enthusiastic valuation. Investors may find it prudent to monitor the situation closely and make value adjustments as necessary.