MINYANVILLE ORIGINAL Mead Johnson
(NYSE:MJN) stock fell from a high of $87 in July to $62 in early November when the pediatric nutrition maker announced that it lost significant market share in China after raising prices. While some of that market share has been gained back, many observers believe that 2013 earnings comparisons will be tough, especially in the first half.
Mead Johnson is one of the only food stocks that I have any confidence in, given the present environment. That is mainly because of the heavy international skew to its earnings growth.
Branded baby formula sells at big premiums to private labels in most all countries. And MJN’s Enfamil is generally a tad higher priced than other brands. There is a bit of science behind the price differential in that some studies show better intellectual development with some of the higher priced brands. Still, the worldwide maintenance of those premiums is the most important factor for analysis.
The US branded-to-private label premium, based on my visits to four differing types of stores, is 62%. With close to 50% of children in this country now born to unmarried parents
, it's obvious that there is pressure on parental budgets to pay for this magnitude of pricing differential.
Beyond that fact, 52% of babies born in the US were covered by the USDA's WIC program
, a special supplemental nutrition program for women, infants, and children, where formula is bought on state contracts. Funding for the program is secured through 2014, so those numbers are unlikely to change. WIC-related sales, a large part of US sales at low margin, represent 3% of global sales for Mead. Combined, US and European sales are 31% of total sales, but only 21% of pre-corporate-expense operating income.
It seems obvious to me -- even without a 7% decline in European volume in the last quarter which helped push the stock down -- that gross margins and probably operating margins will not be going up in either the US or Europe. Another factor, in the US at least, is that the birthrate is at its lowest level since 1920 and probably will not go up much without significant economic growth, which now seems unlikely for the next four years.
Mead management mentioned without quantiying that European market share was being impacted by government cutbacks to reimbursement programs. In the last quarter US/European sales decreased 5.5% after prices were increased 3% for many of the products, although that was countered by a 7% volume decline and a negative 2% currency swing. US/European operating income fell 23%. At the same time, given the large amount of government reimbursement in the US and Europe, I would not expect much margin decline, either.
The bulk of the company's sales are coming from what they call Asia/Latin America segment which represents 69% of global sales with 33% operating margins vs. 20% for US/EUR this year. With China/Hong Kong making up 30% of sales and Mexico is 21%, all the rest of Asia and Latin America combined make up 18% of sales.
In China sales of premium products have been supported by various factors including consumers' continuing to shun local dairy products due to poor sanitation and the deaths of some infants coming from lower-priced infant formula about five years ago. Thus there was a huge investor surprise when Mead, China's market leader with 17% share of the infant formula market, lost 3.5% of market share during this calendar year after it raised prices for the first time in two years.
I believe that Mead management should have known that this was a very poor tactical time to raise prices. China's No. 2, Danone
(PINK:DANOY) has a 14% share; it was known to be clearing out old inventory in preparation for a new product launch. The region's No. 3, Wyeth
(NSE:WYETH) with a 10% share, had just agreed to a buy out by Nestle
(PINK:NSRGY), No. 5 with a 7% market share, and would therefore be reluctant to cede any share by raising prices until its new management was firmly in place. But overall, it seems likely that the market has gotten more competitive there (before the effect of the acquisition), and that no longer-term gross margin expansion should be expected.
Mead has strong positions in other Asian countries where population growth rates are above China and where the percentages of working women will increase faster than in China. Its No. 1 share positions in other Latin American nations -- excluding Mexico (where it is already No. 1) and Brazil -- should allow it to take advantage of new markets with increased sales and higher operating margins, as those markets, and probably China as well, will consume more premium formula.
Using consensus EPS estimates of $3.35 and $3.80 for 2013 and 2014, a 6-7% sales growth rate and some leverage at the operating margin line in developing nations should be enough to get to a 9% compound EPS growth rate for the next five years. That would make the stock worth $81, 20% over the present $68 price, based on a 3.8% risk free rate (2.8% long bond plus 1% countering of quantitative easing) and a 4% risk discount for a high-quality consumer staple, adding to a 7.8% required equity return. My terminal EPS growth rate estimate is 1.5%.
So the stock is a buy. If the dollar falls, it is a big beneficiary. If the US and/or Europe do show economic recovery, it will benefit as well. The main downside risk is gross margin in the US, Europe, or possibly China, where Mead has already gained back of two of the 3.5 share points lost to competitors as of the last quarter’s results, making me somewhat sanguine.
No positions in stocks mentioned.
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