Growth Prospects Make Industry ‘Viable and Attractive,’ Analyst Says

NEW YORK—M&As and low stock valuations have industry insiders speculating on the fate of the natural products industry. Their biggest concern: that it’s fading into a category of the larger food culture.

Not to fear, says Greg Badishkanian, VP of equity research at Salomon Smith Barney, who was recently named one of the Wall Street Journal’s prestigious “Best on the Street” analysts. He predicts a turnaround in the supplements sector and growth in the food and beverage, and personal care categories.

Natural Business: A hefty percentage of the companies listed on the Natural Business Composite Index™ (NBCI) are seeing stagnant or declining stock prices. What is Wall Street’s current perspective on the natural products industry? Is it still a viable industry to cover?

Greg Badishkanian: Overall, the natural

products sector is still a very viable and attractive sector to cover given that these companies have very strong growth prospects. Despite the strong growth profile of the sector, value investors have taken major positions in the space considering the relatively low trading multiples. In addition, many investors find the sector attractive, given that most stocks—even the largest ones—are take-out candidates.

NB: Botanicals & Dietary Supplements stocks have been slumping for about two years now. What is the future for coverage of companies in this category?

Badishkanian: At its peak in mid-1998, the Salomon Smith Barney Nutritional Supplement Composite traded at more than 30x earnings. The group currently has a P/E multiple in the mid-single-digit range. In addition, since the beginning of calendar 2000, the supplements group has underperformed the S&P 500 by roughly 45%. This led to a significant drop in analyst coverage of the supplements segment to the point where many companies have no real research analyst covering them. However, if I am correct in my belief that the sector will turn around operationally during the first half of 2001, we could see significantly greater investor interest and analyst coverage for this category.

NB: When do you see a turnaround in the public markets via IPOs and secondary offerings? What do the companies have to do to capture Wall Street’s interest?

Badishkanian: The nutritional supplements category is relatively out of favor with Wall Street. This is illustrated by the roughly 40% decline in the group’s stock price since the beginning of the year and the relatively low trading multiples (the group trades at only 8x earnings). It will be difficult for any supplements company that does not have proprietary products or market leadership to tap the equity markets. I believe the sector will not turn around until the beginning of 2001. As a result, I don’t anticipate any successful supplements IPOs or secondary equity offerings to occur until mid-2001.

Over the next six to nine months, I anticipate further consolidation to occur. The recent deal by Numico [N.NUM] and Rexall Sundown gives [Numico] roughly 25% market share within the U.S. supplements sector. In terms of size, the smaller players with strong brands and other competitive strengths will be the best positioned to access the equity markets and will narrow the gap with Numico through consolidation strategies.

NB: The Food & Beverage category consists of a sprinkling of tiny companies and one giant, the Hain Celestial Group (HAIN). What can small food and beverage companies do to draw Wall Street’s attention to them?

Badishkanian: Wall Street analysts and institutional investors will naturally gravitate toward the leaders within any sector. In the case of the Food & Beverage segment, Hain has numerous competitive strengths including leading brands, critical mass, a very strong management team and access to all major distribution channels. Also, certain institutional investors and Wall Street analysts will only follow companies with a sizable market capitalization. However, smaller natural food and beverage companies operate within a very high-growth sector. The companies that will garner the greatest Wall Street attention will be those that have leading brands within their respective subcategories and can consistently meet their stated financial goals and targets.

NB: The same is true for the Consumer & Personal Care Products category. What do these companies have to do to begin bringing returns to their shareholders?

Badishkanian: I believe that the natural Consumer & Personal Care Products category should grow more rapidly than the traditional consumer and personal care category. However, many of the companies are too small for major Wall Street firms to cover. There will likely need to be consolidation within this sector by existing players. As the sector consolidates, it would then likely follow the path of the natural foods sector, where traditional players attempt to enter the space through acquisitions.

NB: The Retail & Distribution sector seems to be the NBCI’s strongest. However, it contains a number of small players and the dot coms that seem to be struggling. What’s it going to take for them to be taken seriously by Wall Street?

Badishkanian: I would attribute the strong results of the Retail & Distribution sector to the fact that these companies have fairly large market capitalizations and operate primarily within the natural foods sector. With respect to nutritional e-tailers, there are primarily two issues leading to the demise of this group. First, nutritional e-tailers primarily sell nutritional supplements, which is currently the slowest-growth segment of the natural products industry. Second, the B2C pure play Internet model was based on abundant access to capital to build a brand and acquire customers. With the dot com melt-down, nutritional products e-tailers, similar to other e-tailers, can no longer fund expensive customer-acquisition costs. As they burn through cash, we anticipate further bankruptcies and consolidations.

NB: What do you predict for the upcoming year for companies on the NBCI?

Badishkanian: Not all companies will perform well over the next year. As the sector consolidates, the leaders will gain share and improve their competitive positioning relative to the smaller players. Also, in the shorter-term, the natural foods segment will continue to experience strong, rapid, top-line growth and consolidation. As a result, natural foods companies should continue to do well over the next 12 months. It is anticipated that there will be strong top-line growth combined with consolidation.

In terms of nutritional supplements, anticipate weak sales for the remainder of the year. However, by the end of calendar 2000, I anticipate the sector bottoming out. At that point there could potentially be significant value opportunities.