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| Source: | LOHAS Weekly Newsletter |
| Published: | Sunday, November 01, 1998 |
Sales were up 21%. Net income was up 64%. EPS were up 29%, from $.17/share in 3Q97 to $.22/share in 3Q98.
“We thought the company had a great quarter,” OATS CFO Mary Beth Lewis told the Denver Post.
Wall Street didn’t think so.
The Street expected OATS to finish out 3Q98 with EPS of 23 cents, one penny more than the company reported. For that one penny, Wall Street punished OATS by sending its stock value down 15% in one day.
Such are the current ventings of the volatile U.S. stock market. Up to August of this year the bullish market had decided it was the natural products industry’s best friend. The Natural Business Composite Index™ (NBCI) was consistently outperforming both the Dow Jones Industrial Average and the Nasdaq Composite Index.
On Aug. 3, the friendship hit a rough patch. The market as a whole lost a bundle and so did natural products stocks—especially supplements stocks—and the NBCI began its descent. From its July high of 193.12 it has fallen 78.5 points, to its current 114.67.
The rift between The Street and the industry has remained agape even as the Dow and the Nasdaq have gradually recovered from their August lows, and industry stocks, while gaining some of their lost ground, are still significantly depressed. And the word from analysts is don’t expect things to change much for the rest of the year.
Emotions are running high on Wall Street right now, analysts say. And emotion dominates bear markets—where natural products stocks currently and stubbornly reside.
Simply put, “The market believed the industry had better prospects and now it doesn’t,” says Matt Patsky, managing director of Boston-based Adams, Harkness & Hill. “Market psychology has turned against the group.”
Patsky says he’s seen it before. “It happened in 1994 in a big way. There was a collapse of the sector. Celestial Seasonings went from the high $30s to the teens, Whole Foods Market went from $25 to $9, General Nutrition went from the high $20s to the low teens, and NBTY went from $24 to $4—all in a period of three or four months,” he says.
But analysts also say that comparing the NBCI’s performance with the performance of the Dow or the Nasdaq isn’t appropriate.
For an industry dominated by small-cap stocks, it’s best to watch the Russell 2000 Index, an index made up of the 2,000 smallest U.S. public companies.
“We’re not charting our own path,” Denver-based Hanifen Imhoff analyst Carole Buyers says. “We’re charting the path of the Russell.”
The Russell is down. Despite a resurgence that began in mid-October, it’s off 17.9% for the year, as of Oct. 26. From June until August the NBCI was outperforming the Russell, sometimes by as much as 14%. On Aug. 3, however, while still in the minus percentage column, the Russell started beating the NBCI, and it’s been beating it ever since (see chart, pg. 1).
The question is why?
“The nutrition industry lost more than the rest because it had gone up faster,” says Yudi Bahl, an analyst with Minneapolis-based Piper Jaffray.
But it’s not just market volatility that’s currently hurting natural products industry stock performance. General Nutrition Cos.’ (GNCI) decision to lower prices and recent negative publicity about supplements also have had an impact, according to Bahl. “People have started asking if this is going to lead to a price war,” he says.
Analysts also agree that in volatile markets, small-cap stocks are the first to take a beating and the last to recover. “It won’t be over until some of the large-cap stocks start capitulating,” Buyers says.
A few, in fact, have already begun to crack. Buyers notes that both Coca Cola (KO) and Microsoft (MSFT) have faltered over the past several weeks. “You are starting to see some large, expensive—in terms of price-to-earnings ratios—stocks come down,” she says.
But no analyst is ready to predict that the market will make up with the industry by the end of the year.
Performance for the balance of 1998 will depend on whether the overall economy shows continued signs of weakening, they say.
“I don’t think this industry is recession proof,” Buyers says. “If we have a down economy, I can’t say that these natural products companies wouldn’t continue to react under that kind of pressure. The economic environment for the natural products shopper has changed, and the profile of the natural
products shopper has changed.”
As for the latter observation, Buyers is referring to the largely successful bid by some natural foods retailers to draw crossover shoppers from conventional supermarkets and the similarly successful bid by mass marketers such as Wal-Mart (WMT) and Kmart (KM) to attract natural products shoppers.
Patsky, however, has some optimism that the NBCI could end the year up from its current level. But, he cautions: “The fact is that there is a vicious cycle of tax-loss selling at year’s end. We don’t have any control over that. It’s not rational selling.”
Lana Lazarus, an associate analyst with Nationsbanc Montgomery Securities, sounds a clarion call for long-term thinking. “Look beyond the next several months, even the next 12 months,” she says. “A lot of [the industry’s] stock has been dumped into the market by mutual fund managers with no buyers on the reciprocal end. The underlying fundamentals of this group have not changed. It will rebound.”
All the analysts say there are still winners in this hostile environment. Patsky picks Whole Foods Market (WFMI); Rexall Sundown (RXSD); Natrol (NTOL); and Balance Bar (BBAR). “Look at Balance Bar,” he says. “That stock is down 50% and is beating its numbers. The market is littered with these stocks.”
Bahl likes NBTY. “I also like Natrol,” he says.
Buyers likes United Natural Foods (UNFI). “Their volumes typically stay the same, and they make money on the spread. It’s the more conservative play in the group right now,” she says.
Lazarus likes NTOL, RXSD and HAIN.
Analysts also agree that the current window for IPOs is closed. There is, however, one financing window for private natural products companies that currently is open, in fact, gaping. That avenue is through mergers and acquisitions.
Mergers and acquisitions should be rampant in the short-term because they provide private investors exit strategies, Lazarus says. All generally agree that the natural products industry is ripe for another round of consolidation.
“If you’re trying to buy a business, what better time?” Patsky says. “Companies selling at 40-times earnings a few months ago are now available at six-times earnings.”
It’s finding the money to buy up those markdowns that has some in the industry still stymied.
“Actually, the best place to be right now,” Bahl admits, “ is in a place where you don’t have to borrow money.”