Hansen Natural Corp (HANS)

Here’s why Hansen’s is a great company to own at these price levels.

The energy drink market is growing rapidly. Goldman Sachs and Mintel Research predict it will be a $10 billion market by 2010. (almost double from now).

The leader in market share is Redbull with 43%, but is privately held.

The next largest market share leader is the Monster Energy drink brand. It continues to gain market share and accounts for 17% of the market sales. Hansen’s owns the Monster Brand and it is publicly traded. Additionally, this Monster Energy brand is Hansen’s primary revenue source.

Here is the growth of Hansen’s DSD (direct store delivery (which is their energy drinks)) over the past 4 fiscal years:

$49M 2003
$113M 2004
$270M 2005
$519M 2006

As you can see, the DSD #’s have been growing extremely fast.

This is the company to own for exposure to energy drinks because Hansen’s is still relatively small. Its market cap is just over $4 billion compared to Pepsi’s mkt cap of $127.B and Coca-Cola’s of $148.B. Both those companies have exposure in the energy drink market (with their Sobe Energy, Full Throttle Energy etc.) however, those companies are just too large for their energy drink brands to have much of an impact upon.

Competition

There is tons of competition in this field (with well over 100 brands being sold), however, the market leaders of yesterday, are still the market leaders of today, and will continue to be the market leaders in the future due to their brand recognition and loyalty. It is very much similar to the cola market in the earlier part of the last century. Hundreds, if not thousand of cola brands have existed, yet Coca-Cola and Pepsi have dominated the market. This is not a result of being able to sell their product for less, but a result of being able to sell their products regardless of competitor’s pricings due to their brand loyalty. Monster Energy has this brand recognition and loyalty. Here is a piece by the vice chairman at Berkshire Hathaway on this concept:

Charles T. Munger            

From his speech at The University of Southern California Marshall School of Business, April 14, 1994

A Lesson on Elementary, Worldly Wisdom as it Relates to Investment Management and Business


“And your advantage of scale can be an informational advantage. If I go to some remote place, I may see Wrigley chewing gum alongside Glotz’s chewing gum. Well, I know that Wrigley is a satisfactory product whereas I don’t know anything about Glotz’s. So if one is forty cents and the other is thirty cents, am I going to take something I don’t know and put it in my mouth –which is a pretty personal place, after all- for a lousy dime?

So, in effect, Wrigley, simply by being so well known, has advantages of scale –what you might call an informational advantage.

Another advantage of scale comes from psychology. The psychologists use the term “social proof.” We are all influenced –subconsciously and, to some extent, consciously- by what we see other do and approve. Therefore, if everybody’s buying something, we think it’s better. We don’t like to be the one guy who’s out of step.

Again, some of this is at a subconscious level, and some of it isn’t. Sometimes, we consciously and rationally think, “Gee, I don’t know much about this. They know more than I do. Therefore, why shouldn’t I follow them?”

The social proof phenomenon, which comes right out of psychology, gives huge advantages to scale –for example, with very wide distribution, which of course is hard to get. Once advantage of Coca-Cola is that it’s available almost everywhere in the world.

Well, suppose you have a little soft drink. Exactly how do you make it available all over the Earth? The worldwide distribution setup –which is slowly won by a big enterprise - gets to be a huge advantage… And if you think about it, once you get enough advantages of that type, it can become very hard for anybody to dislodge you.”

As an Investment

Do you know which stock has been the best performing stock over the past decade? It is Hansen’s, and by a very wide margin. All due to their Monster Energy brand. So, is it too late to invest in this company? I thought so until I read this by Warren Buffett on the results of the performance of Coca-Cola which has been a long term holding of his. I see this directly translating to the Hansen’s company today.

Warren E. Buffett         

The Essays of Warren Buffett

Debunking Standard Dogma


“Earlier I mentioned the financial results that could have been achieved by investing $40 in The Coca-Cola Co. in 1919. In 1938, more than 50 years after the introduction of Coke, and long after the drink was firmly established as an American icon, Fortune did an excellent story on the company. In the second paragraph the writer reported: “Several times every year a weighty and serious investor looks long and with profound respect at Coca-Cola’s record, but comes regretfully to the conclusion that he is looking too late. The specters of saturation and competition rise before him.”

Yes, competition there was in 1938 and in 1993 as well. But it’s worth nothing that in 1938 The Coca-Cola Co. sold 207 million cases of soft drink and in 1993 it sold about 10.7 billion cases, a 50-fold increase in physical volume from a company that in 1938 was already dominant in its very major industry. Nor was the party over in 1938 for an investor: Though the $40 invested in 1919 in one share had (with dividends reinvested) turned into $3,277 by the end of 1938, a fresh $40 then invested in Coca-Cola stock would have grown to $25,000 by yearend 1993.”

Valuation

Here is by far the most important aspect of this investment.

The historical average earnings multiple for the market is basically 15. A number of factors determine whether the market pays a premium earnings multiple above this, or awards a discount to. The father of value investing describes these factors best:

Benjamin Graham Security Analysis

The multiplier takes into account a large number of value elements, such as the expected stability of earnings, the expected growth factor, the expected dividend policy…

The chief factors that govern the average or characteristic price-earnings ratios for a given stock may be listed in the following order:
1. Those factors that are fully reflected in the financial data (tangible factors)
   a. The dividend rate and record
   b. Profitability –rate of return on invested capital
   c. Stability of past earnings
   d. Growth of sales and earnings in the past
   e. Financial strength or credit standing
2. Those factors that are reflected to an indefinite extent in the data (intangible factors)
   a. Nature and prospects of the industry
   b. Competitive position and individual prospects of the company
   c. Quality of management

Hansen’s absolutely deserves a large premium due to these factors. (you can call me if you need the reasons explained).

As of right now, there is no premium being given to the forward earnings multiple of Hansen’s in relation to their peers of Coca-Cola and Pepsi. Due to the nature of this industry, we can half-way trust analyst estimates for future earnings (unlike cyclicals such as the financial industry in which analysts can be off by an incredible amount as represented by Bear Sterns enormous recent quarterly loss of $6.90 a share when the Thompson analyst consensus was for a loss of just $1.79 a share).

Currently the forward earnings multiples are:
Hansen’s:   21x
Coca-Cola’s:   21x
Pep:      21x

(The premiums to the market are justified due to the fact consumer staple companies are awarded a premium when the fear of a recession is lingering –because their earnings will still exist where earnings of cyclicals may disappear completely when a slow-down occurs)

All fair right? No!, Hansen’s is growing substantially faster than their competitors and thus deserve to be valued at a higher earnings multiple. Next years earnings are expected to again grow by over 40%, while PEP and KO are expected to just grow earnings by 10% and 12%.

Additionally Hansen’s deserves an earnings multiple premium due to the fact that they could be acquired similarly to the recent Glaceau acquisition by Coca-Cola for $4.1 billion (which was over 6 times revenues). If a similar buyout happened with Hansen’s, their 2007 revenues of $870m would value the company at over $5.2 billion.

Forgetting about being acquired, we can come to a better technique for what the stock should be at in 1 year. We will simply take legendary investor: Peter Lynch’s advice as to what earnings multiple should be applied: (which I feel is appropriate for this company)


From One up On Wall Street:

The P/E ratio of a company that’s fairly priced will equal its growth rate. I’m talking about growth rate of earnings here.

So, even if we discount Hansen’s 40% earnings growth, and award a multiple in 1 year of 30 x earnings. We arrive at a price of:

30 x $2.09 (the average analyst estimates for 2008)
= $62.70

This is 53% higher than the current price of $41.