Hawkins: Seems To Be Overvalued (NASDAQ:HWKN)

Hawkins (NASDAQ:HWKN) is a leading specialty chemical and ingredient manufacturer which provides a wide range of chemical products to industrial, water treatment, and Health & nutrition customers. The company works directly with its customers to make a specific formulation; with its manufacturing facilities located in the central United States, the company manufactures ingredients used in water treatment, health care, and fertilizer segments.

Recently, the company acquired various entities that manufacture chemicals needed in water treatment procedures, which has been driving higher revenues in the recent quarter.

As the management is relentlessly expanding its business operations through various related acquisitions, the earnings might substantially improve.

Since its high in 2011, the stock price remained at nearly the same levels till 2020, but due to the consistently improving operating margins, stock prices have increased in the last two years. After rising over 76%, the stock is trading for about $39.35 per share.

Currently, the company is trading for $827 million, which gives it an earnings multiple of 22 based on its previous nine months’ earnings; such a valuation for a slow-growing company seems fair. At this point, the stock may not provide an adequate margin of safety.

Historical performance

Over the last ten years, revenue has grown from $350 million in FY 2012 to about $774 million last year; such growth is primarily attributed to consistent expansion and acquisition, which shows that management is owner oriented and wants to expand its existing business. Also, over the same period, net profits have remained significantly volatile despite consistent improvement in the revenue and business, which might show that the company doesn’t have pricing power over its customer and suffers significantly during the industry downturns.

In addition, the increase in sales was driven by increased selling prices on many of our products driven by higher costs on many of our raw materials, as well as increased sales of our bulk and our manufactured, blended and repackaged products.

Source: Annual report 2021

The substantially attractive performance in the last year is primarily attributed to higher demand and favorable pricing in its industrial and water treatment segment; therefore, investors must consider that the business performance in the upcoming years will largely depend on industry-wide pricing.

It should be appreciated that the management has expanded the business operations while keeping debt levels at adequate levels; as a result, debt levels are appropriately managed at a moderate level over the period.

Despite significant fluctuations in the operating results, the company has produced significant cash flows for business over a long period; as a result, the company does not need any external source of funding, such as equity dilution, to sustain the business. Such a strong cash flow-producing business model makes the company’s operations self-sustainable and allows the company to expand its business reach.

Over the period, management has made various key decisions, such as efficient acquisitions, consistent buybacks, and dividend payments, which have generated huge value for the shareholders; As a result, the stock has been a compounded machine since its inception.

Strength in the business model

As the company has been allocating capital towards business expansion and acquisition, the company might gain significant market share in the upcoming years.

A robust financial position and a strong cash flow generating business model provide the company with a substantial competitive advantage. Although the business performance has been volatile, strong cash flows are providing significant strength to the business model.

Risk factors

Historically, the company has faced significant pricing pressure from its competitors; as the industry-wide demand drops, the company faces significant trouble protecting its margins; Current rising profits are primarily attributed to strong pricing for its chemicals; therefore, such favorable pricing might not sustain in the coming year, which can cause subdued returns to the shareholders.

The company’s current valuation seems high; any deterioration in the operating margins might affect the share price. A valuation of 14 for a slow-growing company seems high, and the stock may not produce desirable returns from this price.

Recent development

In the recent quarter, revenue increased from $183 million in the same quarter last year to about $241 million; such a strong revenue growth is primarily attributed to industry-wide solid demand and recent acquisitions. As a result of favorable pricing, the net profits have increased to over $18 million.

Also, over the last nine months, the company has produced over $37 million in net profits, which shows that the business margins are improving. But the investor must consider that, with improving operating performance, inventory and receivables are increasing alongside; as a result, cash flow from operations is consistently deteriorating, which might bring substantial working capital load on the balance sheet.

Also, due to recent acquisitions, long-term debt levels have increased to $130 million; if the company further seeks to expand its operations, debt levels might increase significantly.

Currently, the company is trading for about $827 million, producing over $37 million in the last nine months. It seems that the company is trading for over 22 times its previous nine months’ earnings. Although it has significant fixed assets and a strong cash flow generating business model, the valuation seems pretty high compared to its historical range.

Therefore, I believe the company’s valuation is considerably high, and from this point, it may not produce desirable returns for the shareholders. I assign SELL ratings to the stock.