This morning (06/25/18), HAIN announced a CEO succession plan and has undertaken a CEO search, upon the hiring of which, Founder, President and CEO Irwin Simon would become Non-Executive Chairman of the Board. In other news, this past Friday evening, the NY Post reported that Kraft Heinz is interested in purchasing Campbell’s.
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Our research indicates that the tax bill winding its way through Congress, if passed, should accelerate growth which would be most beneficial to our Hardline companies such as Home Depot. The basic mechanisms that cause higher growth include a reduction in income taxes that should drive near-term consumption and encourage individuals to work more, and a large cut in the corporate tax rate which economists almost universally agree should spur investments in capital and, to a lesser degree, labor, driving productivity improvements. As consumption and investments ramp-up, near-term growth should accelerate. Over time, economic growth potential is governed by the accumulation of capital, additional labor and, most importantly, improving productivity. This legislation checks all the boxes suggesting a higher level of growth is probable.
As highlighted by Wolfe Research’s Accounting and Tax Policy’s note, Tax Policy: Marching On and Tax Reform Spreadsheet, tax reform should have a greater impact on high tax payers with a U.S. focus, such as many staples retailers. Indeed, when looking at our coverage universe and the potential EPS impact assuming a proposed 20% U.S. corporate tax rate, many of our covered companies could see a 20%+ boost to EPS. Though the corporate tax rate provisions may not come into effect until 2019, there could potentially be the impact in FY18 from a pull-through of additional CapEx spending as companies may accelerate purchases to take advantage of higher tax write-offs. In our opinion, the shift of CapEx into FY18 could benefit companies that provide IT services near term, specifically AMZN given its market leading AWS position, as it will be the seller to customers who move their purchases from 2019 into 2018.
We are dropping coverage of Whole Foods following the completion of Amazon’s acquisition of the company on August 28, 2017. On June 16, 2017 Amazon announced that it would acquire Whole Foods for $42/share (all cash) for a total transaction value of approximately $13.7 billion. On July 26, 2017, we dropped our rating on WFM given the low likelihood of additional bidders emerging for WFM and our belief that there was minimal FTC risk to the transaction closing. With our dropping of coverage, our previous estimates should no longer be relied upon.
Amazon, as it indicated last week, has lowered pricing on some fast turning items and it has also introduced Whole Foods’ private label items onto the Amazon website. Next up, according to Amazon, will be special pricing for Amazon Prime members. Our research continues to suggest that Amazon’s impact on the $1 trillion-plus consumables market is just starting and the ramifications for the industry are likely to be felt for years. Consumers’ desire to eat healthy and the building appeal of having re-orderable items like laundry detergent delivered to the home makes the combination of Amazon and Whole Foods incredibly disruptive, in our opinion. For the industry… pricing is going down, stores are too big, companies don’t have enough scale, and the cost of doing business is going up. As such, we continue to urge investors to avoid Food and Broadline retailers.
HAIN is set to report 4Q17 earnings tomorrow morning (8/29/17) before the market opens and will host a conference call at 8:30am ET. Our and the Street’s EPS estimates for 4Q17 are $0.41 and $0.40 respectively. Our forecast for the fourth quarter reflects negative low single digit net sales growth for the consolidated company, combined with gross margin pressure and operating expense deleverage, leading to operating margin compression.
We had the opportunity to survey frequently purchased items at Whole Foods in Sarasota Florida on Sunday (7/27/17) and then revisit the store again this morning (7/28/17) to see first-hand Amazon’s announced price cuts at Whole Foods. In our basket of 60 items, 9 products were lowered, with the average decrease in price on those items of approximately 23%. While the price-cutting activities were focused on items such as eggs, milk, butter, and fresh produce, we did note a few items in the center of the store that saw price reductions such as private label pasta sauce. While the price-cutting was sharp, it was fairly limited, resulting in our basket falling just over 2% in aggregate. Nonetheless, we continue to view Amazon’s purchase of Whole Foods as a game-changer for the food-at-home industry and anticipate further price reductions over time.
On Thursday, Amazon and Whole Foods announced that the pending acquisition of WFM would close on August 28th, and that upon close, the company would be reducing prices on certain staples items at Whole Foods, introducing Whole Foods' private label offering through Amazon, AmazonFresh, Prime Pantry, and Prime Now, as well as working to integrate Amazon's Prime offering with WFM's point-of-sale system to bring customers additional savings. Further, the company noted that this was just the beginning of its plans to offer enhanced in-store benefits and lower prices and it anticipates opening additional Whole Foods' stores.
ALDI seems to have found no limit to how cheaply its will to sell this popular summer condiment as we recently spotted a 20oz bottle in Albany, NY selling for a shockingly-low 59 cents! This item had traditionally been sold at 99 cents, but was lowered earlier this year to 79 cents in some stores we visited. Our research indicates that private label pricing has become a focal point for competition in certain areas, especially markets that have seen Lidl opening stores or that have a large ALDI presence. Wal-Mart has been reformulating, repackaging, and reducing its private label prices in select geographies to better compete with the hard discounters and we recently spotted Great Value mustard on an endcap for 80 cents (down from $1.28). Kroger, too, has bene getting more aggressive with its private label pricing in order to compete more effectively. As we noted in our report, The Great Deflation (June 29, 2017), a main challenge for retailers will be falling average selling prices and the negative impact this may have on sales and margin if lower private label pricing becomes more prevalent across the U.S.
WFM reported 3Q17 EPS results that were better than expectations and comp sales are now running positive, although we believe some of this improvement may be due to timing of July 4th. It does appear, however, that the food-at-home industry has seen some stabilization of late in part due to high consumer confidence driven, we believe, by the strength of the equity and housing markets, as well as a robust employment climate. With that said, the structural challenges for the industry remain daunting as Amazon (soon to be armed with Whole Foods) drives into consumables, the hard discounters aggressively move into the U.S., Wal-Mart forcefully defends its leading market position, and the traditional supermarket industry vigorously tries to repel the threat from all these competitors. In our opinion, the war for the hearts and minds of the consumer in the $1 trillion consumables marketplace is just getting started and as such we continue to rate Food and Broadlines Retailers Underweight.
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