Horizon Organic: One to Grow On?


By Amey Stone There's nothing like Thanksgiving to get Americans thinking about food. And there's nothing like an economic slowdown to get investors thinking about food stocks. Both factors benefit Horizon Organic (HCOW), the country's leading distributor of organic dairy products.

The shares of the tiny company -- it has a market cap of just $130 million -- have soared this year. It started out at about $4.50 and closed on Nov. 19 at $12.99 -- a 52-week high. The packaged-foods sector, which investors view as defensive since demand for food remains constant during economic downturns, is flat so far in 2001, while the overall market has fallen about 14%. But the smallest, fastest-growing companies in the group have outperformed the sector, notes Sam Stovall, sector strategist with Standard & Poor's Equity Research.

SELLING AT STARBUCKS. Horizon Organic has shown recent earnings growth few can match. Its profits doubled in the third quarter to $592,000, or 6 cents a share, from $277,000, or 3 cents a share, in the third quarter of 2000. Sales for the quarter were up 17%, to $39 million. The company expects to earn 17 cents a share in 2001 and between 32 cents and 39 cents in 2002 (although a good part of the jump is due to a change in accounting rules regarding the amortization of goodwill from acquisitions).

Horizon's growth strategy is straightforward: the addition of new products, like cheese sticks and flavored milk, and increased distribution, such as selling its yogurt at Starbucks. It also is expanding internationally, with overseas markets now accounting for 20% of sales. The company bought Rachel's Organic Dairy in Britain and has a new joint venture in Japan.

Horizon expects its real growth driver to be an increased demand for organic foods. The highly fragmented market is projected to grow from $9 billion in 2001 to $20 billion in 2005, according to research cited by the company, with consumers willing to pay higher prices to avoid pesticides, antibiotics, growth hormones, and genetically modified ingredients.

"AN OPTION." Rather than claim that organic food is healthier -- which can't be backed up by scientific proof -- CEO Chuck Marcy says simply, "people are concerned about food safety, and we're there as an option." Another selling point: Organic agriculture is better for the environment and healthier for animals, says Marcy.

While that may be a less controversial claim, it has nevertheless opened up Horizon to criticism. Most notable was a recent story in The New York Times Sunday magazine section on the mainstreaming of organic foods that labeled Horizon "The Microsoft of organic milk." Marcy admits the company embraces mass-market production methods but characterizes the article as misleading. The fact is that "organics are going mainstream," says Adams, Harkness & Hill analyst Scott Van Winkle. "You can't do that grass-roots style."

Horizon is already adhering to U.S. Agriculture Dept. regulations scheduled to go into effect in October, 2002, that will require that any food with the "USDA-certified organic" label have 95% organic ingredients. Marcy expects those rules to reassure consumers they're getting more than marketing spin when they pay extra for organic products. "What we as an industry are trying to do is create something that meets the strictest definitions in the world of what organic is, that provides consumers high-quality choice, but that can be produced on a mass basis affordable to the general populace," he says.

HAPPY COWS. Given the additional costs associated with organic-food production, Horizon usually charges a premium of 30% to 50% over nonorganic foods. "We have to be able to produce something that is viable on mass basis," says Marcy.

Two-thirds of Horizon's sales are from regular grocery stores

A mass market is clearly what Marcy, who says his model is ConAgra's Healthy Choice brand, has in mind. Although Horizon is available in health-food stores, two-thirds of its sales are from conventional grocery stores. The company includes its "Happy Cow" logo on all its products -- even juices.

Marcy, who has 25 years experience with major packaged-foods companies, took over Horizon Organic in late 1999 and has put in place more sophisticated systems for logistics and information management. He has also introduced new products and helped the company lock up 60% of the supply of organic milk in the U.S., effectively blocking competition.

He announced recently that Horizon is selling off its company-owned farms and will contract for the organic milk. "We're not farming experts," he says. "We're sales and marketing people and product-development people. That's our core competency."

COMFORT FOOD. Such traditional corporate strategy may not sit well with purists who tend to see organics as a socially conscious alternative to mass-produced foods. But mass production lowers costs, helping Horizon price its products more competitively, and that should offer some comfort to investors. They might also find the "Microsoft of organic milk" label quite attractive.

Noting that the company has resolved some prior manufacturing problems and has been expanding its market share in conventional supermarkets, Adams Harkness' Van Winkle upgraded Horizon to a buy rating in May. His current price target is $14 a share, and he says the stock is still attractively priced relative to some other small food companies that were recently sold.

Investors should keep in mind that Horizon is a small-cap stock, and it traded an average of about 43,000 shares a day in October. That makes the shares more volatile and potentially illiquid, keeping many large institutional buyers out of the stock. Also, although the company is trying to convert more farmers to organic methods, Van Winkle notes, "there are always operational and competitive risks."

Horizon Organic will have to log several more quarters of strong financial performance before large investors jump aboard. But, with its strong recent growth in the face of a weak economy, it could be a stock to be thankful for this Thanksgiving and beyond. Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column


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