Description

Which year doesn’t look like the others?

EPS

2003 - $0.83

2004 - $0.56

2005 - $0.79

2006 - $0.77

2007 - $0.77

2008 - $0.83

2009 - $2.29

ROE

2003 - 13%

2004 - 9%

2005 - 11%

2006 - 10%

2007 - 10%

2008 - 10%

2009 - 23%

Thesis

Hawkins, based in Minnesota, is a small, well-run manufacturer of bulk chemicals (33% of sales) and specialty chemicals (67% of sales) that serves a variety of end markets in its region.  The company has two mains segments: Industrial & Water Treatment.  Market cap is $226m, net cash $30m, EV $196m.

Hawkins saw a huge spike in profits in FY 2009 (ended 3/31/09) due to a boom in the Industrial Segment, with Segment EBIT jumping from $2-4m range over the previous 5 years to $26m in 2009.  To simplify, there were shortages in many of Hawkins' commodity products and the company was long inventory and realized a boost in profits. The Water Treatment segment saw a related effect on a smaller level.

As per the company's most recent press release (see below), the situation has settled down and profits should revert to previous levels this year, FY 2010 (ends 3/31/10).  The company will gain slightly from release in working capital ($6m benefit, by my estimate) and some increased market share, but nothing major has changed in the business.  I estimate that company is worth roughly $16/share, or slighlty above where it traded before the huge spike.  This checks out to about 14x P/E on normalized net income of $9m plus cash balance.  The company has run with a healthy cash balance for years and pays a small dividend.

From the 2009 Q4 press release on 6/4/09:

'Chief Executive Officer, John R. Hawkins, commented, "While we saw some stabilization in commodity prices in the fourth quarter, our raw material costs remained significantly higher than the prior year, driving the higher sales reported within our Industrial and Water Treatment segments. Prices for many of the bulk commodities have declined significantly recently, consistent with weaker demand due to the slower economy. We expect these pricing declines to drive lower selling prices for our products in the coming fiscal year. As we have previously stated, we expect our fiscal 2010 business and the gross profit realized to return to levels more in line with historic results prior to fiscal 2009."'

I have no specific expertise on the dynamics of these markets, but basic economics in a commodity market indicates profits will return to normalized levels shortly, and the company explicitly states that this will, in fact, be the case.

Other relevant commentary from 10-K

Fluctuations in the prices and availability of commodity chemicals, which are cyclical in nature, could have a material adverse effect on our operations and the margins of our products.

Periodically, we experience significant and rapid fluctuations in the commodity pricing of raw materials. The cyclicality of commodity chemical markets, such as caustic soda, primarily results from changes in the balance between supply and demand and the level of general economic activity. We cannot predict whether the markets for our commodity chemicals will favorably impact our operations or whether we will experience a negative impact due to oversupply and lower prices.

Our principal raw materials are generally purchased under supply contracts priced according to predetermined formulae dependent on price indices or market prices. The prices we pay under these contracts generally lag the market prices of the underlying raw material. The duration of our supply contracts has shifted from annual to primarily quarterly or monthly in duration as a result of recent pricing volatility. In addition, the cost of inventory we have on hand generally will lag the current market pricing of such inventory. While we attempt to maintain competitive pricing and stable margin dollars, the variability in our cost of inventory from the current market pricing can cause significant volatility in our margins realized. In periods of rapidly increasing market prices, the inventory cost position will tend to be favorable to us, possibly by material amounts. Conversely, in periods of rapidly decreasing market prices, the inventory cost position will tend to be unfavorable to us, possibly by material amounts. We do not engage in futures or other derivatives contracts to hedge against fluctuations in future prices. We may enter into sales contracts where the selling prices for our products are fixed for a period of time, exposing us to volatility in raw materials prices that we acquire on a spot market or short-term contractual basis. We attempt to pass commodity pricing changes to our customers, but we may be unable to or be delayed in doing so. Our inability to pass through price increases or any limitation or delay in our passing through price increases could adversely affect our profit margins.

Catalyst

Return to historical margins.