Description

Investment Thesis

I am recommending a long position in Mead Johnson Nutrition (MJN). MJN is a very high quality company trading at a fair price. Over the long term, I think it will provide very attractive risk adjusted returns by compounding earnings at a 12%. I think there is a high probability that the company will ultimately get acquired at a significant premium to its current valuation.

History and Business Description

MJN , formerly, a wholly owned subsidiary of Bristol Myers, was listed in the NYSE in February 2009. The float was subsequently increased through an exchange offer with the parent company, BMY.

Mead Johnson Nutrition Company (Mead Johnson) is a pediatric nutrition company. The Company's Enfa family of brands, including Enfamil infant formula, is a global brand franchise in pediatric nutrition. Its product portfolio addresses a range of nutritional needs for infants, children and expectant and nursing mothers. Mead Johnson markets its portfolio of more than 70 products to mothers, health care professionals and retailers in more than 50 countries in North America, Europe, Asia and Latin America. The company was founded in 1905 and is headquartered in Glenview, Illinois.

MJN has one of the most attractive geographic sales breakdowns in the consumer staples space. It derives 64% of its sales from emerging markets, 40% from Asia, 13% from Latin America, and 1% form Central/Eastern Europe. Over the past five years, emerging market sales have been grown organically at 14%. Pediatric nutrition industry sales are estimated globally to be roughly US$20 billion, about half emerging markets and half developed markets. It is estimated that by 2025, developed market pediatric nutrition sales will grow to US$15 billion and developing markets will grow to US$71 billion! Growth in emerging markets will be driven by  a combination of increasing penetration due to higher incomes and higher fertility rates.

Infant nutrition is one of the most attractive categories in the consumer staples space because of its pricing power and potential for innovation. Furthermore, it is ripe for consolidation. The category is dominated by Nestle, Danone, Abbot, Wyeth, and Mead Johnson Nutrition with market shares of 21%, 13%, 12%, 6% , and 16%, respectively. A combination with either Wyeth or Nestle would make most sense in terms of geographic market share distributions. . Nestle would be the most likely acquirer.

Financials and Valuation

MJN trades at a PE of 18x 2010 estimated earnings and an enterprise value/ebitda ratio of 12x estimated 2010 ebitda. This valuation is in line with other large consumer staples companies with attractive international exposure:

Given MJN's substantially higher ROIC, more interesting category growth profile, and potential for becoming a target of M&A (Nestle), MJN should trade at a premium to these companies. Numico, a very similar company to MJN, was acquired for 22x EBITDA and 4.7x sales in 2007. Nestle probably could not have acquired it because of market share issues in developed Europe.

Risks

The biggest risks for MJN are of a short term nature.

Revenue growth could disappoint in the near term. The company has been losing market share in the US to ABT. The US market is dominated by MJN with 43% share of market and ABT with 38% share of market. MJN had fallen behind in innovation, and has addressed the problem with new product introductions. However, there could be a lag between the time when these products are introduced (Enfa Restfull, Enfa Grow), and the changes in market share.

Increase in raw material prices. The industry has historically been able to pass price increases, but there sometimes is a lag.

Catalyst

Catalysts:

There are no specific catalyst in the horizon. Appreciation should come from  the accretion of value over the long term. A potential re-rating or a takeover could significantly improve returns for this investment.