Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Shares of Weight Watchers (NYSE:WTW) lost some weight despite a solid second-quarter earnings report. The change in management and poor revenue guidance for the remainder of the year, are a big worry.

I remain on the sidelines despite the recent sell-off. The recent price action is warranted on the back of really poor revenue developments going forward, as the company's Internet activities start to stagnate as well.

Second-Quarter Results

Weight Watchers generated second-quarter revenues of $465.1 million, down 4.0% on the year before.

Net earnings fell by 16.2% to $64.9 million. Diluted earnings per share fell by 15.0% to $1.15 per share. Excluding a $13.3 million charge related to early extinguishment of debt, both earnings and earnings per share would have increased a little bit.

Adjusted earnings, excluding the debt charge, came in at $1.39 per share, beating consensus estimates of $1.11 per share.

CEO Jim Chambers commented on the disappointing developments, "Current business conditions are challenging, As an offset, we are making good progress with our cost savings agenda. We know there's much more to be done to improve overall business performance. While I'm excited about the team's plans for the January 2014 campaign, the 2013 recruitment weakness means that we'll start 2014 with fewer active members and therefore a lower earnings base."

Looking Into The Results

Weight Watchers is suffering as revenues from its traditional operations are falling. North-American revenues fell by 7.4% while international revenues fell by 8.8%. Central-European revenues actually increased a bit, but the disappointing international revenue developments are mainly caused by a 18.8% decline in the U.K.

A positive point is the 6.6% increase in Internet revenues, which now make up almost one-third of total revenues. Yet these activities are causing concern among investors as the business grew at a much faster pace in recent times.

Despite the struggles, Weight Watchers managed to increase its operating margins by 140 basis points to 33.1%. Combined with the fall in revenues, operating income came in essentially unchanged from the year before. As mentioned above, the $2.4 billion refinancing of its long-term debt resulted in a one-time charge, which hurt net income.

Valuation

Weight Watchers ended its second quarter with $120 million in cash and equivalents. The company operates with $2.4 billion in long-term debt, for a net debt position f $2.28 billion.

Revenues for the first six months of 2013 came in at $952.1 million, down 3.7% on the year before. Net earnings fell by 14% to $113.7 million. Earnings per share actually rose by a penny to $2.02 per diluted share on the back of sizable share repurchases.

At this pace, the company is on track to generate annual revenues of $1.75 billion on which it could earn around $200 million, or between $3.55 and $3.70 per share.

Factoring in the 19% drop in Weight Watcher's shares on Friday, with shares trading at $38, the market values the company at $2.1 billion. This values the company at 1.2 times annual revenues and roughly 10-11 times annual earnings.

Weight Watchers currently pays a quarterly dividend of $0.17 per share, for an annual dividend yield of 1.8%.

Some Historical Perspective

Long-term investors have seen a fair bit of volatility. Between 2003 and 2007, shares traded in a relatively tight $40-$60 trading range. Shares fell toward $20 in 2009, amidst the financial crisis. From that point onwards, shares have seen a steady recovery to highs of $80 in 2011, driven by solid underlying revenue and earnings developments. As growth stagnated and earnings and revenues are declining, shares have lost more than half of their value.

Between 2009 and 2012, Weight Watchers has increased its annual revenues by 30% towards $1.83 billion. Net earnings rose by 45% in the meantime towards $257 million. Important to realize for shareholders, the company has embarked on an aggressive share repurchase program, retiring a quarter of its shares outstanding.

Investment Thesis

While Weight Watchers comfortably beat on its second-quarter earnings report, investors are shocked with the guidance for the second half of the year. Former CEO David Kirchhoff has resigned to be succeeded by former Chief Operating Officer Jim Chambers.

Full-year earnings are now seen between $3.55 and $3.70 per share, below consensus estimates of $3.72 and the previous guidance of $3.60-$3.90 per share.

While revenues from the traditional activities were declining for a longer time, the sudden growth slowdown in the online operations is outright worrying as it was a bright spot within the firm. Weight Watchers blames the increase in free apps as a disturbing factor, but remains confident it will be a temporarily factor given its superior products compared to "calorie-counters."

While the immediate outlook for future revenues is outright bleak, the cost savings initiatives are promising, largely explaining the second-quarter earnings beat. Yet the weaker enrollments will hurt both revenues and earnings going forward, a reason why Weight Watchers aims to cut costs in 2014 by $64 million per year.

Yet management remains optimistic. Enrollments will fall but retention rates and satisfaction among current customers remains at high levels, which provides comfort to management. Therefore all commercial initiatives are focused on boosting future enrollments, but the short-term outlook remains challenged. Yet the long-term growth potential remains as societies across the world continue to be crippled by the challenges presented by obesity.

Consequently, total revenues are expected to fall in the low double digits in the second half of the year, implying that-full year revenues will fall in the mid single digits.

The 20% sell-off following the second quarter results is warranted given the poor revenue outlook despite the positive impact from cost cuts. Investors are shocked that the online business, which performed relatively well, is now suffering as well.

Last year, I took a look at the company's prospects, and I warned investors to be cautious. I reiterate my stance at the moment as the positive effect of cost-cutting initiatives more than outweigh the poor revenue guidance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Weight Watchers - Stock Continues To Lose Weight