If you occasionally leave your house, you know that many Americans, and increasingly people around the world, are struggling with their weight. The problem is getting worse meaning more potential Weight Watchers (WTW) customers. There is also likely to be increasing pressure from companies and governments to get overweight people into weight loss programs. This creates an environment with a growing number of customers and potentially an increasing number of payers for these services.
Weight Watchers should benefit from these trends as it has a strong brand and a clinically proven process that helps people lose weight. The company is known for its weekly meetings, over 40,000 of which take place globally each week, which provide members with a support/motivation network as they work through the program. Increasingly though, the internet is the driver of the business, now accounting for over 25% of sales and 50% of operating income.
Looking at the Numbers
In 2012, over 72% of total revenues were generated during the weekly meetings. Meeting revenues have grown in absolute terms over the last few years, but internet revenue is increasing its contribution. Internet revenues grew from $239 million in 2010 to over $504 million in 2012. Even more importantly, the internet segment now contributes more than 50% of operating earnings. This is a growing, profitable and low capex segment that will contribute a growing portion to future earnings/cash flow.
WTW generates reasonably consistent free cash flow (FCF). If you look at 2011 versus 2012, large swings in working capital accounted for the growth in 2011 and subsequent drop in 2012. Taking the average of those two years, we see FCF ranging from $242 million to $315 million since 2008, including $265 million in the LTM period. The company needs minimal capex, spending only $82 million in the LTM period, including capitalized software. Using the LTM free cash flow against a $2 billion market cap, it's over a 13% cash flow yield. I think that's very attractive in the current environment.
Earnings are forecast to decline over the next couple years, but even using those estimates, I calculate a 9-10% cash flow yield on 2014 earnings. I think there's reason to believe future earnings and cash flow will exceed the current low expectations, from secular trends and a growing online market. The company pays a 2% dividend at the current price and the dividend represents only approximately 20% of free cash flow, leaving the company with significant cash flow to reduce debt, reinvest in the business, make acquisitions or return to shareholders.
Weight Watchers is a valuable brand with a growing pool of potential clients under new leadership. Weekly meetings are a proven strategy for losing weight and a growing online program is a great supplement to that foundation. These factors should enable WTW to take full advantage of the market conditions and continue producing cash flow similar to the levels of the last few years.
WTW is down over 23% in the last three months and close to 30% in the last year, significantly underperforming the S&P 500 index. The company is a low capital expenditure business, has a strong brand name and products/services that target a growing segment of the population. The company has reduced its share count 27% in the last five years. Additionally, as healthcare costs continue to rise, I believe there will be pressures and payments from companies and governments to get people into successful programs. Weight Watchers has a clinically proven program that helps people lose weight and that should help them continue attracting new members, both at meetings and online, in the coming years. At the current valuation, WTW looks attractive on a cash flow basis and I think the shares have the potential to reach $55-60 in the next 1-2 years. With the stock under $40/share, this seems like an attractive entry point.