When I heard of the negative news about Nu Skin Enterprises (NYSE:NUS), it reminded me of Bill Ackman's criticism of Herbalife (NYSE:HLF) being an unsustainable pyramid scheme. Herbalife's stock took a huge plunge at the end of 2012 after Ackman's presentation called for the company's demise. However, Herbalife's stock more than doubled in 2013 as the news surrounding the story subsided. Could Nu Skin see a similar rise as this story subsides?
Nu Skin has a multi-level marketing (NYSE:MLM) business model, where its salespeople make money by selling products and by recruiting others to do the same. Recently, Nu Skin has come under scrutiny about how it operates in China. China accounted for 41% of the company's sales for the 1st nine months of 2013. The claim against the company came from the Chinese state media who accused Nu Skin of operating an illegal pyramid scheme in China. The stock fell 40% in just a few days after the news was released. This took a fairly valued company down to an attractively undervalued company, assuming that the negative news is undeserved.
This is Nu Skin's response to the article that appeared in the People's Daily magazine:
"The article that appeared in today's People's Daily contains inaccuracies and exaggerations that are not representative of Nu Skin's business in China. The reporters did not attempt to verify any information with Nu Skin. We do not believe that the article was the result of any particular government inquiry.
"We are dedicated to operating in full compliance with applicable regulations as interpreted and enforced by the government of China. Nu Skin has an 11-year history of doing business in China under these regulations. Our business activities are regularly monitored by the government in this rapidly growing marketplace. As is our practice, we will communicate openly with regulators to address questions arising from this article.
"Nu Skin has government-approved direct selling licenses to operate in a majority of provinces in China. The most recent government licensure in July further expanded our direct selling footprint to include 19 of the country's 32 provinces.
"We actively educate our sales force to follow all regulations as well as company policies and procedures, and any member of our sales force not operating in accordance with local law or with our company policies is subject to discipline."
It looks like the Chinese government will be investigating the company's operations in China. However, this doesn't mean that any illegal wrongdoing will be found. Nu Skin released another press release stating that it will cooperate with the government in China to ensure long-term sustainable growth. Nu Skin has been operating in China for 11 years, so I don't think that any show-stopping discoveries will be found in the investigation.
Nu Skin has been finalizing its new Greater China regional headquarters and Innovation Park in Shanghai. The new facilities in China includes: world-class anti-aging and development laboratories, manufacturing facilities, modern meeting spaces, and green areas. This consists of three buildings: a headquarters, a product development distribution center, and a vision hall. With an 11-year history of operating in China and with these new facilities being finalized, I think that Nu Skin is confident that it will be continuing to operate in China for the long-term.
It is possible that the Chinese government finds that Nu Skin or some of its sales representatives did not obey certain laws. If that is the case, I would guess that Nu Skin would address the situation, pay fines if applicable, and continue operating in China. I doubt that there will be any major discoveries that would cause the company to no longer operate there.
The recent sell-off in the stock has created an attractive undervaluation in the company. The stock is now trading at only 10.9 times 2014's EPS. The PEG ratio of only 0.47 shows that the company's expected earnings growth greatly exceeds its PE ratio. Nu Skin is expected to grow earnings at 24% - 25% in 2014. It is expected to grow earnings annually at 29% for the next five years.
It's a gamble, but my gut tells me that this will play out like the Herbalife situation. I think that the news will subside. I doubt that any show-stopping discoveries are found in the investigation. I think that the stock will recover fully, although I don't know when the selling will end. If no wrongdoing is found, the stock could be trading north of $130 again when the dust settles. However, I would caution investors to only use money that they would otherwise be willing to take to the casino as there is plenty of risk involved.
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.