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FitLife Brands (OTCQB:FTLF) is a relatively young company. It was only incorporated in 2006 when it was a tiny nutritional supplement vendor selling to a handful of GNC (GNC) franchised stores. The company, formerly known as Bond Labs, traded as a "penny stock" in total obscurity on the OTC market for several years. The new management, led by Coca-Cola veteran John Wilson, came aboard in 2010 and decided to shake things up. FitLife simplified its capital structure by converting its preferred stock into common, did a reverse stock split to get its share price closer to $3 (a minimum starting price to list on NASDAQ), and, finally, changed its name to a more appropriate and catchy "FitLife."
At the same time, the management has embarked on a very aggressive growth strategy to expand its business abroad and start selling to GNC-owned stores. If this strategy is successful, the company will probably list on NASDAQ in a near future where it will be more appropriately valued based on its very high growth rate (39% CAGR), clean balance sheet, and simple well-understood business. Not only is the company undervalued based on its current growth, but also there are several well-known catalysts, each of which can double the stock price.
FitLife stock price has been climbing since its recap last year:
Today, FitLife brands sells only to one type of customer: General Nutrition Center (GNC) franchise stores, which total about 1,000 in the US and another 1,900 abroad. While this may look like a serious concentration risk, in reality, all franchise stores make purchasing decisions independently. Every franchise store is required to carry GNC made merchandise, which represents about 80% of SKUs, the remaining 20% are bought from other vendors to "provide choice." FitLife is very well-represented in non-GNC store inventory, responsible for 20% of non-GNC merchandise sales (3-5% overall store sales). The adoption rate of FitLife products has been tremendous: today about 800 GNC franchise stores carry its products (80% penetration rate), up from only 250 locations in 2009.
The franchise business itself is an accelerating growth driver for GNC. The franchise stores grew their revenue 22% in 2012 and 13% in 2011, with the majority of growth coming from abroad: 8.2% international vs. 5.9% domestic (per GNC's last 10-Q). GNC has not yet fully penetrated large emerging markets: it only has one flagship store in China and Russia, and a handful in Brazil. Almost all GNC stores abroad are franchises, making it a familiar market for FitLife.
Having penetrated the majority of the US franchise stores, FitLife sees two major growth opportunities: sell to GNC franchises abroad and sell to GNC-owned stores. FitLife had a falling-out with GNC corporate stores several years ago and is working to repair the relationship. They have been in discussion the past two years, after GNC saw tremendous success FitLife had with its franchisers. If the GNC corporate becomes a customer, it has a potential to almost triple revenues at once (73.5% of GNC's 2012 sales are through corporate stores).
GNC 2012 sales (2012 10-K):
Internationally, FitLife is already selling its products in ten countries, starting with Australian GNC franchise stores in June 2012. While an incredible 39% compounded growth rate of last three years is likely to moderate, the company still projects a double-digit top line growth rate for next 3 to 5 years. FitLife has also very limited Internet sales, mostly directly from its brands' websites. There is clearly a large opportunity to expand on the web.
According to FitLife's investor presentation, they are the number one external vendor in GNC franchise stores. In my conversation with the management, they were refreshingly frank, explaining that nutritional supplement business is essentially pure marketing (just like carbonated sugary water called Coca-Cola) as they re-mix well-known ingredients to create new products. FitLife doesn't have any R&D people and outsources all manufacturing. Today, the company workforce is only 15 people and the business requires little capital. As FitLife's revenue gets larger, the economy of scale will kick in as SG&A expenses will be spread over a larger base improving operating margins.
Sports nutrition is the main focus (FitLife presentation):
There are four main lines of products with somewhat overlapping offerings:
Body-shaping work-out oriented NDS:
Body-building focused PMD:
And seems to be defunct CoreActive (this brand's website is down):
Another nice thing about this business is its "speed to market." Unlike pharmaceutical companies' drugs, which require a lengthy and expensive FDA approval process, supplements don't need approval if they use well-known ingredients (per FitLife's 2012 10-K):
"…the Dietary Supplement Health and Education Act of 1994 ("DSHEA"), which established a new framework governing the composition, safety, labeling and marketing of nutritional supplements. …Generally, under DSHEA, dietary ingredients that were on the market prior to October 15, 1994, may be used in nutritional supplements without notifying the FDA. New dietary ingredients, consisting of dietary ingredients that were not marketed in the United States before October 15, 1994, are subject to a FDA pre-market new dietary ingredient notification requirement unless the ingredient has been present in the food supply as an article used for food without being chemically altered."
So, basically, FitLife can easily chase any dietary or fitness fad as long as it doesn't use new ingredients. It did fail once in 2010 in its ambitious attempt to market an "anti-hangover" drink several years ago, which can still be found on a stale Facebook page. But I still commend the management to try to hit a home-run" with a new "Red Bull"-size sales opportunity. It's still possible that FitLife may unexpectedly come-up with a "hot" product no one anticipates.
According to the management, FitLife strives to maintain a loyal following and uphold its brand reputation by "truth in labeling" practice. It displays the exact amounts of each ingredient in every serving of its products. This may not sound important for a casual customer, but these products are sold to nutrition enthusiasts, who are often fanatical about what "they put in their bodies." I am personally a bit skeptical about FitLife's (and just about any other nutrition company) marketing claims but a Google search turned generally very positive (and probably independent) reviews of FitLife products. Many reviews can be found on bodybuilding website.
I believe a significant brand equity combined with an ability to quickly bring new products to the market is the main durable competitive advantage of FitLife.
Products are continuously brought into the market (FitLife presentation):
FitLife has significantly changed its capital structure in the last 5 years. First, it acquired NDS Nutritional Products at the end of 2008 for only 4x EBITDA in 50% cash and 50% restricted stock transaction, including 18 months earn-out provisions. In October 2013, the company changed its name to FitLife, bought out its preferred stock with common equity and debt. Once it publishes next quarter results, its simplified balance sheet should be net cash positive and could make it a good acquisition target. There are very few warrants outstanding and almost nothing off balance sheet, so the financial statements are very much "what you see is what you get."
FitLife balance sheet prior to recap, the "yellow" items will change next quarter (2013 Q3 10-Q):
Valuing FitLife is not an easy task. There are several (very positive) catalysts, which may make any relative or intrinsic valuation meaningless. It is best to provide the "base" valuation and estimate the value range of each catalyst while stating assumptions.
Base case: None of the catalysts materialize
FitLife doesn't achieve any significant international growth, apart from already existing franchises, and continues to sell to GNC franchises only. It maintains its share of sales to the existing customers but since it's already in 80% of the franchise stores, it will organically grow at the same rate as GNC's top line franchise sales at 6.8% for the next five years (per GNC's last 10-Q). If we assume that the company at its maturity in 5 years will be valued at a modest 10x EV/EBITDA and estimate 13% weighted cost of capital (beta = 2), we get about $20.4 million enterprise value or $23.4 market cap, which is 31% higher than its current price.
Catalysts 1: FitLife strikes a deal with GNC Corporate stores
GNC corporate stores today represent 73.5% of total GNC revenue. Since both franchise and corporate stores carry similar inventory and serve the same customer base, it's logical to assume that FitLife can reach the same sales volumes. On the other hand, the GNC corporate would be in much stronger negotiating position due to its monopsony position (reverse of monopoly where the buyer is the monopolist). Therefore, I assume FitLife will achieve four times the current revenue, but with the gross margins a third lower, resulting in the company losing 1/3 of its operating margin of 7.8% for new stores. This could translate in 300% immediate gross income growth, or 180% net income growth assuming a full tax rate, which will only be applied after it exhausts $20 million in net operating losses carryover.
Catalysts 2: FitLife successfully enters foreign GNC franchise market and achieves 50% penetration rate
FitLife has been very successful in "spreading the word" among GNC franchises, allowing it to achieve an 80% penetration rate in the US. Unfortunately, the foreign GNC franchise markets are much more fractured and less competitive, as one needn't usually worry about another GNC store stealing its customers because of superior product selection. I assume only 50% long-term penetration rate (in five years), but the same gross margins as today's. There are 1,900 foreign GNC franchises vs. about a 1,000 in the US. If we assume that they are equally profitable, this would translate to about 120% of additional revenue (perhaps a bit less since FitLife already has some small foreign sales). Everything else being equal, the company could be worth twice as much if it expands internationally.
Catalysts 3: FitLife is acquired by GNC (or someone else)
If FitLife becomes larger, it may become a competitive threat to GNC products as some large GNC competitor may decide to buy the firm (RiteAid, Walgreens, CVS). Since GNC's gross margin of 37% is about the same as FitLife's, I should value FitLife on the EBITDA multiple, plus an acquisition control premium. Current GNC's EV/EBITA is 12.0 vs. 8.3 for FitLife (also worth noting that GNC has significant net debt but FitLife doesn't). If we assume FitLife will be taken out at 12x EBITDA, plus a typical 40% control premium, it should be worth 88% more than its current price. The acquisition will probably not happen within the next couple of years as FitLife has over $20 million unrealized net operating losses, some of which could be lost in the case of an acquisition (see Section 382 of IRS code).
Even without catalysts, FitLife seems 31% undervalued. If the management of the company is successful in carrying out its expansion strategy, the company is a likely "multi-bagger" with each catalyst doubling the equity value.
Additional disclosure: Some of my prior micro-cap articles have caused unusual price volatility after their release. It's not my intention to effect short-term price appreciation as I believe this investment to be an excellent long-term choice. However, I reserve the right to reduce my long position if the price exceeds my short-term target.