Seeking Alpha
Long only, CFA, small-cap, fund holdings
Profile| Send Message|
( followers)  

Summary

  • Weight Watchers' current price provides an opportunity for investors to buy a brand-name, high-margin, cash flow-rich business at a bargain price.
  • Concerns over Weight Watchers' debt are overblown, as the interest coverage ratio more than provides enough cash to cover interest and principal payments.
  • Management has lowered expectations and set the bar very low for this year's earnings, therefore, the market could be overly discounting the chances of a turnaround.

Weight Watchers International (NYSE:WTW)

There have been some great articles here on Seeking Alpha regarding Weight Watchers stock and the favorable risk-reward profile it presents investors. I won't delve into all the particulars of the company and its business details, so as not to repeat what others have already mentioned. I would, however, like to add my two cents briefly in a quantitative way with some number-crunching to come up with an estimate of intrinsic value based on free cash flow, something that Weight Watchers has consistently been able to generate.

Weight Watchers is the most well-known weight management services and products company in the world. With shares down 75% from their all-time highs, investors can acquire a business with brand-name recognition, along with a methodology that's been proven to work systematically for people over the company's 50+ year history. Management has pretty much lowered all expectations by reducing 2014 EPS guidance by 63% from 2013 EPS. The share price currently reflects this. Therefore, any kind of earnings surprise or good news can give the stock a big bounce. In other words: "Heads: I win a lot, Tails: I don't lose that much."

Using a free cash flow model, I'll attempt to show that even under pessimistic scenarios, patient investors have a good amount of potential upside with the current share price around $20.

Investment Positives

  • Ability to acquire a consistently cash-generative, low capital-intensity business for about 4 times median free cash flow over the past 7 years. (Where free cash flow is defined as cash from operations minus capital expenditures.) This is about a 20% free cash flow yield, based on median free cash flow over the past 7 years.
  • Ability to acquire the business for 2.5 times median EBIT over past 7 years and 4.5 times expected 2014 EBIT.
  • Management considers debt reduction a priority.
  • Management expects revenues to decline at a higher rate in fiscal 2014 than that experienced in fiscal 2013. To offset, they expect to reduce costs and support plans for future growth.
  • $150 million gross annual savings goal by end of 2014.
  • Management expects revenue growth in 2016 and $2 billion in revenue by 2018.
  • 50% stake of large investor, Artal Group, gives investors confidence that there are large stakeholders that won't stand idly by without initiating a turnaround.
  • Interest coverage ratio (EBIT / Interest Expense) of 4.4 for 2013 and expected value of 2.0 for 2014 shows that company has sufficient cash flow to cover its interest expense.
  • WTW plans to expand into healthcare and partnerships with health plans to provide dieting and weight management solutions. The recent offering of Weight Watchers for Diabetes has landed Orlando Health, a large not-for-profit healthcare network, as its first client. Weight Watchers has been trying out its new diabetes offering in several areas around the country.
  • Spokeswoman and celebrity, Jessica Simpson providing her testimony and how well Weight Watchers worked for her could lead to increasing brand popularity.

Investment Risks

  • Revenue decline may continue to accelerate faster than cost savings can be achieved.
  • Debt-service on long-term debt of $2.36 billion can become overwhelming if revenues continue to decline, resulting in less cash available to invest into the business.
  • Continuing declines in "paid-weeks" metric and meetings recruitment may be difficult to turn around.
  • Propagation and increasing popularity of free mobile weight loss apps can continue to lead to revenue declines.
  • Uncertain outcome from recent class action lawsuit filed on behalf of investors who purchased Weight Watchers common stock between February 14, 2012 and October 30, 2013 alleges that Weight Watchers misrepresented material facts and/or failed to disclose adverse facts.

Industry-Implied Free Cash Flow Valuation

WTW free cash flow for the fiscal year ended Dec 31, 2013:

Operating Cash Flow ($mm): $323.52

Minus Capex ($mm): $61.93

Equals Free Cash Flow ($mm): $261.59

Divided By Average FCF Yield of Personal Services Industry: 5%

Equals Industry FCF Yield-Implied Fair Value ($mm): $5231.80/56.4 million shares out = $92.76 per share

If we require a more stringent free cash flow yield than the industry of, say 7.5%, we get a fair value of:

$261.59 / 7.5% = $3487.87 / 56.4 million shares out = $61.84 per share

Discounted Free Cash Flow to Equity Valuation

Assumptions:

2014 numbers are taken from management guidance given in the fourth-quarter earnings conference call. The following year's numbers are using assumptions I believe are reasonable and conservative. Free cash flow to equity is defined as:

FCFE = Net Income + Depreciation/Amortization/Non-Cash Charges - Fixed Capital Investment - Working Capital Investment + Net Borrowing

Since the value of a stock is theoretically the present value of all future cash flows available to shareholders, this is the amount that is available after all capital expenditures, interest and principal payments are paid. What's leftover is money that could be paid as dividends to shareholders.

Intrinsic Value per Share based on Free Cash Flow to Equity Valuation given below: $57.29

As can be seen, the valuation depends heavily on the company's ability to repay debt and eventually reverse its revenue decline.

(click to enlarge)

Conclusion

The current price of Weight Watchers stock ignores the value of the company's brand power and cash flow-generating abilities. Management's commitment to drastically reduce costs and pay off debt is another positive. For patient investors that have at least a year or two horizon, WTW's current price presents a bargain opportunity to invest in a high-margin, low capital-intensity business that has proven it's not a fad over 50 years of history. In today's current market of lofty stock valuations, WTW is one company where the risk-reward is skewed to the upside.

Source: Weight Watchers: A Bargain Price In A Pricey Market