Why Herbalife Is Heading To $65

Apr.25.14 | About: Herbalife Ltd. (HLF)

Summary

Herbalife's price-to-earnings ratio of 11.67 is 7 points and 10 points below GNC and Vitamin Shoppe, respectively and suggests considerable under-performance.

The company has paid $123.1 million in dividends and repurchased $297.4 million in common shares, which was outstanding under our previous share repurchase program.

Consider, my $65 price target is still $29 under analysts' highest price target of $94 and $22 below the median target of $87.

To say Herbalife (NYSE:HLF) has had a "turbulent year" would be a gross understatement. With the stock trading at around $57 per share, the company has lost almost 30% of its value since the end of 2013. On the bright side, however, since March 21, Herbalife shares are up 16% since the stock bottomed at $49.54.

We can't mention Herbalife without bringing up the name Bill Ackman, the hedge fund manager and notable short, who insists that Herbalife is nothing more than an elaborate pyramid scheme. This is even though the company has posted sales of more than $5 billion. Since then, the Federal Trade Commission has opened an investigation into Herbalife's operation, which is largely known as multilevel marketing - the same used by Primerica (NYSE:PRI) and Amway.

Herbalife, which is cooperating fully with the FTC's probe, is not taking these accusations lightly. The company continues to stand by its business model and its reputation. Investors aren't taking chances, however. On Monday, when Herbalife reports first-quarter earnings, analysts are certain to press management for questions. The only answer that will matter, however, are those listed in strong revenues and profits. But how will the Street respond?

So far, analysts appear a bit more pessimistic. Although earnings-per-share estimates have remained steady over the past 30 days, since the February quarter, estimates have dropped from $1.37 per share to $1.29. While that might be seen as a bad sign, it also points to a low bar for Herbalife to jump over. Consider that over the past four quarters, the company has seen its income grow by an average of 10% year-over-year, including a 21% surge in the third quarter. For the full fiscal year, analysts are expecting earnings of $6.06 per share.

In terms of revenue, analysts will be looking for a 9% year-over-year jump to $1.23 billion. Last year, Herbalife posted revenue of $1.12 billion. This company has not had any problems with revenue growth. And I don't expect it to start this quarter. Herbalife has a string of three quarters of reported revenue growth, including a 13% jump in the January quarter, reaching $1.27 billion. For the full year, revenue is projected to roll in at $5.30 billion, which will be good enough for a 10% year-over-year jump.

So what's an investor to do?

Going forward, it's going to be hard for Bill Ackman to prove how Herbalife is anything other than a legitimate business. The company, which has locations in 90 countries, has been in operation for 34 years and has posted 20 straight quarters of earnings beats. And given that the FTC's investigation is expected to take more than a year before it is completed, Herbalife will have several opportunities (with its own performance) to demonstrate more transparency. Further, from an investment perspective, I think this stock has been "de-risked" to some degree.

Consider, Herbalife is now trading at 11-times trailing earnings. This means the company is being valued on an assumption of very little growth. What's more, that Herbalife's price-to-earnings ratio of 11.67 is 7 points and 10 points below GNC (NYSE:GNC) and Vitamin Shoppe (NYSE:VSI), respectively suggests considerable under-performance. But as we've highlighted; the fourth quarter report showed record gains, not just from revenue and earnings, but the company reported a 36% jump in cash flow, reaching to $772.9 million.

In terms of risk, there are very little. The company is paid $123.1 million in dividends and repurchased $297.4 million in common shares, which was outstanding under our previous share repurchase program estimate. From my vantage point, Herbalife is trading at a strong discount to long-term potential. Accordingly, the stock should (at minimum) regain its $65 value in the next 6 to 12 months. Consider this is still $29 under analysts' highest price target of $94 and $22 below the median target of $87.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's healthcare sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.