Retail has been beaten down through the first 5 months of 2014, and Q1 earnings reports are seeing retailer after retailer being sold off. The hangover from a weak holiday season and horrible weather nationwide has led to poor comparable store sales and missed estimates.
It is exactly in these kind of forests where value investors like to hunt. But with retail, we need to be careful. Competitive advantages here are often zilch, customer tastes can be fickle, and the sector has a history of once-major players falling apart [e.g., J.C. Penney (NYSE:JCP), K-Mart, Borders - just to name a few recent examples].
To succeed in retail, we need to find a dominant player in a niche segment, preferably one with limited competition and relatively predictable demand. And, of course, a stock price well below a reasonable fair value calculation.
We might have found one.
GNC: Dominating the Health Supplements Niche
General Nutrition Centers (GNC) dominates the health supplements specialty retail niche. With over 8,700 locations (about 40% company-owned), the chain dwarfs its second-largest competitor, Vitamin Shoppe (NYSE:VSI), running almost 13 times the number of stores. GNC's product breakdown is: 44.5% sports nutrition (protein powders, sports drinks, health bars, etc.), 38.6% VMHS (vitamins, minerals and health supplements), 11.6% diet products, and the remainder from other media, food, and store club subscription fees.
GNC has a rarity in retail - competitive advantages. Its 80-year old brand makes it easily the most recognized name in its space. Its tremendous scale gives it the ability to launch exclusives with 3rd-party vendors and undercut competitor pricing if necessary. Over 50% of GNC's sales come from its own proprietary brands like Mega Man, Ultra Mega, and Total Lean.
Another thing I like here is that the nutritional supplement market has shown to be relatively recession-proof and has good overall industry growth. Even in 2009, GNC increased sales and operating income, and the industry overall grew 6% annually through the recession. Going forward, growth potential continues to look bright, with the industry expected to grow from $32 billion in 2012 to $60 billion by 2021, about 7.2% compound annual growth.
The Stock is Losing Weight
GNC reported Tuesday, disappointing investors with a slight earnings miss and 2014 guidance cut, leading to a 14% sell-off Wednesday. The stock now trades near $38, which is almost 11% lower than the company's previous 52-week low, and its lowest price since February 2013. The stock's forward P/E ratio is now a value 12.3, well under VSI's 15.6 - even though GNC's operating margins are far better (18% vs. 10%).
The sell-off looks overdone. Management commented that very poor weather in January and February was behind a good chunk of the -0.7% comparable store number - in March, comps improved to about +3%. Another issue is the phase-out of DMAA-based pre-workout products after an FDA warning last April, as well as more-negative-than-usual media reporting concerning vitamin and fish oil-based products (according to management).
Management does not feel the company has suffered market share loss, and gross margin percentage has held steady at around 38%. VSI reported on Wednesday, and although its comparable store sales were slightly better than GNC's (+2.3%), they were not dramatically better.
In all, this leads me to believe that GNC is suffering some short-term issues that it should work through in a few quarters. For patient investors, the current quote looks could be an attractive buying opportunity.
Given the company's recent guidance, pre-tax income should grow about 5.5% this year. Most analysts see double-digit growth returning into 2015, and I believe GNC's growth initiatives (particularly international) and continued industry expansion should allow it to generate 5-7% growth for several years thereafter. An aggressive buyback program will also contribute, reducing shares by 10% over the next year or two.
The company has carried an EBIT/EV earnings yield of about 8.5% for the last several years, a fair multiple for a strong retailer with decent growth. Averaging this multiple with a discounted free cash flow calculation, GNC looks to be worth somewhere in the $55-60 range. That represents a 55% margin of safety from current prices.
Disclosure: I am long GNC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.