GNC - Credit Suisse Turns Optimistic, And I Agree

| About: GNC Holdings, (GNC)


Credit Suisse upgrades shares of GNC.

Given the disastrous year so far shares were pricing in pretty much all the bad news.

Yet the company is addressing its challenges, including top executive management changes, creating a better risk-reward opportunity in my eyes.

Shares of GNC (NYSE:GNC) managed to catch a break after a disastrous year so far. Shares have suffered from worries about a general FDA warning about the safety of supplements, increased competition and customer confusion about its pricing strategy.

All of this resulted in comparable sales to plunge as both the CEO and CFO have left the company as well in recent times.

That being said, shares are nearly cut in half from their highs of November of last year. As such I am inclined to pick up some shares at current or slightly lower levels in the coming weeks.

Credit Suisse Turns More Optimistic

Analysts at Credit Suisse upgraded their rating on GNC from neutral to outperform on Monday. Analysts attached a $43 price target to their recommendation, suggesting quite a bit of upside from current levels.

Analysts have identified thee main factors to push shares higher. The first is the fact that they like the newly appointed CEO Michael Archbold which has both experience and success in the area in which the company is competing.

Furthermore the analyst team believes that the market has ¨over penalized¨ GNC. Even after Monday's 5% jump, shares are still down over 40% year to date. If the company could ¨tinker¨ some fundamentals, the company and stock could be a whole different story.

Last is the potential for a possible tie-up in the industry with competitor Vitamin Shoppe (NYSE:VSI), given that Mr. Archbold has been the COO at that company a few years ago.

A Troubled 2014 So Far

Of course GNC's shares have made a big plunge so far this year amidst a rapidly softening of the operational performance in the first two quarters. This came after investors have become used to double-digit revenue growth in recent years.

Another worry was the high management turnover which has made some investors nervous. Investors never like to see a CEO and CFO leave in a very short time frame, especially with the operational business seeing some turmoil.

Just last week it was announced that Michael Archbold has replaced former CEO and Chairman Joseph Fortunato. This followed the resignation of CFO Michael Nuzzo in June of this year.

A Quick Peak At The Latest Trends

GNC reported revenues of $675.2 million for the second quarter which was actually down by 20 basis points compared to last year. Despite the flattish sales, the fall in earnings was very much limited with earnings being down by 2.5% to $69.9 million. Earnings per share rose by four cents to $0.77 thanks to sizable share purchases offsetting the actual dollar decline in earnings.

Comparable sales for the quarter fell by 4.0%, or 3.3% after adjusting for the negative impact of the Eastern holiday. Despite the soft quarter, expansion is allowing for flattish revenue growth.

For the year, revenues are seen roughly flat as international expansion is offsetting a mid-single digit fall in comparable sales for the third and fourth quarter. All of this should result in adjusted earnings of $2.85 per share for the year which is flat compared to 2013. Flat revenues are helpful, so are rather sizable share repurchases which has reduced the outstanding share base by about 10% on an annual basis.

What About The Valuation?

The +40% correction this year left shares trading at $34 per share. Given that there are some 90 million shares outstanding, equity is valued just shy of $3.1 billion.

It should be noted that the firm carries some debt. Even as GNC holds $118.5 million in cash and equivalents, the total debt load of $1.34 billion results in a $1.2 billion net debt position for the firm. This leverage position has increased recently as the firm used the lower share price to repurchase shares at a rapid pace.

On a trailing basis, GNC has posted sales of $2.64 billion on which it has reported net earnings of $260 million. This values GNC's equity valuation at 1.2 times annual sales and just 12 times earnings.

What To Do?

GNC's shares have fallen quite a bit, with shares being cut nearly in half from $60 in November of 2013 to lows of $31 in recent weeks. The upgrade from Credit Suisse pushed share up to $34, but of course investors are still very much unhappy.

Investors have been very unhappy with the rapid fall and current decline in comparable store sales amidst internet competition from competitors like (NASDAQ:AMZN) and a very promotional and confusing pricing strategy to customers.

The company has committed to rely less on promotion and has seen two of its key executives leave in the meantime, yet the core business remains rather intact although there are some headwinds of course. While I like the fact that the company has used the opportunity to buy back some shares at lower levels, they should not be too aggressive. The increase in leverage is a bit risky if the situation in terms of organic sales growth is improving in the medium term.

Back in May, when the stock was still trading at around $37 per share, I last took a look at the company's prospects. I concluded that the company was off to a bad start driven by both structural and one-time issues such as bad weather and FDA warnings on vitamin and fish, while the market has become more competitive.

While GNC clearly has some above average risks given the outstanding debt and the key personal turnover amidst operational difficulties, the rewards are potentially big as well. If the company can be stabilized and show modest growth again, the $43 price target could rather quickly be achieved. Even in such a scenario shares trade at just 13-14 times earnings of about $3 per share.

I must say that I largely agree with Credit Suisse, having put the company on my watchlist for a much longer period of time. A re-test of the $31-$33 region allows me to slowly built up a modest position.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in GNC over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.