GNC Holdings Looking To Go Much Higher

Aug.27.14 | About: GNC Holdings, (GNC)

Summary

GNC's earnings expectations are far too low.

The repurchase program alone could be enough for GNC to hit 10%+ annual earnings growth.

A huge recent insider purchase provides additional validity to the long case.

Shares of GNC Holdings (NYSE:GNC) have been on a very wild ride over the past several years. In just the past three years, shares have seen $20 and $60, although they're about in the middle of that range now at $37. The company, which seems to be a perennial buyout target that never materializes, experiences booms and busts in sentiment that drive shares higher and lower with frightening speed. After plummeting from $60, is the bottom in for GNC around $32? In this article, we'll take a look at GNC's prospects in light of its valuation to see if it's worth a look for your portfolio.

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To do this, I'll use a DCF model that you can read more about here. It uses inputs such as earnings estimates, which I've sourced from Yahoo, dividends, which I've set at 5% growth annually, and a discount rate, which I've set at the 10-year Treasury rate plus a risk premium of 7.5%, reflecting the volatile nature of GNC's business and share price. The idea is that investors want to be compensated for this additional risk.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior-year earnings per share

$2.85

$2.84

$3.17

$3.53

$3.93

$4.37

x(1+Forecasted earnings growth)

-0.40%

11.60%

11.32%

11.32%

11.32%

11.32%

=Forecasted earnings per share

$2.84

$3.17

$3.53

$3.93

$4.37

$4.86

Equity Book Value Forecasts

Equity book value at beginning of year

$8.27

$10.47

$12.96

$15.79

$18.97

$22.56

Earnings per share

$2.84

$3.17

$3.53

$3.93

$4.37

$4.86

-Dividends per share

$0.64

$0.67

$0.71

$0.74

$0.78

$0.82

=Equity book value at EOY

$8.27

$10.47

$12.96

$15.79

$18.97

$22.56

$26.61

Abnormal earnings

Equity book value at beginning of year

$8.27

$10.47

$12.96

$15.79

$18.97

$22.56

x Equity cost of capital

9.90%

9.90%

9.90%

9.90%

9.90%

9.90%

9.90%

=Normal earnings

$0.82

$1.04

$1.28

$1.56

$1.88

$2.23

Forecasted EPS

$2.84

$3.17

$3.53

$3.93

$4.37

$4.86

-Normal earnings

$0.82

$1.04

$1.28

$1.56

$1.88

$2.23

=Abnormal earnings

$2.02

$2.13

$2.24

$2.36

$2.49

$2.63

Valuation

Future abnormal earnings

$2.02

$2.13

$2.24

$2.36

$2.49

$2.63

x discount factor(0.099)

0.910

0.828

0.753

0.686

0.624

0.568

=Abnormal earnings disc. to present

$1.84

$1.76

$1.69

$1.62

$1.55

$1.49

Abnormal earnings in year +6

$2.63

Assumed long-term growth rate

3.00%

Value of terminal year

$38.13

Estimated share price

Sum of discounted AE over horizon

$8.47

+PV of terminal year AE

$21.64

=PV of all AE

$30.11

+Current equity book value

$8.27

=Estimated current share price

$38.38

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As you can see, the model produces a fair value of $38, around $1 above where shares trade today. At first blush, this would seem to indicate shares are a buy right now, but in order to increase our chances of success, we need to first understand what we're looking at.

The model produces a fair value, and not a price target. The distinction is important, because a price target takes an EPS estimate and projects a price out into the future. By contrast, the fair value produced by the model is a price that shares are a good value at today. In other words, the model is saying that GNC is a buy at any price under $38.38, given the inputs I described above; the present value of the company's future earnings stream, adjusted for dividends, is higher than the current share price.

So we've established that GNC is a good value based on earnings estimates, but what else does it have going for it? For one thing, I think 11% earnings growth is not only achievable, but very beatable. GNC has shown a propensity to grow earnings much more quickly than that in the past, a reason why the stock traded for $60 less than a year ago. I think there is a lot of upside risk to those estimates, and if GNC can beat estimates, it should have an outsized affect on the stock price, as it has in the future.

GNC is also, as I said, a constant target of buyout chatter. With the recent acquisition of Vitacost by Kroger (NYSE:KR), chatter has picked up again. I personally don't think GNC will be bought, but the talk is nothing but good for shareholders. This isn't a reason to buy the stock, but it sure helps provide a pop every so often. And of course, I could be totally wrong and GNC may be bought; but hoping for a buyout is not a valid investing strategy.

The other thing I love about GNC, apart from very strong fundamentals, is that the company is buying back cheap shares. The company recently committed to an increased share repurchase program, now at $500 million. This would be good for around 15% of the float at current prices. I don't think GNC will be able to use all $500 million at these prices, so the final tally will likely be lower than 15%; but still, even if shares take off, the company will likely retire 10% of the float or more with this repurchase program. That alone could be enough to meet GNC's earnings estimates set forth above. In other words, with this share repurchase program in place, GNC's actual business could be virtually stagnant, and it could still meet earnings targets. Yes, please.

And I'm not the only one that likes it. A board member recently bought 30,000 shares at $35.41, sending shares higher on the news. That is a lot of money, regardless of who is doing the buying, and I always want to see insiders putting their own money at risk. We've got that now in a big way with Hines' recent purchase, and it means nothing but good things for GNC's long-term prospects if a senior member of management thinks so highly of the stock at these levels.

GNC has fallen a long way from its highs, but for new investors, now is a great time to get into the stock. The company has terrific fundamentals and relatively low growth expectations. A huge insider purchase has spurred investor sentiment, and the enormous share repurchase program could help GNC hit its earnings estimates even without nominal profit growth. There isn't much not to like here, and as a result, I'm calling GNC a strong buy right now.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within 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.