At the end of Nutrisystem's (NASDAQ:NTRI) Q3 conference call transcript, a commenter asked this (perhaps rhetorical) question: "So, why the big selloff today?!"
Rhetorical or not, it was a fair question: NTRI beat analyst estimates and raised the midpoint of guidance ranges (while also tightening those ranges), while on that call management sounded both pleased with the results and optimistic about some of the opportunities ahead. Yet, shares fell 10.5% in trading the day after the release; while they would erase those losses in the following week, they've since retreated to a seven-month low at the current price of $22.27.
source: FINVIZ.com
NTRI may have been a victim of high expectations: it had made significant upward moves in full-year guidance after both Q1 and Q2, but the Q3 hike was just half a penny at the midpoint (to a range of $0.91-0.96). And the late summer share price, as I wrote in September, seemed like it had gotten ahead of itself, with NTRI trading at over 30x even the high point of its guidance range.
Back at a more reasonable multiple, the company looks enticing. CEO Dawn Zier has done an impressive job since taking over in 2012, execution appears rock-solid, there are growth opportunities in retail, and the ability to "reactivate" customers magnifies the impact of the current growth in new signups. The competitive worries that an Oprah-backed Weight Watchers (NYSE:WTW) will erode NTRI's share strike me as overblown and a bit too simplistic, and regardless may be more than priced in. I think $22 remains not quite compelling enough, though a dividend yield back over 3% helps. But around $20, I'm likely to be a buyer; I like the business, I like the management, and it looks like the double-digit growth seen over the past two years will carry on into 2016.
Q3 Earnings
The headline numbers in the Q3 earnings release looked impressive: revenue up 16%, Adjusted EBITDA up 33%, and net income up 44%. The growth came even against a moderate tailwind in the form of a dry ice shortage, which CFO Mike Monahan on the call said hurt revenue by $1 million (about 1%) and gross margins by 120 points (a low double-digit impact on net income and EPS). Delays - and returns - of frozen food created by the shortage were the culprit; the shortage appears to be resolved, with only minor impact expected on Q4.
Revenue from new customers was up 20% year over year; reactivation revenue (sales to customers more than nine months after the initial purchase) rose 6%, and is guided to 5-6% for Q4. Nutrisystem is benefiting both from an increased focus on those dormant customers and last year's new customer growth, which increases the pool of potential reactivation targets. That pool will continue to increase, a good sign for reactivation revenue in 2016, given what appears to be a high-teen full-year growth rate for new customers this year. And those revenues tend to be higher margin, given the far lower acquisition cost to bring customers back for a cycle (or, increasingly, a la carte "maintenance" purchases) relative to attracting new registrations. Retail sales were up 35% year over year; while still a very small part of overall revenue (6% year to date), Nutrisystem is gaining increasing penetration at Wal-Mart (NYSE:WMT) and Sam's Club, along with shipping to five supermarkets for "diet season" 2016 (the post-New Year's Day stretch when many customers focus on weight loss resolutions). That appears to be a focus for long-term growth, and there are hopes for some nice synergies as well, with the retail presence (including 7-day packages) boosting awareness and adoption of the direct programs.
On the cost side, SG&A grew just 7.3% as a percentage of sales, as Nutrisystem was able to leverage that spend; notably, G&A actually was down 4% against 2014 and is up just 2% year to date. The increase is coming almost solely from marketing expense, which is up 15% through the first nine months, with almost all of that due to media spend per the 10-Q. Capex was guided higher due to some supply chain and warehouse needs to support increasing shipments of frozen foods, but both marketing and capex investments imply that management, at least, doesn't see the business returning to its stagnant early-decade ways in the near future.
The one piece of potentially worrisome news was Q4 guidance; while revenue is guided up 12-13%, earnings are actually flat, with the midpoint of Adjusted EBITDA and EPS guidance almost exactly even to Q4 2014 results. Some bleed over from the dry ice issue may be to be blame; similarly, increased retail shipments (depending on revenue/cost recognition) and marketing spend could be pressuring margins for the quarter. But given one of the big fears surrounding NTRI - competition - the possibility of narrowing margins might have led to some of the recent weakness in the share price.
Here Comes Oprah
As of this writing, shares of Weight Watchers are up 291% - two hundred and ninety-one percent (!) - since Oprah Winfrey bought a 10% stake in the company in mid-October. NTRI shares fell over 9% on the news, as investors saw a potentially revitalized Weight Watchers as a new competitive threat.
That read-across struck me as a bit simplistic. Weight Watchers did have potential liquidity problems on the horizon, and the possibility of WTW disappearing probably would have been a potential benefit for NTRI. But it's not as simple as arguing that every dollar that Weight Watchers makes comes from Nutrisystem.
Zier pointed out earlier this year that the two products are "very different", and clearly set out to again make that distinction in her prepared remarks after Q3. She again reminded listeners that:
"Our business model is also very different from others in our space: we are an e-commerce and retail company with a highly variable cost structure. We sell our product and don't have the complexities of center franchises or a multi-level marketing network."
Zier later added that:
"I want to maintain that our growth over the last few years did not come at the expense of others, and that in a market of this size where share even among the largest suppliers is relatively low, that there is opportunity for all to grow."
Showing the interest in the subject, the second question of the Q&A asked about WTW and Oprah directly, with Zier pointing out that Nutrisystem is "a lot more structured - and let's be honest, a lot of people need that."
It's an interesting question as to what effect a better-positioned WTW might have on NTRI. Zier noted that Oprah's impact could help the industry simply by creating media attention. And the two products are different: Nutrisystem is more structured, shipping the precise meals for a 28-day cycle directly to its customers while Weight Watchers is far more of a "do it yourself" program, using apps and/or meetings along with a point system to allow its members more flexibility.
But at the same time, there likely is some direct competition, and there has been in the past; for instance, NTRI cited WTW's influence as a key cause of a poor diet season performance in 2011. Nutrisystem's upfront price - a full month costs over $300, even with first-order discounts - is a bit of a competitive detriment. It's easier for less committed dieters (or less financially comfortable customers) to use the lower-price, monthly-pay WTW rather than shelling out what could be close to $1,000 for Nutrisystem's products at the average ~11-week length of stay. (That $1,000 should of course be considered in the context of what customers would normally pay for food over those 11 weeks, but behavioral economics isn't always as simple as all that). And if you look at the charts, it does appear that one stock's success generally comes at the expense of the other:
WTW data by YCharts
Still, I'm not sold on the idea that WTW provides a major impact to Nutrisystem's growth. The company's 2014/2015 performance isn't necessarily coming at the expense of WTW; it's free apps, not Nutrisystem, that have damaged Weight Watchers' business, by the admission of WTW management itself. Through the last two years, Nutrisystem has proven to be at the least resilient against those apps, along with fitness trackers like Fitbit (NYSE:FIT); revenue growth has been in the double digits, and as importantly, the company has been able to increase pricing. Whether NTRI is taking some share from WTW isn't entirely clear, but given how much share those apps have taken, NTRI's performance implies both that a) it can succeed anyway and b) it has some protection from the DIY weight loss model, whether that model is based on app usage and fitness bracelets or Weight Watchers meetings.
While there may be some competition around the margins (and Q1 '16 should give a better read on WTW's standing post-Oprah), the 9% decline on the news, let alone the additional 6-7% drop since, seems to have priced much of that in. Meanwhile, it's not at all certain that Weight Watchers suddenly is that much more formidable; the near-quadrupling of its stock may have much more to do with a massive short squeeze than any real change in sentiment going forward.
Going Forward
Where WTW may provide some friction could be beyond the weight loss space. In its Q3 release, Weight Watchers said it would "expand our purpose from weight loss alone" and Nutrisystem touted similar, unspecified plans, on its Q3 call. Zier said the new program would be discussed further on the Q1 call, and compared it to the company's Nutrisystem D plan for diabetics.
Within the legacy business, there still seems room for growth. Reactivation revenue growth should continue next year, if only because of the larger pool; it did decline in 2014, but even a sharp reversal seems unlikely at the moment. Retail growth should continue at a nice clip as well, with products expanding shelf space and reach. A similar growth rate next year should provide 2% overall growth. Something like 5% new customer growth, 3-5% reactivation growth, and a 2% boost from retail gets NTRI to the 9%+ top-line growth seen by analysts for 2016 while likely supporting mid-double-digit EPS growth (analysts are targeting a 20% improvement).
Those growth figures strike me as somewhat conservative, particularly with marketing spend up and adoption of the higher-priced "Uniquely Yours" plan increasing. If you look at Nutrisystem's website, there are some weak reviews for dinner items, and a plan to add the frozen dishes available in Uniquely Yours (which are better reviewed) and replace some of the less-popular dishes should boost both origination and retention. UY customers - nearing 40% of the total - stay longer, and while the frozen dishes are lower-margin on the gross line, the retention makes the program higher margin on the operating line. CFO Monahan said the company still thinks it has room on price, and the entrance of a number of startups such as Blue Apron and Plated may be helping; those companies ship fresh, higher-end food but at a cost generally above $10 per meal per person, perhaps making Nutrisystem's price point (for admittedly lower-quality food) some more reasonable by comparison.
If you trust management here - and I do - there's still a multi-year runway for growth. I don't think WTW is going to have the level of impact some may suggest, and Oprah or not, it seems difficult for that company to get its house in order within a matter of weeks (Q3 2015 revenue was down over 20% year over year; WTW is a multi-year turnaround project at this point). There's a core value proposition to Nutrisystem's direct shipment and ease of use, and the ability to expand that model to more "maintenance" sales or beyond the diet market offers promise.
The biggest risk is that 2014 and 2015 are largely a head fake; as I pointed out in September, Nutrisystem's revenue and profits are well below 2010 levels (2016 guidance implies only a return to the business's performance six years earlier), and eons from the $777 million in sales and nearly $3 in EPS the company generated in 2007. With Zier having led a pretty solid turnaround at NTRI, there remains the common question of whether Nutrisystem is really a better company for the long run, or whether better execution (and, perhaps, some help from weakness at Weight Watchers) simply has led to the recapture of low-hanging fruit. I think there's still room to run, but from this standpoint, Q1 and the all important "diet season" look key.
Valuation
At $22+, I can see the argument for a long position right now. The stock is near a level that's provided support; the forward multiple (using consensus) has dipped below 20x; and if one believes that dividend yield can support stocks in this environment (as I've argued multiple times), than perhaps support should hold around the $22-23 range, where the yield clears 3%. There's growth opportunities here; in the near-term, expectations likely have come down ahead of Q4 earnings, and given that NTRI generally seems to guide a bit on the conservative side, there's reason to take the long side into those Q4 earnings.
But those earnings still are almost three months away, and I'm not sure what the compelling reason to jump in here is yet. The stock still trades over 22x the midpoint of 2015 EPS guidance even excluding the $1+ per share in cash, so there is some growth priced in here. Around $20 - where FY16 nears a market multiple and the dividend yield reaches 3.5% - I'd be interested, and if the stock could get to $17-18, I'd back up the truck.
But at $22, even reasonable growth is priced in to a certain extent, and this has been a relatively volatile company in a relatively fickle space. I do think the WTW impact is being overstated, but that doesn't mean it can't continue to impact Nutrisystem's shares in the near term, particularly if Oprah's presence in December and January creates more buzz about Weight Watchers. And Oprah aside, it's not impossible that the stock could reach or near $20 over the next few weeks (a 10% decline for a consumer stock in this jittery market doesn't seem unreasonable).
I'd take a long look then, because the only major issue I see with NTRI at the moment is price. The company looks like it's in good shape for diet season 2016 and beyond; while there are some risks to growth, there's a lot of upside for NTRI if its turnaround has more left to come.
