NutriSystem Losing Weight Against a Slowing Economy

Many of us have seen the Dan Marino commercial lauding the benefits of the NutriSystem (NTRI) weight loss program. The company helps people lose weight by actually delivering food to customers in pre-measured, ready to eat servings. The company has been adding new customers quarter by quarter and hopes to have 1 million active customers by the end of the year. While women have been the company’s primary target, the focus is now shifting towards men, whom the company say will spend more per customer and will be likely to stick with the program (or return after quitting) for a longer lifespan than their female customers.

NutriSystems stock dropped after last quarter's earnings announcement. The firm earned $0.96 cents per share on revenues of $214m. This leaves EPS up 81% and sales up 61%. The bad news was that the company was beginning to see weakness after Glaxosmithkline (GSK) released an over the counter weight loss pill that may be robbing NTRI of some market share. Management guided analysts to expect Q3 revenue at $200-208m and EPS at $0.77 - 0.82. These levels would obviously indicate stalling on a sequential basis even though they would show growth over Q3 of 2006. A growth rate of 30% or less would definitely be a change for the company who grew over 50% for all of 2006.

One of the issues the company is running up against is the constant need for advertising in this industry. Last year the company was successful in launching its Dan Marino campaign and that success is now causing difficult comparisons as we are now approaching a full year since the ads started. Attracting men to the system has been more costly causing customer acquisition costs [CAC] to increase dramatically this past quarter. CAC increased 17% to $182in Q3 and management has guided investors to expect this metric to continue to increase. At the same time, revenue per new customer has grown but not significantly enough to offset this additional cost. The jury is still out because the advertising spending can have a lagging effect, but the costs should raise investors eyebrows and I believe management should be held accountable down the road to make sure those dollars are paying off.

One possible benefit to the stock is the company’s ability to repurchase shares. During Q2 the company purchased 329,000 shares but during Q1 the company was much more active because the stock was at a lower price. One would assume that since the company has cash available and has shown a willingness to purchase shares when they are depressed, that they are actively in the market now buying shares. However, economics will eventually prevail and if the business itself is affected by the competition or rising advertising costs, the stock will continue to drop.

I believe that we will see lower prices from here. The diet industry is one of fads and it will probably be necessary for the company to re-invent its approach every few years to keep customers returning. Competition is fierce and the potential for a slowing economy may cause consumers to be less likely to spend on non-essentials. While food is definitely an essential - pre-packaged diet meals are something that can be cut from a tight budget. Next quarter's earnings call will be important as the company continues to clarify what the road ahead looks like.

Disclosure: Author has a short position in NTRI

NTRI 1-yr chart