NutriSystem Looks Sweet Heading Into Earnings

NutriSystem (NTRI) has become the newest addition to the Ambitious Investor portfolio. The company reports earnings on Tuesday afternoon, and presents excellent risk/reward characteristics that make it a compelling purchase ahead of the announcement. Our reasons are outlined below:

1. Consensus estimates by analysts have been revised down significantly over the past couple of months, indicating that the street feels the company will fall short of their guidance/targets. This means expectations are extremely low for the company, thereby making it easier to surprise to the upside.

2. NTRI already forecasted a revenue drop of 20% into their guidance from the previous quarter. The company has clearly set the bar low, which made for a big pay days for the shorts sellers who were in the stock a few months ago. However, given that this quarter represents the "New Years Resolution" season, we believe it is unlikely that we will see such a sharp drops in their revenue from the "pre-holiday" quarter.

3. Short interest is 71%!!!! That means that any slight beat in their report will trigger a massive short squeeze. And even if they miss, is the short interest actually going to spike to 90%? Doubtful. And is the small remainder of investors who are holding the stock long, going to sell at a 52 week low when they have already ridden the stock down this far? Again, doubtful. Therefore, the selling pressure on the stock should be fairly limited.

4. NTRI is only trading at 7 times earnings. That is not only a historically and extremely low valuation for the company, but it is significantly lower that its competitors. WTW and HFL for example both trade at nearly 20 times earnings. Plus WTW also reported solid earnings on Thursday night, and the stock took off. It could be an indication that the industry is in good shape.

5. Revenue over the last year was just under 800 million. The company's current market cap is 800 million. That means it is trading at only 1 times sales! The rest of the industry trades at more than twice sales. Again, this is another indication that it is deeply undervalued.

6. On the day the stock collapsed back in October, we saw huge institutional buying from the likes of Citigroup and a number of large hedge funds. The average price they acquired the stock at was likely between 30-34. Although this is not an absolute indicator for the undervalued nature of the company, it certainly aids the argument.

7. Just in the last few months, the company has dramatically expanded its product line to appeal to a broader group of people. Before, their primary product was Nutrisystem Nourish, which was marketed to a broad and general group, but lacked appeal to the male and elderly demographics. Now, they have introduced lines that separately target Men and older individuals as well, which should be reflected in this upcoming report.

8. One of the things that hurt NTRI in the past quarter was that, although revenues were solid, their net income was much lower due to higher customer acquisition and retention costs. A part of that can be due to the large celebrity endorsements they had to pay for (Dan Marino, Don Shula). Although some of those expenses will be continue to be present, the large bulk of these up-front costs have already been paid out, and therefore will have less of an impact on the current quarter.

9. There has been recent speculation surrounding a possible acquisition of the company. Although this does not support an argument to buy the stock ahead of the report, this speculation should provide a solid buffer to the downside should they in fact disappoint.

Bottom line: Even if the company misses estimates, there is minimal downside risk based on the factors listed above. However, should they surprise Wall Street, the upside potential is massive, and could catapult the stock north of 40 from its current level of 23 making for an excellent risk/reward opportunity.

Disclosure: long NTRI

Comments

[David Tsao:]

I have a position in NTRI, but they need to focus more on the social support aspect of their business. Online community was really hard to find on their web site which they spoke to during their last conference call. The commercials of late fall victim to the "lose weight fast, get X number of meals for free!" lines. If they put a bit more focus on wellness I'd predict they attract a new base of customers.

2008 Feb 18 09:27 PM

[watdouknow:]

What the heck is going on ?

Its going down 25% or so in after-market trading, post-earnings announcement.

2008 Feb 19 04:42 PM

[G23ROCKS:]

"And is the small remainder of investors who are holding the stock long, going to sell at a 52 week low when they have already ridden the stock down this far? Again, doubtful. Therefore, the selling pressure on the stock should be fairly limited."

Sell, and SELL they did!!

On disappointing forward guidance, NTRI fell 22% after hours! OUCH!!! Not so sweet! I don't think anyone could have predicted that. IMO, NTRI has strong valuation and will be a good stock to own long term. I bought today at $23.10 and again after hours at $17.93.

-BD

2008 Feb 19 05:47 PM

[Dr. Duru:]

It is amazing that a stock with so much short interest could fall so far in after hours. Perhaps shorts will lock in profits in the morning.
Anyway, hindsight is 20/20, but the problem here is that cheap can always get cheaper. There is nothing that says that NTRI's earnings can't keep going down and further than anyone expects. And there is nothing that says that NTRI's initiatives can't fail. If the company announced a significant buyback or if insiders started snapping up stock, I might be convinced there is real value here.

2008 Feb 19 10:44 PM

[in4thelonghaul:]

Interesting that in spite of going into earnings with roughly 70% SI, there was a 24% drop in sh/pr AH...and no significant covering bounce near the end of AH trading.

NTRI guided FY08 adj. EBIDTA at 125-135 mln, but only 18-22 mln adj. EBIDTA for 1Q08 while acknowledging that the economy was a factor influencing consumer discretionary spending. Well, if the economy continues under pressure into 2008, then it is logical to speculate that their projection of FY08 adj. EBIDTA of 125-135 mln may be overly optimistic, again setting up for a further downward revision.

One would assume that the shorts will "need" to cover soon, but should upcoming reports indicate a worsening economy, I'm wondering if they might even redouble their attack...driving this company down towards $12.00 range.

Will be interesting to see if any significant short covering develops within the next few days.

No current position in NTRI.

2008 Feb 20 12:09 AM

[Chungst:]

Check out the link: shortsqueeze.com/?symb...

Short interest is about 71% of the float!!!

2008 Feb 20 02:31 AM

[CrossProfit_:]

Just a quick convenient summary of Mr. Goyal's stock picking performance to date (as per SA postings). Note that no time frame is mentioned by the author, hence this is not to be taken as an absolute truth.

1) CROX 09/2007 short = correct
2) SHRP 10/2007 long = oops/wrong
3) SHFL 10/2007 long = wrong
4) AEO 11/2007 long = wait and see
5) COH 11/2007 long = wrong
6) LULU 11/2007 long = wrong
7) ASTI 11/2007 short = wait and see
8) ESLR 11/2007 short = correct
9) FSLR 11/2007 short = correct if you got out in time.

Being that this is the tenth pick it is easy to run the statistics.
10) NTRI 02/2008 long = read the ticker!

Summary:
30% correct
20% maybe
50% wrong

Let's hope this improves to 50/50 over time, as we all have bad runs...every now and then.

2008 Feb 20 11:48 AM

[ngoyal:]

Thank you all for your comments and feedback. NTRI's results were quite disappointing. Even though they beat estimates, their revenue guidance was lowered so dramatically. The tapered guidance was likely priced into the already depressed stock, but the amount by which forecasts were slashed was unacceptable, and justifies the negative reaction in the stock price.

2008 Feb 20 01:29 PM

[ngoyal:]

CrossProfit, although I cannot defend my choice in picking NTRI, I will defend my track record. Although a few of my articles did not provide a time frame for investment, the retail picks surely did provide a time horizon as I provided year end targets. My solar article provided targets with time horizons as well. And you seemed to leave out many of my picks which brought great returns.

That said, here is my track record as per my SA postings. These are the % gains/losses based on the price targets I wrote of. For those with no price targets, I used today's price in deriving these figures.

Short YGE - 30% gain
Short SPWR - 40% gain
Short STP - 45% gain
Short CSIQ - 20% loss
Short FSLR - 10% gain
Short ASTI - 5% gain
Short ESLR - 30% gain
Long NTRI - 25% loss
Long COH - 5% loss
Long AEO - 2% loss
Long LULU -22% gain
Long SHFL - 35% loss
Long SHRP - 10% loss
Short CROX - 53% gain

If you average all these returns, there is no questioning that my recommendations have outperformed the market by a wide margin.

2008 Feb 20 01:52 PM

[CrossProfit_:]

Neal Goyal,
Thanks for the update. Thanks for not taking offense as none was intended. Thanks for the professional response.
CrossProfit

2008 Feb 20 03:35 PM