The devil's bargain between Wall Street and growth stocks goes a little something like this: “You give us exactly the growth we expect or more (but never less!) and we'll support extreme valuations that your cash flow probably can't support”. There's also an “or else” attached – if a company disappoints even slightly, there's an outsized price to pay.
Honestly, that's about the only context in which Herbalife (NYSE: HLF) is really disappointing anyone, and perhaps shareholders can count themselves lucky that the stock isn't down even worse against a backdrop of a pretty ugly tape.
More Growth In Q3
Herbalife's growth is almost hard to believe. Apparently there really is gold in guarana, protein shakes, and the other assorted supplements and “solutions” that the company offers through its army of over 2 million independent sellers.
Revenue rose 30% as reported this quarter, with volume growth in excess of 23% and organic growth on the order of 24%. The U.S. and Canada region was once again a laggard, but hardly embarrassing with 16% growth (and over 12% volume growth). Latin America continues to be a great market, with sales up 35% in Mexico and 51% in the rest of the region and totaling more than 40% of U.S. and Canadian sales.
Herbalife likewise would seem to have nothing to apologize for in its profitability. Gross margin eased off a bit, but operating income rose 50%. Although operating margin expanded more than two points to just under 17%, it still seems a bit low given the nature of the business. That raises a yellow flag for earnings quality analysis, but it's not too different than the levels reported at USANA (Nasdaq: USNA), Nu Skin (NYSE: NUS), or even venerable Avon (NYSE: AVP).
The Guidance “Problem”
Apparently the stock is selling off in the wake of earnings because of the company's disappointing guidance. Taking the midpoint of management's guidance, earnings for 2012 are going to be a whopping 5% below the prior Street average (and unfortunately, sarcasm doesn't always translate in the written word).
Here's a few points to keep in mind. First, Herbalife had a heckuva run earlier this year and another mini-run into earnings. Valuation and expectations were running high. What's more, earnings estimates had been moving up for the three months prior to this quarter and the FY 2012 estimate three months ago stood more or less where the high end of management's guidance stands today.
Don't forget as well that this a company with a long history of exceeding Street estimates by double-digit percentages. In other words, this is not a good basis for hurried selling.
Are There Real Reasons To Worry?
Just because guidance isn't the right thing to worry about doesn't mean that there aren't reasons to worry. For starters, Herbalife's performance in China isn't all that strong (volume was up just 2% this quarter). USANA is doing about as well in dollar terms now and showing much better growth. Then again, Avon and Nu Skin have both had quite a bit of historical success in China only to see stagnant performance of late, so it's too soon to call this a problem or an underperformer.
Along similar lines, competition is an ever-present threat. Supplement stores (and their online stores) like GNC (NYSE: GNC) and Vitamin Shoppe (NYSE: VSI) and online retailers like Amazon (Nasdaq: AMZN) are not real competitive threats outside of the U.S., but they are threats nevertheless here at home and there are plenty of small nutrition and supplement companies popping up in China, Korea, and Japan (where there is a long tradition of alternative medicine). Likewise, in-store retailers like Hypermarcas are doing well in Brazil and may eventually crimp Herbalife's growth.
The Bottom Line – Paying The Price For Growth
All in all, those are admittedly not especially strong objections to Herbalife's business model. What's more, this company produces excellent returns on capital and good free cash flow margins on a comparables basis (though still seemingly too low relative to its business model), and is a legitimate play on rising incomes in emerging markets.
Valuation is the issue. It's difficult to stretch a cash flow margin to the point where it looks cheap, and likewise the more traditional valuation metrics don't scream “bargain”. Then again, there aren't a lot of companies showing that sort of growth in sales, earnings, or free cash flow and growth almost never sells cheaply on Wall Street. For investors who believe that growth will eventually validate the price or believe they are nimble enough to sell out before growth concerns really punish the stock, this is still a stock worth the due diligence.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.