The multilevel marketing industry has faced a number of challenges and bad press. The continued short on Herbalife (NYSE: HLF) by activist investor Bill Ackman has led to tensions in the industry. The FTC vindicated Ackman by finding that the company had numerous bleaches such as the marketing of its business opportunity. It was fined $200 million and a number of stringent measures were put in place to ensure the company operated ethically. Comedian John Oliver also had a piece on MLM which exposed it as a pyramid scheme. Nu Skin Enterprises (NYSE: NUS) has also been investigated a number of times by the SEC and the Chinese authorities. All of these issues have led many people to question the business model and its future.
Nu Skin, Herbalife, Avon and Nature's Sunshine VS S&P 500 Source: Seeking Alpha
Introduction to Nu Skin
NUS is a global MLM company that operates in more than 50 countries. The company was established in 1984 by Blake Roney, Sandie Tillotson, and Steve Lund in Utah. Steve Lund serves as the company's board chairman while Sandra is a Senior Vice President (SVP). Blake served as the company's CEO from 1984 to 1996 and as the chairman of the board from 1996 to 2012. The company has a total of 4,800 employees and 22,000 sales representatives in China. It has about a million sales leaders. The staff operate from the headquarters in Utah, research and development (R&D) facilities in Utah and China, distribution centers, manufacturing centers in China, and in the retail stores in China.
Nu Skin generates its revenue from two main divisions: beauty and personal care division (Nu Skin) and the nutritional division known as Pharmanex. The personal care brand makes 57% of the company's revenues while Pharmanex is responsible for 43%. Apart from the two main divisions, the company sells a number of home care products that generate a tiny percentage of the revenues. For instance, in China, the company sells an air purifier because of the pollution levels in the country.
Source. Seeking Alpha
Nu Skin products include: ageLoc Spa, ageLoc transformation antiaging skin care system, ageLoc true face essence ultra anti-aging skin care serum, Epoch products, and a number of cosmetic, personal care and hair care products. The ageLoc skin care products represents 21% of the total revenue and 41% of the Nu Skin category.
The Pharmanex products are: ageLoc TR 90 weight management and body shaping, LifePak, and ageLoc R 2 nutritional supplements. The ageLoc TR 90 represents 11% of the total revenue and 28% of the pharmanex brand.
According to Nu Skin, most of the revenues come from the Greater China region with the United States representing 10% of the total revenue.
Source. Seeking Alpha
In the last three years, Nu Skin share price has declined from a high of $137 in January 2014 to a low of $27.51 in 2016. The company's current share price is $51 at a market valuation of $2.8 billion and an enterprise value of $2.69 billion. It has a trailing PE of 20.78 and a forward PE ratio of 16.20. It has 54.45M outstanding shares and a float of 51.21M. 2.26% of the shares are held by insiders while 78.90% are held by institutions. The rest of the company is owned by Ping An of China Securities a leading Chinese investment firm. 4.34 million shares are sold short.
Nu Skin's Decline
NUS' share price has fallen from a high of $137.7 in 2014 to a low of $39.2 in 2016. The fall can be attributed to a number of factors. First, Pershing Square Capital launched a short campaign on Nu Skin's competitor, Herbalife in 2012. The short questioned the company's practices such as the selling of the business opportunity. The company was then investigated by FTC leading to a $200 million settlement in July 2016. This made many investors to dump their stocks in MLM's and others to avoid the sector completely.
Second, the company experienced major problems in China which is its largest market. In 2014, the company was forced to suspend distributor recruitment in the country following investigations by the China State Administration for Industry & Commerce (SAIC). The company settled with the authority and came up with stringent methods of operations. It paid $43 million. In China, the company does not have local distributors. Instead, it has retail stores and sales people who are paid a retainer salary and commissions on sales. Nu Skin has also been involved in a number of cases about its operations in China.
Third, the company was investigated by Securities and Exchange (SEC) commission. The investigation was in regard to the company's charitable contributions in China. NUS was accused of paying $150,000 to a Chinese communist party official so that he can intervene in the cases the company was facing. In September, the company paid about $750,000 to settle the case.
Fourth, the company revenues and profits have been in decline. The company had operating income of $554 million in 2013, $352 million in 2014, and $244 million in 2015. The management attributed the decline to the China's problems and the decline in the number of Actives and Sales Leaders in all regions as shown below.
Source. Nu Skin
The Case for Nu Skin
As mentioned above, Nu Skin's stock price and revenues have been on the decline. However, I believe the company can achieve a successful turnaround. Consider the following reasons.
First, Nu Skin is not Herbalife. Herbalife was accused of focusing on the business opportunity than on the sales of its products. People were paid according to the sales of the products and the number of people they recruited. Videos of sales leaders promising potential distributors were shown. Nu Skin's business model is very different from this. In all markets apart from Mainland China, distributors are paid by reselling products to consumers and through the commissions earned on sales of products. The company said this in their 2015 report:
Our sales force is not required to recruit or sponsor others, and we do not pay any commissions for recruiting or sponsoring.
A number people have questioned the company's recruitment model where one has to purchase a not-for-profit starter kit for a small fee. However, I don't see the problem with this since the distributors are not employees of the company. Therefore, while the company operates in the same industry as Herbalife, the two companies have different strategies. In Mainland China, the company's largest market, the company has implemented the proposals from SAIC. All this removes the pyramid scheme risk from the company.
Second, the company is set to benefit a lot from the Trump administration and policies. The company has a corporate tax rate of 37.7%. Trump has promised to lower this tax to 15%. If this happens, the company will save millions of dollars. This is coupled with the fact that most of the company's sales are outside the United States. Capital repatriation to the country will save the company a lot of money which is held overseas. Trump has also said that he wants a weaker dollar. A stronger dollar is not ideal for a company like Nu Skin which generates most of income from outside the United States. Therefore, if Trump puts in place measures to weaken the dollar, this will be a major benefit to Nu Skin. As shown below, since Trump was elected president, the company has not benefited from the Trump boom.
Source. Yahoo Finance
Third, the company seems to be in the right directions in its turnaround. As you already know, turnarounds do not always take a straight path. As you can see in the figure below, in the first three quarters of the year, the company seems to be doing well. This is despite the fact that in 2016, the dollar strength increased compared to most currencies.
Source. MSN Finance
Also, consider the following statement from the company's November conference call and factor in the anticipated currency moves in 2017.
So for 2016, we're raising our annual guidance to $2.23 billion to $2.25 billion, continuing to assume a negative impact from foreign currency of approximately 2%, with earnings per share of approximately $2.60 to $2.64 or $2.96 to $3 when excluding the $0.36 impact of the Japan customs charge, which we took in the first quarter of this year.
For the fourth quarter, we project revenue of $550 million to $570 million with earnings per share of $0.77 to $0.81. Our revenue guidance in the fourth quarter anticipates a negative foreign currency impact of approximately zero to approximately 2%.
Source: Seeking Alpha
Fourth, in terms of valuation metrics, the company is currently trading at a discount compared to the industry. The company has a PE, PB, and PS of 20.8, 3.3, and 1.3 respectively. This compares to the industrial average of 26.7, 6.5, and 2.9. NUS also has a ROA of 8.5 compared to the industrial average of 7.5 and a 3 year average revenue growth of 1.8 compared to the industrial average of -4.6. Consider the following numbers.
NUS PE ratio of 20.96 is cheaper from the 35.2 the company had in October. The profit margin has gone up to 9.41% from a low of 0.70% in March 2016. The quarterly (YoY) revenue growth has gone up from a low of -24% in 2015 to 5.75% Quarterly cash and short term investments have gone up from less than $250 million in 2014 to the current $532 million. Quarterly SG&A expenses have gone from more than $650 million in 2014 to $395 million. Despite the challenges, the annual long term debt has gone up from $193 million in 2014 to $249 million.
Fifth, the company Ping An has minority stake in the company. Ping An is a large Chinese investment firm with more than $81 billion in assets under management. The company has more than 20 years' experience in the Chinese market. This makes it an ideal partner for Nu Skin which has China as its largest market. I believe this relationship can help the company navigate the Chinese regulatory environment and create shareholder value.
Finally, the company is diversified in two broad areas: beauty and personal care, and nutritional. The two areas contribute significantly to the company's revenues. The company also has other small products that contributed $5.6 million. Nu Skin has recently launched its new anti-aging product, AgeLoc, in a number of markets. AgeLoc allows people to customize their anti-aging products according to their needs.
As noted here, anti-aging sector is one of the fastest growing areas in skin care. All this is different from what most MLM companies offer. Herbalife's core products are in weight management, targeted nutrition, and energy and fitness. Its skin care products contribute insignificantly to the company's revenues. Avon's main products are in the beauty vertical with no nutritional products. The same is true with Nature's Sunshine and other companies. For Nu Skin, the two main areas or segments are almost equal which makes the company have diverse source of clients.
While I believe that Nu Skin is currently undervalued and poised for growth, a number of factors might hinder this growth from happening. One, new regulations might be introduced in the MLM industry which might have serious implications for the company. Second, the company might face class lawsuits from clients. Since this industry is quite delicate, the lawsuits can have serious implications on the company's stock price. Third, the business can face challenges in a strong dollar environment. Finally, the success of Nu Skin depends on economic growth of the countries it operates. A weak economy can affect how people shop its products.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NUS over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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