I wrote several bullish articles on GNC Holdings, Inc. (NYSE: GNC) such as My GNC Valuation, Reaching The Bottom and Managing The Debt, and therefore I would like to provide an update following 2Q 2017 earnings results. From my perspective, the earnings results were in line with the expectations and confirmed that the new strategy is working. The management highlighted key milestones for the second half of the year and therefore I remain bullish.
For the rest of the year, the company should achieve growth in same-store sales, should generate at least $200m in free cash flow and pay down the revolving facility worth $131m. These are all positive news and should support further price appreciation of GNC Holdings. Also, technical indicators point to interesting set-ups. So, let’s look at what just happened in the first half of 2017 and what should happen in the back half of the year.
GNC generated $50m in free cash in the first half of 2017. $50m is not that stellar performance compared to last year but the cash uses were much better. Out of $50m, the company paid the term loan facility in the amount of $40m and increased cash holdings on the balance sheet to $52m. Last year, the company generated $110m in free cash, bought back stock in the amount of $230m and paid dividends in the amount of $27m.
Clearly, the uses of cash this year are steps towards the right direction and more sustainable. In addition, $50m this year includes approximately $22m negative working capital driven primarily by paying down the accounts payable. Therefore, $72m should be a more normalized cash flow generation level for a half year. This would translate to $144m for the full year or approximately 2.1 per share. Interestingly, the management set some ambitious expectations for the remainder of the year.
The management still believes they can achieve free cash of more than $250 million for the full year.
This means $200m of free cash in the second half of the year, which should be driven mainly by positive changes in working capital and inventory management. This is very ambitious but the CFO seemed very confident with that number. If GNC can achieve that, the shares should appreciate. In my opinion, most of the analysts discount that number considering the first half cash flow generation and therefore there is a potential to over-deliver analysts' expectation.
This cash should be the primary driver of the debt reduction. This means that if the company delivers their own expectations, they should end the year with the debt below $1.4bn and perhaps even below $1.3bn. Considering, the debt was $1.6bn a year ago, it will be a massive improvement.
Same-store sales growth
The second improvement should come with the same-store sales increase. This is a very critical indicator and if the growth is achieved, the shares should increase. The management highlighted that pilot stores have already achieved a same-store sales growth in 2Q.
Also, there was a sequential improvement from the previous quarter across all stores.
In addition, last year second half was a disaster, therefore, setting a very low bar to achieve this milestone. As a result, achieving same-store sales growth should not be that difficult. The growth will be the last confirmation that the new GNC is working well.
Furthermore, the margin has stabilized in the first half and should be expected to stabilize for the full year. The earnings confirmed no further deterioration in the margin, achieving a gross margin of 30.6% in the first quarter and 32% in the second quarter adjusted for one-off items. Even though it should be pointed out that the CFO now expects SG&A to be in the range of 24-25% rather than 23-24% compared to previous expectations. Nevertheless, the overall operating margin has stabilized.
The big picture is that the first half confirmed that the profitability has stabilized and there are important milestones that should materialize in the second half. In addition to that, there were interesting remarks said by interim CEO.
Interim CEO, Robert Moran, signed up for another six months. Mr. Moran is deeply involved with the company since he bought 900,000 shares (1.3% ownership) and will make sure that the new CEO will give the company positive direction and continue with the strategy he established. Mr. Moran’s mission was to fix the broken model and stabilize the business.
In my point of view, this mission should expire by year-end with the achievement of positive comps and debt reduction. The mission of the new CEO will be to fight the transformation of the business towards omnichannel, address a strategy with the franchises and possible international expansion to China. This is confirmed by some interesting sentences on the last call said by Mr. Moran.
I conclude the fundamental story that the New GNC strategy is working and shows signs of improvements, which should continue to materialize in the second half of the year. Now, I turn to technical indicators.
First, GNC shares have a long-term bearish momentum originating in 2015. The shares declined almost 90% during the last two years ($51.7 peak in August 2015 to $6.5 bottom in April 2017). And so the current price appreciation could be seen as a corrective pullback before the next bearish move but I think otherwise. Particularly, at a price of $11, there is 50-day moving average pointing to the downside and this price has been also working as previous short-term resistance on the way down in the end of 2016 and beginning of this year.
Therefore, this price should work as a temporary resistance on the way up as well. Now, given the improvement in the fundamentals of the business, I can’t think of any reason why the shares should reverse to the downside once again and attack the lows of $6.5. Therefore, I am looking for the resistance on the way up. Also, the shares have been gaining a positive momentum lately.
First, the shares were setting higher highs and higher lows. They broke an important $9.5 level on the way up. Even though the shares are testing this level as I am writing this article on the way down. This is an important technical level since the shares attacked this price three times. First, after positive 1Q 2017 results, the shares spiked to the upside but reversed at $9.5, attacking all-time lows of $6.5 from April this year. However, the bears could not make another low and ended up just an inch higher of $6.6 in May.
Then, the bears made another push to the downside in June but could not break the $7.0. In July, the bears were making one last push to the downside and could not break below $7.5. On the way up, the shares set a high of $9.57 in April this year, after first quarter positive results. Then, the shares spiked in June without any fundamental news setting a high of $8.4.
This price was attacked once again in July in anticipation of 2Q 2017 results. Now, after the earnings results, the shares broke to the upside once again and broke an important $9 level, which was attacked unsuccessfully in April and July. Therefore, now there is $11 to watch on the way up. This level acted as a strong resistance on the way down and I assume this would be a temporary top on the way up.
To sum up this paragraph, the shares have been having some positive momentum lately setting higher highs and higher lows over the last three months. There will be an important $11 level where there is a confluence of numerous technical levels. The recent weakness in shares could be a good opportunity to add shares and prepare to attack the $11 level.
The first half of 2017 confirmed that the new strategy is working for GNC. The fundamentals of the business are gradually improving and the bears have been losing battle lately. The next two quarters should bring a positive news with respect to free cash flow generation, same-store sales growth, debt reduction and possible new strategy with respect to franchises and the China market. Therefore, fundamentally, the shares are poised to the upside.
Technically, there is still a bearish momentum with moving averages pointing to the downside. However, the shares have been gaining a bullish momentum lately setting higher highs and higher lows. $11 will be a very important level to watch. In conclusion, the current weakness could be a good opportunity to add shares for the possible attack of $11 and possible delivery of the management expectation in the second half of 2017.
Disclosure: I am/we are long GNC.
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.