Risk Gets Lighter, Opportunity Gets Bigger For Weight Watchers

| About: Weight Watchers (WTW)
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The recent drop in Weight Watchers' (NYSE:WTW) price presents great opportunity for investors. True, the Q2 2012 earnings call revealed a downtrend in U.S. and international revenues and weeks paid. And I expect that, on the margin, Weight Watchers may continue to lose consumer customers. Let's face it, a weight-loss program is not exactly high on the priority list when money is tight.

Focus on Wellness Programs and Preventative Care

However, the opportunity for Weight Watchers is not in building up its consumer business. The opportunity is in the health insurance business, namely wellness and preventative care programs.

United Health Group (NYSE:UNH) is already incorporating Weight Watchers into its anti-obesity and wellness programs. Some employers, like United Parcel Service (NYSE:UPS), have chimed in and now offer employees additional incentive to use the Weight Watchers' programs offered by United Health.

I believe what United Health and UPS are doing is the beginning of a big trend in healthcare, and Weight Watchers -- and some programs like it -- will likely benefit significantly. Here's why:

It costs 50% more to cover medical costs for someone who is obese versus someone who is at a healthy weight; and

obesity is the leading cost of healthcare.

Weight Watchers is more than just a low-calorie diet. It also provides regular counseling and tracking of each client's weight and calorie intake. These measures greatly enhance the effectiveness of the program and, more importantly, enable Weight Watchers to empirically demonstrate the ROI (return on investment) it can bring insurers.

Obesity Is an Expensive Problem for Insurers and Employers

According to the Center For Disease Control (CDC) website, 35.7% of U.S. adults were obese in 2009-10.

No state has met the nation's Healthy People 2010 goal to lower obesity prevalence to 15%. The number of states with an obesity prevalence of 30% or more has increased to 12 states in 2010. In 2009, nine states had obesity rates of 30% or more. In 2000, no state had an obesity prevalence of 30% or more. (Source: CDC website.)

As obesity has become our nation's top health problem, insurers and employers are forced to focus efforts on reducing the prevalence of obesity. Given the high costs of obese people, employers and insurers have a pretty big budget for investing to reduce health care costs. In other words, the cost of prescribing a Weight Watchers' program is far less than the cost of benefits for an obese person.

As long as that is the case, then insurers and employers should be motivated to utilize programs like Weight Watchers. Consequently, I think it is safe to say that more insurers will follow United Health's lead and make Weight Watchers part of their health care services. Probably not all insurers will go with Weight Watchers, but chances are more than good that a least a few will choose it to help keep costs down. Weight Watchers is very well-positioned to win contracts with other insurers given its experience with United Health and the scalability of its business.

Large and Growing Target Audience

Weight Watchers is not just for the obese. It also serves the needs of those looking to improve their image by shaving off a few pounds. The company's advertising includes many famous celebrities (e.g., Jessica Simpson, Charles Barkley, Dan Marino, etc.) who have benefited from its product. This marketing strategy enables Weight Watchers to appeal to higher-end consumers. In an economy where consumers of almost all spending levels are looking to cut costs, many might turn to Weight Watchers as a lower-cost alternative to plastic surgery or liposuction.

By catering to such a wide range of potential customers, the company's target audience includes nearly everyone who is not already thin. That is a lot of people.

Very Attractive Valuation

Weight Watchers is a winner for investors because the valuation is cheap. The stock price is giving the company no credit for being able to grow its business. At about $45/share, the price implies the company's profits will permanently decline by 30% from the 2011 level. In other words, the market is pricing in a larger profit decline than what the company's management forecast in the Q2 2012 earnings call. Moreover, the market's current expectations (at ~$45/share) assumes a permanent decline of 30%. That positions the stock with significant upside.

This story gets better, as few investors realize the high returns on invested capital (ROIC) achieved by this company. Its ROIC rivals that of some of my favorite tech companies like Google (NASDAQ:GOOG) and Lam Research (NASDAQ:LRCX). I like to think of Weight Watchers as almost like a software company. It has recipes for food (like code) that it can distribute to a nearly infinite number of customers with very low marginal costs. True, preparing and delivering a meal is more costly than copying code from one computer to the next, but not that much more. And Weight Watchers' ROIC shows that it can prepare and deliver meals quite efficiently.

A high ROIC also translates into faster profit growth for a given level of revenue growth than lower ROIC companies. In addition, Weight Watchers' business model can scale more easily than more capital-intensive businesses.

Figure 1 shows that Weight Watchers' ROIC has been consistently higher than that of the market-weighted average of the current S&P 500 companies over the past five years. In 2011, the company's ROIC rose much more than the S&P 500's ROIC. That is an impressive achievement.

Figure 1: Weight Watchers Achieves Higher Returns On Capital

Source: New Constructs, LLC and company filings.

Win-Win Opportunity for Investors

One of the best win-win combinations in today's world is Weight Watchers stock. The combination of large growth potential, a cheap valuation, and a highly scalable business model make Weight Watchers a great investment opportunity. Remember the quote by Warren Buffett: "Be fearful when everyone is greedy. Be greedy when everyone is fearful."

My rating on the stock is Very Attractive. It also made my Most Attractive Stocks list for July. Click here for more details on my Weight Watchers rating and my top-rated ETFs and funds that hold Weight Watchers.

Disclosure: I am long WTW, GOOG, LRCX.

Disclaimer: I receive no compensation to write about any specific stock, sector or theme.