A Capital-Light Business Model Marketing Weight Loss Programs
Nutrisystem (NTRI) is a key player in the weight loss management industry. The company develops and markets meal plans which they claim offer a low calorie, nutritionally balanced meal which satiates their customers while helping them lose weight. The meal plans are then outsourced for production to nearly 35 food manufacturers. The fulfilment is outsourced to a 3PL company.
The primary focus of the company is to market the programs to their target customer segment which is primarily women in the 45-55 age group and wanting to lose about 40-50 lbs. The typical weight loss is 1 to 2 lbs per week and a typical customer stays on the program for about 11-12 weeks. We can assume that during this period the customer has lost about 12 to 25 lbs. It is worth noting that most people stop the program before reaching their goal. It could be because of the customers’ own psychological fatigue in continuing the diet or it could be that they are fatigued from the same Nutrisystem food. In any case, the lifetime of a customer is about 12 weeks, i.e. just short of 3 months.
The company also maintains the customer service and counselling center.
The business has seasonality with highest revenues in the first quarter.
The typical customer starts out with a trial order and then starts with a four-week plan. Most customers choose the “auto-delivery”, meaning orders for future months are delivered automatically until the customer cancels the orders. This probably generates higher persistence levels for 2 more months. After that, the average customer drops off.
The pricing of the food is quite competitive at around $3 per meal or $10 per day. Customers still need to buy fresh fruits and milk etc. from their local grocery. However, compared to most other weight loss programs, this is quite inexpensive.
Since the company outsources manufacturing, fulfilment and delivery, that makes it quite an asset-light model.
Company’s flagship brand is Nutrisystem. It has acquired the “South Beach Diet” brand in 2015 for $15 million and has added it as a second brand in the system. That should definitely help it attract a new customer segment which responds better to this distinct brand. The company has guided for a revenue contribution of nearly $70 million for 2018. 2017 revenue contribution was probably in the range of $25 to $30 million. With an operating margin of about 10%, it means a payback on the acquisition in 2-3 years. A great acquisition, if it pans out as expected by the management.
A Small Oligopolistic Niche in a Large Addressable Market
Given the obesity and overweight population of more than 200 million and an estimated dieter population of 100 million, the addressable market is very large. Nutrisystem is a well-recognized brand within the industry with a revenue rank of #2 behind Weight Watchers (WTW) and ahead of Jenny Craig and Medifast (MED).
Besides the direct competition, the primary competition is from self-managed dieters. Competition also arises from substitute products and solutions coming from pharma companies and many other diet foods, meal substitutes, surgical procedures or other solutions, including fitness apps and wearables etc.
However, the commercial weight loss market is dominated by the 4 key players above and is growing. Nutrisystem is likely to maintain its #2 position.
Strong Cash Flow, Zero Debt, Cash Rich
The company generated revenues of $697 million in 2017, nearly doubling its revenues from $358 million in 2013; a growth rate of 18% cagr.
The company has a gross margin of nearly 53%. The primary expenses of the company are the SG&A of which nearly 70% is marketing costs. The dominance of the marketing expenses reinforces that Nutrisystem is primarily a marketing company once the key product line of the weight loss diet meals is in place. Given the large addressable and highly underpenetrated market, the scalability exists as long as new products are added to address new customer segments and marketing is scaled to reach out to those customers.
Just to keep the numbers in perspective, in 2017, the company spent nearly $200 million on marketing to generate revenue of nearly $700 million, about 3.5 times.
Let us examine whether the business model is actually asset-light. There is $72 million in cash and cash equivalents. That is not an asset needed for the business. Assuming it is returned to the shareholders, the remaining current assets are nearly $80 million. Correspondingly, there is $66 million in current liabilities. Net current assets required are $14 million. Further, net fixed assets are $31 million. Net tangible assets were about $45 million. These generated a revenue of nearly $700 million. This is definitely an asset-light model.
The operating margins of the company are about 8-10%. On $700 million sales, the operating profits were about $83 million. This year has generated higher than 10% operating margins.
While the operating cash flow changes from year to year, it approximately equals the operating profits on an average over multiple years.
The depreciation charges at about $13 to $15 million are similar to annual capital additions of about $13 to $15 million.
The company uses the free cash flow to pay dividends and uses the remaining primarily for share repurchases. Very little capital is required for financing future growth in terms of working capital increases or new fixed assets. Company has shown its willingness to use the free cash flow for acquisitions in the case of the South Beach Diet acquisition of $15 million. However, compared to the annual cash flow generation of about $80 million it is quite small.
The company has spent nearly $500 million in marketing spends in just the last 3-4 years. This has created a brand asset which is not visible on the balance sheet. However, it does reflect in the marketplace with Nutrisystem able to attract a large share of the commercial weight loss customer segment.
Also note that the CEO and the Chief Marketing Officers have extensive experience at Readers Digest Association, which has a strong focus on direct marketing. This expertise of direct marketing is quite apt for Nutrisystem which primarily generates revenue (more than 90%) from direct marketing.
The fundamental business model of the company appears asset light, robust, and throws off lots of free cash. Company has zero debt and is cash rich. Growth in the past has been in double digits and given the large addressable market it is likely that it will continue sustaining that growth rate in the long run.
The key question before investing is: Is the company available at a significant discount to its intrinsic value?
We plan to address that question in a future post.
Disclosure: I am/we are long MED.
Additional disclosure: This is not a buy or sell recommendation.