Timothy Ramey, CFA  just cannot get enough of MLM companies. As noted in a prior article, the food, beverage, and nutrition industries analyst at DA Davidson seems to find ways to create news regarding Herbalife Ltd. (NYSE:HLF) even when there is seemingly little (or no) news on the topic. The analyst is out with a new report about the MLM industry, focusing mostly on Herbalife, but also a bit of USNA and NUS. The report is titled MLMs Into the Endgame, below is the full note, which was published today.

herbalife

 MLMs Into the Endgame: USANA Health Sciences, Inc. (NYSE:USNA), Nu Skin Enterprises, Inc. (NYSE:NUS), Herbalife Ltd. (NYSE:HLF)

  • Investor William Stiritz described the current state of affairs as “the endgame” of the MLM controversy. We agree. The three MLMs under our coverage continue to outperform in both stock price and fundamental performance. Year-to-date, USANA Health Sciences, Inc. (NYSE:USNA) is up 157%, Nu Skin Enterprises, Inc. (NYSE:NUS) is up 151% and Herbalife is up 110%.
  • Data as of 8/30/13 indicate short interest for Herbalife and USANA declined since last month, while Nu Skin’s ticked slightly higher. Herbalife’s short interest fell 2.6% to 27.8% of shares outstanding. Nu Skin’s short interest rose 6.4% to 3.2% of shares outstanding. USANA’s short interest fell 1.1% to 14.8% of shares outstanding. See Exhibit 3 for further illustration.
  •  We now know that Pershing Square’s short of Herbalife was 14% of the $10.7 billion portfolio as of August 31st, indicating a position as of that date of short 24.5 million shares (+/- 0.8 million shares for rounding), which today is a $1.7 billion short position.
  • Highly respected investor Bill Stiritz filed a 5.2% ownership position of Herbalife on September 2nd. This bodes well for other long HLF investors, as he has a reputation for doing leveraged deals where everybody wins. He has an unblemished record with the banks, and equity investors who invested alongside Mr. Stiritz have tended to see full returns as well. Perhaps most interesting, Mr. Stiritz developed soy protein isolates while CEO of Ralston-Purina and ultimately sold that business to DuPont – which now calls it Solae. Solae’s largest customer is Herbalife. Mr. Stiritz can trace his daily Herbalife shake back to products he developed 30 years ago. It would not surprise us to see Mr. Stiritz join the Herbalife Board. His experience in consumer packaged goods and view of capital allocation would be incredibly valuable.
  • Continued publicity from Pershing Square. We believe all of the attention created by Pershing Square has shed light on the business opportunity that these MLMs create. Despite negative accusations, each company is seeing solid growth in active distributors, as shown in Exhibit 4. The central question Pershing Square raised in support of its $0 price target was the premise that Herbalife is an illegal pyramid scheme. That question has been clearly vetted by our work (and many others) as false.
  •  Looking ahead. While we downgraded Nu Skin earlier this month, the company is in the midst of a 4-week period where it may sell north of $500 million of weight loss kits in its LTO (limited-time-offering). We expect this will be a spectacular success. Having said that, we believe much of the movement in the stock since the Q2 report on 8/1/13 must be thought of as discounting this event.
  • We are expecting Herbalife to receive its audited financials back from PwC in the coming weeks. We believe the eleven-point, 52-page letter sent from Pershing to PwC telling accountants how to do accounting will have no impact on the audit or its timing.
  • Speaking of accountants, last Friday USANA switched firms from PwC to KPMG. They filed the customary statement that there was no disagreement between PwC and USANA.

Herbalife is 12.0x 2014 EPS and 7.8x EV/EBITDA; Nu Skin is 16.6x EPS and 9.8x EV/EBITDA; USANA is 13.9x EPS and 8.3x EV/EBITDA. We reiterate our BUY rating on Herbalife and our NEUTRAL rating on Nu Skin and USANA.

We continue to rate Herbalife BUY with a $92 price target. As we stated on January 2nd, it is our 2013 Single Best Idea. Even with the shares up 110% year-to-date, we still see multiple catalysts to drive the valuation higher. Herbalife is a high-quality growth stock with double-digit revenue growth averaging 19.5% for the four years ending 2013. The “go-to-zero” hypothesis has been dismissed by our work and by serious work done by Herbalife’s top investors.

We continue to expect Herbalife to do a leveraged recapitalization after its re-audited financial statements have been issued by PwC. The company could do a $2 billion share repurchase and still have Debt to EBITDA of 2.5x or less. If we assume they buy back 26.7 million shares at $75 per share for a $2.0 billion cost, and we assume a 4.0% cost of funds, our 2014 estimate would go up by $1.10 per share to $6.85. We remain BUY rated with a $92 price target based on 16x our 2014 EPS estimate.

Earlier this month we reduced our rating on Nu Skin to NEUTRAL, previously Buy, as shares close in on our price target. Our Buy rating dated back to May 3, 2006 with the stock at $14.75. The shares now trade at 16.6x our 2014 estimate of $5.60, arguably still cheap for a company that has compounded growth in EPS at a 22% rate since our Buy rating was initiated just over seven years ago. The shares were up 532% during this term and up 153% year-to-date. Even so, we are reminded that the valuation of MLMs does not yet correspond, fully, to their growth rates. If this was not an MLM we would have a 25x EPS target equal to $130.

We continue to view Nu Skin’s management and business model as world-class. This company has executed growth in a truly spectacular way and has returned significant cash to shareholders along the way with a dividend today that has tripled since 2006. It has a conservative net-cash balance sheet and a stated desire to grow its dividend and buy back shares. We reiterate our $100 price target.

USANA remains attractive, albeit fairly priced; rated NEUTRAL with an $83 price target.