Herbalife Ltd. (NYSE:HLF) disappointed investors last night with its latest earnings report. Short-sellers have claimed a win, although as Bronte Capital chief John Hempton notes, most of their case has been based on the company’s business model. Nonetheless, he says last night’s earnings miss indicates that the upside to owning Herbalife has shrunk but that he can imagine few worse short positions.

Herbalife Ltd. (NYSE:HLF) ends earnings winning streak

Last night Herbalife Ltd. (NYSE:HLF) posted earnings of $1.55 per share on $1.31 billion in revenue, compared to consensus estimates of $1.57 per share in earnings and $1.4 billion in revenue. Hempton said in his blog post on Bronte Capital‘s website that short-sellers’ view that Herbalife’s fundamentals don’t matter is just flat out wrong. This is why the company’s stock dived after last night’s earnings miss.

The reason he has been long on the company is because he sees “a huge amount of real consumption.”  He calls the company a “sort of cult of weight loss” and explains that Herbalife has been able to continually create big numbers of customers who consume its products daily. He adds that if the company continues to get more repeat customers, its earnings “can grow for a very long time.”

Herbalife LTd. HLF
Herbalife LTd. HLF

Herbalife Ltd. (NYSE:HLF) shows slowing growth

Hempton states that the bull case assumes that Herbalife will see continued mid-single digit growth “for a very long time” and that in ten years, the multi-level marketing company’s earnings could be $30 per share and its stock be trading at $600 a share. However, he also states that there is a problem when investors assume a company will continue to grow endlessly. He says growth has to stop eventually, and if it does so next year, investors who buy the stock at a high price will lose money.

He says the company’s big problem in last night’s earnings report was that it showed slowing growth. In fact, Herbalife had seen growth in all areas until recently. In the first quarter, the company saw its very first slowdown, which caused him to reduce his long position. And if sales can decline in one area, they can decline in any area, meaning the growth between 2008 and 2013 seems not to be bulletproof any longer.

Another big problem he saw was that the number of sales leaders increased faster than sales, which means mid-level distributors are starting to see their income being pressured.

Longs getting worried about Herbalife?

Hempton said Herbalife’s latest numbers showed some vulnerability because of the sales decline in Malaysia where a new competitor entered the market. Previously, the market had been the company’s best market, as its business model there was slightly different. Whereas in the U.S., Herbalife has nutrition clubs, in Malaysia, it has a boot camp model in which the company uses free fitness classes in a local park to draw in buyers. He sees this business model as being better than the nutrition club model, so if sales there declined, he thinks Herbalife could be in a bit of a problem.

He notes that short-sellers are assuming that Herbalife will collapse suddenly like a pyramid scheme and that their thesis doesn’t allow for a resurgence in sales, which is what has happened. However, the sales decline in Malaysia worries him and he wonders if South America is following suit or if “something else is happening.”

Nonetheless, he remains bullish on Herbalife, although he says it’s “just not as great as it was before” and that the “upside has shrunk.” He still doesn’t think there are many stocks that represent worse short positions than Herbalife though and plans to wait on his long position and see what happens.