Herbalife More Akin To Amway Than Nu Skin: Canaccord

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Herbalife More Akin To Amway Than Nu Skin: Canaccord
By Herbalife International of America, Inc. (http://www.herbalife.com) [CC BY-SA 4.0], via Wikimedia Commons

Herbalife Ltd. (NYSE:HLF) shares fell after reports emerged that Nu Skin Enterprises, Inc. (NYSE: NUS) would be investigated by Chinese officials for running a pyramid scheme. Scott Van Winkle, CFA and Mark Sigal of Canaccord Genuity believe that Herbalife is very different than Nu Skin, and that the sell-off is unwarranted. Below is a summary from a recent by the two analysts.

Herbalife Ltd. (NYSE:HLF) THE SYMPATHY TRADE IS MISGUIDED

Herbalife Ltd. (NYSE:HLF) shares fell 10% Thursday in sympathy with a massive sell-off in the shares of Nu Skin (NUS : NYSE : $84.80 | HOLD) on the heels of the Chinese government announcing it seeks an inquiry into Nu Skin’s business in China. While we would expect a sell-off of the magnitude that NUS shares saw yesterday to put some pressure on the direct selling peer group, a 10% correction in Herbalife looks grossly overdone.

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First, China only accounts for about 10% of Herbalife Ltd. (NYSE:HLF) sales and, given a lower level of profitability in that market, might account for half that level of profits. Beyond the fact that the risk adjustment to the share price is probably double the profit contribution, we would argue that the risk isn’t even present in HLF operations. Nu Skin has posted stellar triple-digit growth in mainland China for some time, operating a model that is different than Herbalife’s and much more difficult to control than Herbalife given this growth. Herbalife utilizes a compensation
model in China that is much different than Nu Skin, more in line with market leader Amway and those used by other direct sellers. Nu Skin employs distributors, allowing for a more aggressive compensation structure than Herbalife utilizes.

Herbalife’s service provider model has long been vetted in China given its long history of use and requires salespeople to register with local government authorities and pay VAT taxes before compensation is received from Herbalife for services; many salespeople operate retail nutrition clubs or similar models, which is a form of retailing well understood.

Further, Herbalife’s key weight loss products aren’t associated with any aggressive efficacy claims that could lead salespeople to exaggerate the science or efficacy of the products. In fact, market leader Amway has built its China business on a protein-based nutritional beverage just as Herbalife has.

The real comp for HLF in China isn’t NUS, but Amway, and its multibillion dollar business is among the oldest and most stable in the market. We see little risk associated with HLF’s China exposure and thus a sell-off equating to double HLF’s profit contribution from mainland China looks misguided.

Beyond the fundamental outlook for HLF in China that we believe doesn’t warrant any measurable discounting in the shares, yesterday’s correction probably serves to increase the likelihood that HLF steps up its buyback activity in a significant way.

With nearly $1B of cash by Q4 end, and audited financials to facilitate adding some leverage, we expect the unreasonable share price weakness in HLF will result in more buyback-related earnings accretion. We continue to expect strong Q4 results will also serve as a positive catalyst when reported next month and recommend buying HLF on yesterday’s share price weakness.

Herbalife Ltd. (NYSE:HLF) VALUATION

Herbalife Ltd. (NYSE:HLF) trades at just 12.7x our F2014 EPS estimate and just 8.2x EBITDA, a valuation that remains discounted to the peer group and HLF’s historical average forward PE. Our $87 price target implies 14x our preliminary F2015 EPS forecast in the $6.20 range. This preliminary F2015 EPS target conservatively assumes modest 10% EPS growth vs. the trailing 3 year CAGR of over 25%. Given the removal of the audit overhang and our expectation for a more significant share repurchase in the not too distant future, we maintain our BUY rating.

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