Amid Controversy, Herbalife Appears To Be Fairly Valued

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Herbalife Ltd. (NYSE:HLF) has been a target of short selling by Pershing Square’s Chief Bill Ackman. He delivered a 342-page presentation at the Ira Sohn Conference on December 19, 2012. Ackman said that Herbalife Ltd. (NYSE:HLF) had no value, that it was a pyramid scheme, and thus the stock price will end at zero. The stock lost half its value in the next 3 days.

Almost a year later, the stock has recovered and it is trading at $77.09 from its December 2012 trough of $26.06. Ackman is still maintaining his short position and he delivered another 300 page presentation on December 2013, sent a letter to PWC, auditor of Herbalife Ltd. (NYSE:HLF) and started lobbying in Washington against the company, calling on legislators to investigate it. Herbalife Ltd. (NYSE:HLF) on its part released statements that Ackman’s claims were baseless and that betting against one nutritional product company is risky.

Furthermore, other hedge fund investors have a long position at Herbalife Ltd. (NYSE:HLF). Carl Icahn, CEO of Icahn Enterprises, is the largest shareholder on Herbalife holding $1.1 billion in the stock which amounts to a 16.5% ownership stake. Other reputed investors including Dan Loeb, George Soros, and Stanley Druckenmiller have owned the stock and made millions on their long position over the past year. Consensus remains bullish on the stock with an average target price of $90 for year-end 2014. Analysts estimate 2013’s earnings to be $5.25/share, higher than the $4.05/share recorded last year.

Bullish case

In order to support further stock price appreciation, Herbalife Ltd. (NYSE:HLF)’s needs differentiation from its competitors reflected in superior financials, product mix, and growth prospects. Also, if the market already accounted for positive factors in the price of the stock, then upside is limited as the value of the stock is close to its trading price.

Financially, the company is strong as shown by its improving free cash flow, strong net margin TTM (11.5% HLF versus 10.8% industry average) and return on assets and equity. Also, net income and revenue growth have exceeded industry averages.


Source: Morningstar

trailing total returns

Source: Morningstar

Furthermore, Herbalife Ltd. (NYSE:HLF)’s performance has been outstanding for the last 1, 3 and 5 year periods. So far, the company has passed scrutiny from auditors and analysts and has enjoyed some support from Washington thanks to its continued lobbying efforts. Additionally, Herbalife Ltd. (NYSE:HLF)’s is gaining visibility in potential growth markets, such as Russia, where it won the 2013 Healthy Nutrition Award. Distributors state that Herbalife Ltd. (NYSE:HLF) is enjoying customer loyalty despite increasing competition and a possible share buyback that could also boost the firm’s stock.

Controversy adds to uncertainty

However, the company’s products are facing more competition as nutrition shakes and supplements are being manufactured and distributed by other multi-level marketing firms such as NuSkin and retailers including GNC. Herbalife Ltd. (NYSE:HLF)’s product formulas have remained consistent over the years while some competitors have innovated incorporating more protein and hunger suppressants in their products. Also, according to some prominent investors such as Jim Chanos, products may be overpriced to both consumers and distributors which could make the business model unsustainable.

Herbalife Ltd. (NYSE:HLF) continues to be subject to controversy regarding its sales practices, revenue sources (i.e. how much revenue is generated from product sales, shipping, and recruitment) and advertising claims regarding its products. On January 3, 2014, the Federal Trade Commission said that it will investigate misleading weight loss claims in advertisements for weight loss and nutritional supplements. The news caused Herbalife Ltd. (NYSE:HLF)’s price to tumble as much as 3.9% in intraday trading.

This investigation announcement comes after other calls to investigate Herbalife Ltd. (NYSE:HLF)’s sales and recruiting practices by some members of Congress and Hispanic oriented interest groups such as NYPD Hispanic Society, League of United Latin American Citizens, the Federation of United Michoacan Clubs of Nevada and nonprofit legal organization Hermandad Mexicana. Allegations calling for investigation include outrageous claims for potential profits to distributors, inability to return inventory, pressure to recruit new distributors and debt incurred as a result of difficulty in selling products. Hispanic interest groups also claim that Hispanics are targeted with the Herbalife Ltd. (NYSE:HLF) opportunity as their unemployment rate is higher and they are more in need for extra income. Thus Herbalife’s continued growth may be hampered by lack of product innovation and continued defense against negative allegations.

Are investors too optimistic?

In summary, Herbalife Ltd. (NYSE:HLF)’s stock price may remain range bound this year. S&P Capital IQ analyst Tom Graves believes that favorable news about Herbalife Ltd. (NYSE:HLF)’s customer and distributor loyalty, share buyback impact, and passing audit concerns over business model and financials is already factored in the stock’s price. He sees sustained scrutiny, growth limitations, and concerns over business models as constraints to a higher valuation. S&P’s price target of $75 for Herbalife Ltd. (NYSE:HLF) already accounts for the positive effect of a potential share buyback.

This year 6 Wall Street analysts placed buy calls on Herbalife Ltd. (NYSE:HLF), 1 has a hold outlook and 1 has a sell recommendation. Also, the top ten institutional shareholders own 63.77% of Herbalife Ltd. (NYSE:HLF), with the largest owner being Icahn Associates. If just a few of these institutional owners sell the firm’s stock, particularly hedge fund owners with shorter holding periods, the stock price could decline from current levels.


Source: Morningstar

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