When Herbalife released its latest earnings report last night, many investors—particularly bulls—focused on that adjusted earnings beat. But does anyone take time to read the company’s financial release in detail to see exactly what is and isn’t included in that “adjusted” number?
Of course the bears certainly do, and at any rate, after Wall Street had a closer look at Herbalife’s earnings report, the stock plunged, suggesting that perhaps, just perhaps, the bears are on to something.
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But then again, Bronte Capital’s John Hempton thinks the company is doing a good job fending off the pyramid scheme allegations that have plagued it for years now.
So which side are you on? Here’s what the longs and shorts have to say about last night’s earnings report
What does Herbalife mean by “adjusted”?
In a blog post, Quoth the Raven explained some very interesting things to take into consideration when it comes to Herbalife’s earnings report. The author sides with activist investor Bill Ackman in believing that Herbalife is a pyramid scheme, and he thinks last night’s earnings report shows signs that the alleged pyramid is beginning to collapse. He even goes so far as to draw some comparisons with notorious convicted Ponzi scheme operator Bernie Madoff.
After combing through Herbalife’s 10-K filing and comparing his findings with those of Twitter users, Quoth the Raven discovered just how “adjusted” Herbalife’s adjusted earnings were. The adjusted number was $1.41 per share.
Venezuela doesn’t count apparently
So what wasn’t included in that number? For one thing, Venezuela, which has been giving Herbalife problems for multiple quarters, isn’t included in the adjusted number. It gets its own row. Also the blogger questions why Herbalife still hasn’t updated the SICAD II rate of 50:1 that it’s using for the bolivar, which currently trades for about 170:1 compared to the U.S. dollar.
If that adjustment was made, he states that Herbalife would have to write off approximately $30 million to $35 million and cut its guidance by another 15 cents to 20 cents per share. Ouch.
Other problems in Herbalife’s earnings report
Some other questionable items in Herbalife’s earnings report include the fact that the company’s gross margin is the same even though global currencies have been fluctuating like made. Herbalife also missed revenue estimates and issued weak guidance.
Additionally, CEO Michael Johnson claimed on the earnings call that Herbalife has a “healthy” balance sheet, but as Quoth the Raven notes, the company ended 2014 with -$400 million in shareholder equity. Also hundreds of millions of dollars of the company’s assets are intangible, and its free cash flow is moving in the wrong direction.
The blogger points out a whole host of other potential problems as well, but these problems are probably not going to be enough to convince bulls that they’re wrong about Herbalife.
Bronte Capital likes Herbalife in the long term
For the bullish side, John Hempton of Bronte Capital said in a blog post today that Herbalife “should come back growing volume with a vengeance.” He also referred to the multi-level marketing company as a “deferred growth story.”
Hempton named only two bad items in Herbalife’s earnings report, which were the sharp decline in volume and the inventory build during the quarter. He notes that both elements, when combined, mean the company’s cash flow was “sequentially far less good.”
He also pointed out the element management played up, which was the record high distributor retention level. Hempton added that in the past, volume has been correlated closely with distributor numbers, which means either the distributor retention rate is going to fall off or volume is going to pick up.
Herbalife defends against pyramid scheme allegations
The Bronte Capital chief also explained about some of the recent changes Herbalife made to its business model in Eastern Europe. For example, the company now requires new distributors to qualify more slowly than that did in the past. This change and the others are similar to what the company has already been doing with its business model in other parts of the world.
Additionally, Hempton explained why Herbalife is making these changes. The most interesting reason he gave was because the multi-level marketing company is “very good at fending off Ackman’s complaints.” He notes that slowing down the initial orders from new distributors is “antithetical to inventory loading.” Of course inventory loading is a requirement of a company being a pyramid scheme, he says, so by avoiding it, Herbalife is attempting to protect itself from that allegation.
Overall, he thinks the changes will make Herbalife stronger and also provide an explanation for why the company’s sales are falling and its inventory levels are rising.
Today Herbalife ultra-bill Tim Ramey of Pivotal Research aksi released his report on the company’s earnings. Naturally, he liked what he saw and blamed pretty much all of the company’s problems on currency exchange rates. However, he did not note the interesting things Quoth the Raven noted regarding currencies, specifically, the Venezuelan bolivar.
The Pivotal analyst actually still thinks Herbalife stock will go to $75 per share. Right now the bears have the multi-level marketing company firmly in hand, however. During regular trading hours today, shares of Herbalife plunged as much as 9.71% to as little as $31.44 per share.