Seeking Alpha: Is The Medifast Model Built To Last?

When I last wrote about Medifast (MED) ("Medifast May Be The Best House On A Scary Street"), I thought that the shares certainly looked cheap, but that the risks of the weight loss industry and the company's model made it a less desirable choice. Since then, the shares are up about 13% even with two quarterly misses on revenue and more weakness than expected from weather and a challenging consumer retail environment.

As the shares have risen but the business really has not improved all that much, I find less value in the stock today. I may well be too bearish on the company's plans to franchise its Weight Control Centers, but I don't like the apparent sensitivity of revenue to promotional spending. Medifast does not seem too expensive on standard valuation metrics, but I just don't see enough momentum in the business to be all that excited by the potential.

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Is The Medifast Model Built To Last?

Seeking Alpha: Medifast May Be The Best House On A Scary Street

In principle, weight loss should be an incredible honey pot for pharmaceutical, packaged food, and consumer service companies. In reality, it has proven considerably more difficult for anybody to make consistently good money in the space. Sometimes the problems are largely self-inflicted (Weight Watchers (WTW) certainly comes to mind here), and sometimes the issue is more related to consumer patience/discipline.

Whatever the case, investors trying to profit from the weight loss theme through publicly-traded stocks have faced a treacherous environment. Nutrisystem (NTRI) has been strong this year, but the five-year returns of stocks like Weight Watchers, Nutrisystem, Arena Pharmaceuticals (ARNA), and Vivus (VVUS) haven't been that great relative to the S&P 500.

That brings me to Medifast (MED). Medifast has been quite strong relative to this group of weight loss-centric stocks (and the S&P 500 as well) over the past five years, though the last year hasn't been nearly so good. Although the company's weight control center strategy hasn't worked out so well, the relationship-driven "Take Shape For Life" has, and the company has generated some solid free cash flow of late. Although I have my concerns with the business model and the concept, the valuation doesn't seem demanding to me and this may be the best house on a very scary street.

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Medifast May Be The Best House On A Scary Street

Investopedia: Weight Watchers Still Can't Get It Right

I generally try to consider both the positives and negatives of every stock I analyze, but that has gotten increasingly difficult with Weight Watchers (NYSE:WTW). I have long had my issues with this management team, and I believe management errors have finally started to take their toll on the valuation. While I do believe the brand carries considerable value and that this could be a highly attractive business if run properly, I have little confidence that this team can do it.

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Investopedia: Weight Watchers May Be the Best House On An Awful Street

Everybody knows that obesity is a huge problem in America, but it's devilishly hard to make money here on a sustained basis. The sales of various diet drugs and devices have largely disappointed their developers, and even those companies that have steered clear of the FDA process (supplements and "nutritional products") have struggled to make the money that investors expected. That puts Weight Watchers (NYSE:WTW) in a curious place - although Wall Street has gotten a lot more rational about this name (and the stock has badly underperformed this year as a result), it's still not necessarily a compelling stock today, even though it may be the best-positioned company in the market.

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Investopedia: Nutrisystem Still Searching For Sustainability

One of the things that makes the health/lifestyle/fitness market tricky is that not only do companies have to fight to attract customers, they have to continue the fight to keep them. With customers constantly looking for weight loss options that are easy, effective and cheap, Nutrisystem (Nasdaq:NTRI) has had a difficult time finding a steady growth trajectory. (For more, see Earning Forecasts: A Primer.)


Promotions Drive a Tougher Comp 
Nutrisystem certainly closed the 2011 year on a down note. Revenue fell about 20%, due at least in part to promotional activity that wasn't as successful as hoped. Although management doesn't really provide clear retention or recruitment numbers in its conference call, it seemed pretty clear that both metrics were worse than what they had hoped.


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Investopedia: Wall Street Isn't Buying The Medifast Story

Whenever an investor finds a stock that looks simply too cheap, it's wise to question why that may happen. Some stocks are simply under-followed and over-looked and represent real bargains. In other cases, investors have made mountains of molehills and overestimate the risks present (or underestimate the growth). Then there are cases where the Street may be right to be wary and cautious, and a seemingly cheap stock is, in fact, priced appropriately for the risks.

In that vein, it's worth taking a closer look at Medifast (NYSE:MED), as this growing weight loss play seems cheap, relative to historical financials.

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Investopedia: Weight Watchers - Yo-Yo Performance And Debt Gluttony

The combination of an asset-light business model and a strong brand can be tremendously powerful, and Weight Watchers (NYSE:WTW) clearly has the sort of returns on capital that bespeak a quality business. Unfortunately, operational stability has proven elusive and the company's decision to launch a large buyback is going to stretch an already stressed balance sheet even further. (For related reading, see A Breakdown Of Stock Buybacks.) 

A Slightly Soft Fourth Quarter  
Although Weight Watchers' reported fourth quarter results were OK, they were not as strong as the sell-side projected. Sales grew almost 13%, but were a a bit shy of expectations despite being around a 60% jump in online revenue. Total paid weeks did climb nearly 34%, though, and North America's meeting revenue rose about 8%.

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Investopedia: More Yo-Yo'ing At Weight Watchers

Weight Watchers (NYSE:WTW) is one of those oddly volatile stocks. Although the company's inconsistent attendance history and highly levered balance sheet no doubt explain some of it, it is curious that this is a Wall Street plaything. With the company offering disappointing guidance on attendance, it looks like this earnings cycle is just feeding that volatility engine once again. (To know more about analyzing a business, read How To Evaluate A Company's Balance Sheet.)

Good Performance All Around  
Weight Watcher's third quarter was actually pretty strong in many respects. Revenue was up almost 30% as reported, and more than 26% on a constant currency basis. Paid weeks rose 38% and overall attendance was up 9%. North America was strong - revenue was up almost 25%, paid weeks were up almost 26% and attendance jumped more than 13% (though was up just about 5% on a rolling two-year basis). International was not so strong - revenue was up just 7% in constant currency and attendance growth barely surpassed 1%.

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Investopedia: Herbalife - Stealth Emerging Markets Play?

It doesn't matter how much doctors and nutritionists may decry supplements, they are popular and people want to believe in them. That has underpinned good growth in a sector with none of the patent worries of pharmaceuticals and minimal FDA interference. It has also led to solid stock market performance for traditional store-based retailers like Vitamin Shoppe (NYSE:VSI) and GNC (NYSE:GNC) as well as multi-level marketing firm Herbalife (NYSE:HLF). (For help on choosing stocks, check out How Investors Can Screen For Stock Ideas.)

Growth in a Bottle in Q2  
Herbalife continues to rack up impressive growth. Revenue rose 28% in the second quarter, with organic growth on the order of 20%. There are several metrics that investors can use to evaluate the underlying momentum of Herbalife's business and regional volume points is one of them. By this standard, volume rose more than 17% in the second quarter, with exceptionally strong growth in Asia-Pacific, Mexico, and Central/South America. Results in North America and Europe were more sedate (mid-single digit growth), while the China numbers were actually down about 9%. Overall reported revenue from China was flat, though. 


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Investopedia: Can NutriSystem Find A Healthy Size?

With the FDA seemingly adamant about approving new weight loss drugs, it would seem to be better days for Weight Watchers (NYSE:WTW) and NutriSystem (Nasdaq:NTRI). Although it is anybody's guess as to how much competition would have come from Vivus (Nasdaq:VVUS), Arena (Nasdaq:ARNA) or Orexigen (Nasdaq:OREX) (or may still come, if these companies can appease the FDA), these two companies represent the only concentrated plays on weight loss and obesity. 

Unfortunately, dismal guidance from NutriSystem has this stock on the ropes for the time being.  

A Sour End to 2010  
The problems at NutriSystem start right at the top. The company reported that revenue fell 17% in the fourth quarter; analysts were expecting a down year-on-year comparison, but more on the order of 5%. Surprisingly, the company nevertheless posted solid improvements in gross margin, adjusted EBITDA, and operating profit - the latter of which clearly benefited from a lower marketing spend in the quarter.  

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Can Investors Fatten Up On Weight Loss?

I would like to make one addition (or rather, an extended explanation) to part of this article. In it, I discuss Arena's lorcaserin and mention its somewhat dicey legacy. What I did not have time to adequately mention in the original is that there is a significant biochemical difference between lorcaserin and its predecessor fenfluramine. Fenfluramine caused serious cardiac side-effects because of its effects on type 2b and 2c receptors. Lorcaserin is active only with the 2c receptors and does not cause the same side-effects. 

That said, investors would be mistaken to believe that many (or even "most") physicians will do the perfunctory research necessary to understand that distinction. Consequently, there is a real risk of "guilt by mis-association". If Arena can get a strong marketing partner, one that can spend the time educating docs, it won't be a problem. But if Arena has to go it alone, they may be hampered in their efforts to really get docs to understand the difference and use the drug.  

You cannot read a major U.S. newspaper for more than a week before you will read something about the "obesity epidemic" in the country. To be fair, it is a serious problem with major ramifications on the health, productivity and economy of this country for years to come. But rather than fret about a problem with no clear solution, investors can do what they do best - figure out a way to make a buck off the situation. 

Diet, Exercise and SupportIn terms of non-medical intervention, there are two clear leaders in the U.S. obesity market - Weight Watchers (NYSE:WTW) and NutriSystem (Nasdaq:NTRI). Here is a classic good news / bad news dilemma for investors. Both of these companies have exceptional returns on capital, strong brand value, asset-light business models and huge addressable markets. Unfortunately, that is hardly a secret on the Street, and both stocks carry valuations that do not suggest ample appreciation potential. 


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