Weight Watchers International Inc.
Top Buy (Conservative)
Weight Watchers is one of the top providers of weight-loss services worldwide. The core of Weight Watchers offering is group-based support, with over 45,000 meetings and over 1 million attendees every week. Meeting fees accounted for 51% of revenues last year. Weight Watchers online program, incorporating the firm's dietary point system and offering optional face-to-face support, has been gaining traction, driving 28% of sales. Product sales account for 14% of revenue and include company-generated items such as snack bars, books, points calculators, wearable activity monitors, etc. Finally, licensing the brand name to 3rd party products and franchise royalties account for 7% of sales. Weight Watchers operates in over 25 countries throughout North America, Europe, and Australia, with international contributing 40% of revenues.
While I don't expect robust growth from this pick, there are certainly opportunities that the firm can pursue to grow. Weight loss is an ever-growing need, with 70% of the adult U.S. population considered overweight and an astounding 35% classified as obese. With increasingly sedentary lifestyles and poor eating habits, the need for weight loss solutions should only increase going forward. Further penetrating the men's market is an opportunity here, one recently proven by Nutrisystem to be lucrative if done right. WeightWatchers.com puts the firm's powerful brand into the emerging mobile app weight loss ring, and it represents a high margin growth driver. Finally, the company believes it has a large business-to-business (B2B) opportunity, using its respected brand and proven meeting-based solution to gain acceptance as a partner to employers and health care companies looking to improve outcomes for clients and employees (and in the process, reducing health care costs).
Few industries are as competitive as consumer weight-loss solutions. Competition runs the gamut from large product-based firms like Nutrisystem or Medifast, to the latest fad diet (think South Beach, Atkins, etc.), to a glut of mostly-free mobile app calorie and activity counters. However, I believe Weight Watchers has carved a defendable niche in this maelstrom of offerings. First, the brand name is easily one of the best-known and best-respected in the field, having been around since the early 1960's and licensed by numerous product firms and restaurants. Also, no firm can (or has even tried to) replicate Weight Watchers' meeting infrastructure, and it has been shown time and again that group support is one of the most successful strategies for sustainable weight loss outcomes. Looking at the company's steady results, even in the 2008-09 recession, it is clear that the company possesses a defensible economic moat.
Competition and operational misfires remain the two largest near-term risks. Weight Watchers' stock has been cut in half over the past year after 6 months of double-digit meeting attendance declines and weaker-than-expected growth in the Internet segment. Management blames an unfortunate marketing campaign derailed by Jessica Simpson's pregnancy and more consumers trying free mobile apps as two prominent contributors to the weakness - both manageable problems, in my view. Longer term, I'm concerned about the company moving away from meeting-based weight loss solutions (where the firm's moat exists) and into the more crowded field of Internet-based offerings. Medical breakthroughs in weight-loss pills could cause a drop in demand, as the "quick fix" is a strong marketing draw. Also, Weight Watchers has a highly leveraged balance sheet, where prolonged poor results could cause a violation of debt covenants and in the most dire (and unlikely) of scenarios even put the firm at existential risk.
Weight Watchers has a mediocre team. David Kirchhoff has been CEO since late 2006, and he previously held both the CFO and COO of Europe/Asia titles prior to his promotion. Under his watch the company has performed decently, growing revenues about 50%, operating profits 34%, and reducing share count by 25%. Artal Luxembourg still owns about 52% of the company (it purchased WTW in 1999 from Heinz), giving it control of voting matters. While I have confidence in the team's ability, there are warts here. Both the President of Europe and the CTO are recent departures, Weight Watcher's stock price is actually down in Kirchhoff's tenure, the dividend hasn't been raised since he took over in 2006, and debt has nearly tripled. Also, the Dutch Auction buyback last February reduced share count by 25%, but at a massively inflated price of $82 per share - double where the company trades at today.
Weight Watchers has a highly leveraged balance sheet, with just $70 million in cash offsetting a large $2.4 billion in total debt. Fortunately, the firm is a very reliable cash generator, even during the 2008-09 recession, so the debt is less of a concern than it would normally be. Additionally, interest coverage ratio is acceptable at 5.6 times, and a recent refinancing should improve that further going forward, as well as pushing debt maturities out to the end of the decade. Weight Watchers pays a 1.7% dividend yield that is safe (under 17% payout of free cash flow), though it hasn't been raised since being instated in 2006.
2013 has been a difficult period for finding remarkably undervalued stocks, and sometimes we've had to compromise a bit to find good investment opportunities. Such is the case with Weight Watchers. MagicDiligence believes the firm is clearly undervalued, selling at half of its stock price a year ago and over 35% below the $57 sell early target. The recent weakness in sales seems to be due to fixable problems with marketing and difficult comparisons against a very strong 2011. At a 10.2% earnings yield, Weight Watchers trades meaningfully below its long term average of about 9%. The balance sheet is a concern, as is the competitiveness of the market, but at current valuations I feel we have a wide enough margin of safety to outperform the market with WTW.
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Steve does not own WTW.
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