Weight Watchers International Inc.
Top Buy (Aggressive)
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It was with much interest that I read Weight Watchers' Q1 results and conference call. Can this really beaten down company turn it around?
Q1 results were pretty much as advertised - bad. Revenue fell 17%, as meeting paid weeks declined 16%, online was down 12%, and product sales were down as well. Cost reductions are trailing revenue loss, with operating margin contracting to 12.5% from a 5-year average of about 27%.
On the positive side, management commented that subscription trends were "not getting worse", which is good news I suppose. Guidance for 2014 was actually raised a bit, and Weight Watchers plans meaningful spending cuts in both marketing and SG&A. The plan going forward relies heavily on upgrading the company's technology systems to support their business-to-business healthcare initiative, starting with a plan for those suffering from diabetes. Also in focus using technology is to make Weight Watchers' offering more personalized instead of so rigid. To this end, Weight Watchers acquired Wello, which uses video chat to connect consumers to fitness and personal trainers.
With a little more color into the company's plan, and at least some idea of where Weight Watchers may bottom, we can update our expectations a bit. I'm lowering the sell target to $32 from $37, and setting a buy under price of $22. Weight Watchers is still a risky stock, and the stock is likely to be volatile through the turnaround efforts. The company's $2.4 billion in debt remains worrisome, even though the next redemption is not until 2016.
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 much 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 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 trades at only 1/3rd of its value of a few years ago, after over a full year of double-digit meeting attendance declines and significant deterioration 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, but early 2014 marketing has not been very successful either. 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. 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 an unproven management team. James Chambers just joined the company in January 2013 as COO, and was quickly elevated to CEO in August, taking over for lackluster predecessor David Kirchhoff. He has held executive positions at Kraft and Cadbury, but has never been CEO at a public firm. Artal Luxembourg still owns about 52% of the company (it purchased WTW in 1999 from Heinz), giving it control of voting matters. Recently, new management has embarked on an aggressive campaign to re-invigorate the business around a more flexible consumer offering and an increased focus on business-to-business program sales.
Weight Watchers has a highly leveraged balance sheet, with just $230 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 risky at just 3.9 times, although a recent refinancing should improve that further going forward, as well as pushing debt maturities out to the end of the decade. The company recently suspended its dividend to focus on turnaround efforts and paying down the debt.
At this point in time, Weight Watchers represents a high-risk turnaround play. 2013 was bad, and early 2014 results and guidance indicate a firm caught in a downward spiral. With a poor balance sheet, the risk level is elevated if management cannot get the business turned around. Over the long term, I feel that Weight Watchers' proven system for success will win out over the latest fad of activity monitors and free calorie counting apps, but there is no guarantee. MagicDiligence sees Weight Watchers' stock as worth about $32, a significant upside, but the downside potential is considerable as well.
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Steve does not own WTW.
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