Weight Watchers International Inc.
Top Buy (Aggressive)
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Although certainly not a great quarter, Weight Watchers' Q2 report showed a company that is putting a lot of effort into a turnaround, and that effort seems to be showing initial indications of bearing fruit. Revenues continue to be weak, down 16%, as poor recruitment trends over a nearly 2 year period continue to weigh on both meeting and online subscribers. However, the firm has rapidly moved to revamp marketing costs, which were down 35% and helped the company deliver a very good 30.4% operating margin.
Going forward, Weight Watchers has 4 objectives: improve current performance, "re-imagine" core offerings, growing the healthcare business with employers and insurers, and strengthening the organization. We touched on the first. On the second, the company has partnered with Fitbit and plans changes to reduce the rigidity of Weight Watchers' core program going into next year. On the third, the company does not expect meaningful contribution until 2016.
Weight Watchers seems to have bottomed here, but the company is not out of the woods yet, and in fact the first half of 2015 will be difficult too given poor recruitment through this year. Still, the stabilization is good to see, and at this point the company does not appear in imminent financial danger given its cash flow generation. The target price remains $33.
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. 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 in healthcare, 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 20 months of double-digit meeting attendance declines and significant deterioration in the Internet segment. Management blamed 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 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 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 $327 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 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 suspended its dividend in 2014 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, 2014 hasn't been any better. With a poor balance sheet, the risk level is elevated if management cannot get the business turned around. However, there are some signs of a stabilization late in the year, and management has done a good job cutting costs to maintain profitability through this difficult period. 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 $33, a significant upside, but the downside potential is considerable as well.
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Steve owns WTW.
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