Weight Watchers International Inc.
Top Buy (Aggressive)
Latest Research Note
We're seeing the cumulative effects of Weight Watchers' weak recruitment throughout the year, with Q3 results showing a 8.5% drop in revenue, and management's expectations for double-digit revenue declines in Q4 and throughout 2014. On the plus side, cost cutting measures are ahead of the curve, with expenses down almost 15% and operating margin actually outpacing last year's at 31.6%. Meetings continue to be quite weak, with revenue down in the 13-15% range, and attendance down 16%. Active online subscribers also fell for the first time ever, down 5.3%.
The firm also suspended its modest dividend, which will save the company about $50 million annually, and although it wasn't explicit I would expect share repurchase activity to remain on freeze. This makes sense, as the firm will need capital to invest in its turnaround plans, and to pay down its substantial $2.4 billion in debt. The $1.5 billion in share repurchases last year (at $82 per share!) continues to look like a massive mis-allocation of capital.
I've always had low expectations here, but management has been particularly downbeat on next year and I've dialed back even a bit more. The sell early price is reset to $49, and the buy under price is $36. Given the very weak meeting trends and large debt burden, I'm also moving the stock to the "aggressive" portfolio. The shares look attractive at current prices, but investors should also be aware of the risks.
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 has been cut in half over the past year after 9 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. 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 $181 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 (barely) acceptable at 5 times, and 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.
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. The brand is a strong one with a long history of success, even in the face of waves of competition. Such is the case today, with free smartphone apps and activity tracking monitors moving people away from support-based weight loss solutions. Weight Watchers is moving to turnaround its business, and it should be able to do so in time. A recent decline in the stock price to under $33 makes the margin of safety here attractive. The balance sheet is a concern, as is the competitiveness of the market, but at the recommendation price I feel we have a wide enough margin of safety to outperform the market with WTW. MagicDiligence believes Weight Watchers is worth $49 a share.
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Steve does not own WTW.
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