Weight Watchers International Inc.
Top Buy (Aggressive)
Latest Research Note
After two quarters of decent performance (particularly on the profitability side), Weight Watchers just took a complete nosedive in Q4. Even against weak comparisons from last year, the firm posted a 10% revenue decline despite increasing marketing expenditures by 17%. Just as bad, the firm's pricing power seems to be eroding, with gross margins coming in at just 50%, vs. mid-50s for much of the past year. Topping off this sundae of disappointment, 2015 guidance was just eyebrow-raising bad with full year earnings guidance of $0.40-$0.70 per share. This was shocking to me.... in the 2 most recent quarters before this one, the company had delivered over $1.60/share!
I'm now concerned about this pick. There has always been a fair amount of financial risk here, as the company carries almost $2.4 billion in debt and has a $300 million redemption this year. Interest coverage for the year was just 2.5 times, in serious "alarm" territory. Weight Watchers still generates a fair amount of cash, but the downward trend is very concerning. I was of the opinion that the firm would be able to maintain solid operating margins but this assumption is very much in question now. Even with a $100 million cost cutting program, interest coverage will be very tight this year.
I am setting an interim price target of $17 on Weight Watchers and am planning to revisit the pick after their 10-K is filed. At this point, I WOULD NOT put new money into the stock (the "buy under" price is $0). After we get a chance to study the full financial reports, I'll post another update with additional thoughts.
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.
Weight Watchers is on hold. MagicDiligence WOULD NOT put new money into the stock, as Weight Watchers is now in very serious financial health and must execute a turnaround to avoid critical liquidity issues. We will revisit the stock after its 10-K is filed to dig into the financial numbers in more detail.
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Steve owns WTW.
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