AMGN - Medifast: A Revamp Is Necessary An Embrace Of GLP-1s Can Help

2023-06-14 14:50:00 ET

Summary

• I view Medifast’s traditional business model at increasing risk from the growing popularity of GLP-1-based drugs.
• Recent M&A activity within the industry provides an indication of the premium investors are willing to pay for those who embrace change.
• Medifast is currently deploying positive cash flow dollars to the maintenance of an over 8% yielding dividend as well as to share repurchases.
• While it would be a disappointment to investors, I believe the time is ripe to deploy the capital to more gainful ventures.
• I believe shares can support a price in excess of $100/share following a pivot in strategy and a reallocation of cash flows away from shareholder payouts.

There is GPT and AI. And then there is GLP-1s and weight loss.

The public interest in the former is well documented and can be seen in shares of NVIDIA ( NVDA ), which are up nearly 200% YTD. The latter, too, is a hot topic of the day. But it is perhaps less covered. Shares in names, such as Novo Nordisk ( NVO ) and Eli Lilly ( LLY ) are up 15% and 22% YTD, respectively.

Those are modest gains, considering new GLP-1-based drugs, such as Ozempic, Wegovy, and Mounjaro, are expected to become some of the best-selling drugs in the pharmaceutical business. Is this pharma’s ChatGPT moment? I’d say it’s significant, at the very least.

For example, current estimates from drug analytics firm, IQVIA Holdings ( IQV ), sees spending on weight loss drugs rising 378% from 2023 to 2027. And a rash of companies are rushing in to cash in on the market for weight loss, which is expected to reach +$60B in 2023, according to Morningstar, with about 21M people taking GLP-1 products around the world.

These companies include Amgen ( AMGN ) and Pfizer ( PFE ). In PFE’s case, some analysts believe the potential in their weight loss candidate is yet to be baked into the stock, which is viewed to be fairly valued at $75/share. That’s nearly 90% above current trading levels.

Medifast ( MED ) has not embraced the new realities just yet. But I suspect they will. In my view, a pivot in strategy paired with a reallocation of cash from shareholder payouts to investing activities can easily support a share price well in excess of $100/share.

How Can Exposure To GLP-1s Help MED's Share Price?

Given the expected growth in these new drugs, investors are clearly assigning a premium to those who embrace it. WeightWatchers ( WW ) is a case in point. For 60 years, the company has relied on the model of “lifestyle changes.”

While this model has staying power, it’s not on the right track. At the end of 2022, WW had 3.5M members . That was down from 4.2M from a year earlier and from their record high of 5.0M in 2020. This is putting pressure on both top and bottom line results. At the end of Q1, the company reported a nearly +$30M operating loss.

No matter, shares are up nearly 80% YTD after being down about 90% over the past five years.

Why? In April, the company recently acquired telehealth provider Sequence. This company focuses on providing treatment for weight loss and can connect customers with doctors, who can then prescribe weight loss drugs, such as those in the GLP-1 class.

Following the closure, the stock was upgraded by Goldman Sachs ( GS ) and inputted a price target of $13/share. That represents another 85% upside from the current run up. This upgrade largely stemmed from the potential exposure to the drugs. The optimism surrounding the future benefits is also overshadowing their near-term weaknesses. The stock, for example, surged 40% on the day of their Q1 release, which was mixed at best.

Why Should MED Embrace GLP-1s?

Compared to WW, MED operates on higher margins, maintains a cleaner balance sheet, and retains more of their operating cash flows. The outperformance of WW, then, is unacceptable.

For its part, MED’s first quarter results came in ahead of their expectations. But investors would be remiss to buy into that positive spin in the commentary. Revenues and gross profit were down 16.4% and 18.5% YOY. This came as their active earning OPTAVIA coaches, a pivotal nonmonetary metric, declined by 5,200.

Gross margins are better, at least when compared to peers. But their downward trend on additional investment in their core business is not promising. The company is getting a reprieve on SG&A costs, which keeps their operating margins in check, but this is due in part to the decline in the number of active earning coaches. Not a positive by any means.

In Q1 commentary, CEO, Dan Chard, elaborated on the initiatives that he believes will reestablish their performance to a target of 15% annualized revenue growth and 15% operating margin by 2025. This is dubbed the 15x25 initiative.

Getting there involves improving performance surrounding customer acquisition, which has been on the decline. Efforts in programming, coach-led training, and offers is viewed by MED as the path forward on this.

But in my view, an embrace of GLP-1-based drugs would make attainability of their goals more feasible. In programming, for example, they are striving to “focus on the entire health & wellness journey.” If so, then drug-based solutions should serve as a complement to their more traditional approach, given current demand trends.

And in coach-led training, they recognize that “changing social media algorithms requires new strategies to reach customers.” One key variable that is holding back the performance and productivity of their existing coaching network is that social media algorithms favor current trends, which is overwhelmingly centered around the new GLP-1 drug class. By embracing this new realty, MED would gain better exposure to their overall core business.

In their offers, growing exposure to the Latin American market was talked up on their recent release. The opportunity appears to have merit. But I don’t view this as enough to turn around the performance of the company. Recently, the company announced an exit from their operations in Hong Kong and Singapore as part of their assessment of the changing demand trends. International exposure, therefore, may not always turn out as expected. On the other hand, a supplementary class of product offerings could generate interest, which could then lead to additional app exposure.

Why MED Should Cut Or Suspend Their Dividend?

At present, MED is paying out over 100% of their EPS in a dividend that is yielding about 8%. They are also engaging in share repurchases. In my view, this is a disservice to investors that deserve better.

It is not a question of coverage or safety. The company generates more than enough in cash flows to satisfy their dividend. At the end of 2022, for example, MED generated about +$178M in free cash flows. And their dividend ran in the neighborhood of +$70M. Granted, they are tapping into existing cash balances to repurchase their shares. But they are in a cash position of over +$120M. And they have no interest-bearing debt.

Their finances are on strong footing. But is returning cash to shareholders the best use of cash? I would say that it is not. WW paid just over +$100M for Sequence and was rewarded with a 80% rise in their share price. MED has maintained a high yielding dividend, which continues to be noted in their earnings’ commentary, yet shares are down over 50% over the past one year.

A target payout ratio of 70% of EPS appears more reasonable to me. Full-year guidance wasn’t provided. But EPS is seen at a midpoint of $1.38/share in Q2. A quarterly dividend of $0.95/share would keep the payout within the 70% target. And it would keep the annualized yield at about 4.5%, while also preserving more dry powder for more shareholder friendly initiatives.

Is MED A Buy, Sell, Or Hold?

An openness to embracing emerging solutions is clearly necessary. Both WW and MED are seeing declines in key nonmonetary metrics. This is coming at the same time that alternative solutions are soaring in popularity. Their customers and coaches appear to be chasing the next big thing. WW has recognized this and has been rewarded, accordingly.

I sense that MED will soon follow. In the past, CEO, Dan Chard, has noted the risks surrounding the new wave of drugs and has expressed confidence in their current approach. And it’s true that there are risks in the new GLP-1s. There are side effects, some severe, and in the long-term, the trend could prove fleeting.

Despite this, MED hasn’t fully dismissed the rise of these alternative solutions. On their recent call, they also led me to believe that they are actively exploring ways to better serve a more diverse array of customers. In response to a question relating to the GLP-1s, Mr. Chard responded with, “ …. So we want to -- we plan and are looking at ways to ensure that we're relevant for customers who want to be on the GLP-1 drugs and also those who want to do it without. ” Perhaps this could lead to something more shareholder friendly? Time will tell.

Down nearly 30% YTD and near their lows, MED warrants attention, especially considering recent developments in the industry. Shares, therefore, are viewed as a “strong buy.” In my view, the stock can easily support a price in excess of $100/share. For perspective, the stock traded at nearly $200/share at its highs. A more concrete embrace of current trends can help them get there.

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