MED - Medifast: An Attractive Dividend But Operating Results Need Further Improvement

2023-03-22 06:28:07 ET

Summary

• Medifast operates in the health and wellness industry and is the owner of the OPTAVIA brand, a popular weight loss and diet program.
• The company generates its sales through a large network of independent coaches who work at arms-length with its customer base.
• Though the industry is intensely competitive, the company has held up strongly over the past several years.
• Strong cash generation and zero exposure to interest-bearing debt enable Medifast to provide a steadily growing dividend payout.
• Though an upside exists, Medifast did struggle in 2022 and likely faces an uphill climb in new customer acquisition in the current market environment.

Medifast ( MED ) is the company behind the OPTAVIA brand, which is a popular weight loss and diet program that has been featured in a number of platforms through the years.

Driving the company's sales are their large network of independent coaches. These coaches market their products through word-of-mouth, digital marketing, and social media, among other outlets.

While the industry is hyper-competitive and subject to continuous change, MED has held up strongly over the years. Shares, nevertheless, have fallen victim to the occasional boom and bust cycle. Elevated short interest is also present on the stock, though other names within the sector also possess similar levels of short interest.

At present, shares are trading near their 52-week lows at just under 10x forward earnings. In addition to the potential value proposition, the stock also comes paired with a dividend that is currently yielding about 6.5% and is growing at an attractive multi-year compound rate. While shares are worth the add to the watchlist, the company did struggle in 2022, and full year guidance wasn't provided due to current uncertainties. In my view, new initiation, therefore, is best left on hold until there is further clarity on their recent initiatives.

The Business

MED operates in the health and wellness industry and is the owner of the OPTAVIA brand, a popular weight loss and diet program that is centered on developing new healthy habits through smaller, foundational changes.

A key aspect of the business is the utilization of independent OPTAVIA Coaches. The company currently has about 60K coaches in their network. Furthermore, about 90% of these coaches were OPTAVIA customers prior to becoming a coach.

As part of the model, aside from working with the customers in developing healthy habits, coaches are integral in marketing the company's products and plans, which includes their proprietary "fuelings", which are essentially a pre-packaged set of meals delivered to the customer at a price point of between $400 and $500 a month.

MED's coaches are classified as independent contractors, not employees. As such, the company primarily incurs incentive/commission-based costs as opposed to payroll-related expenses. Furthermore, the coaches do not handle or deliver merchandise to customers. This enables them to maintain a more arms-length transactional relationship with the customer.

Competitors

MED operates in a very competitive industry, one that is served by a diverse array of companies. Notable publicly traded peers that operate in the general health and wellness diet industry include Usana Health Sciences ( USNA ), WW International ( WW ), Herbalife ( HLF ), The Simply Good Foods Co. ( SMPL ), and The Hain Celestial Group ( HAIN ), to name a few.

After posting outsized gains over the past three years, MED has taken a steeper hit in recent periods. They are down about 12% YTD, for example. Most of their peer group, on the other hand, currently are trading in a positive range.

The declines have, however, brought valuations down to more discounted levels in relation to their peers. From a price/earnings standpoint, MED trades at a premium to HLF. But when stacked against enterprise multiple, the company trades at a marked discount.

This is despite strong profitability metrics. Margins, for example, are in-line with USNA, a competitor that, though more diversified, still trades at a sizeable premium to MED.

Further distinguishing MED from their peers is their dividend payout. Of their peer group, they are the only one that offers a payout.

Recent Results

Total revenues in Q4 declined 10.7% and their total active OPTAVIA coaches at year end was down on a sequential basis. Furthermore, average revenue per active earning coach was down 12.4% YOY, due to continued disruptions in customer retention and softness in customer acquisition.

Gross profit ("GP") also took a hit of 16.1% during Q4 due primarily to one-time expenses associated with the restructuring of external manufacturing agreements, as well to the effects of the inflationary environment, which more than offset pricing adjustments. In addition, GP margins took a notable step down to 69.3% from 73.7% in the same period last year. Excluding the one-time charges, however, GP margins would have been down just 80 basis points ("bps") YOY.

Savings in selling, general, and administrative ("SG&A") expenses, which were down 13.1% during the quarter and down 170bps as a percentage of revenue, buffeted some of the impact to total income from operations.

Nevertheless, operating income was still down 30% from the year ago period. Though margins were also down for the period, excluding the one-time charges, they would have been up 340bps to 15.8%.

For the year , total revenues were up 4.8% due to an increase in the number of active coaches and higher productivity through the first half of the year, as well to favorable pricing tailwinds. In addition, gross profit was also up 1.1% due to the higher overall revenues. While overall net income was down in 2022, on an adjusted basis, excluding the one-time charges, diluted earnings would have been up 4.4%.

Looking ahead, management provided first quarter guidance but withheld on their annual outlook due to current uncertainties surrounding their efforts in improving customer acquisition, which continues to underperform historical averages.

Dividend Safety

MED currently provides a quarterly payout of $1.65/share. At current trading levels, this represents a yield of approximately 6.5%.

In addition to an attractive yield, the dividend is backed by a strong track record of record. Over the past three years, for example, the payout has grown at a compound rate of nearly 25%. Most recently, however, the payout was increased 0.6% to its current form.

Though the company turned in a less than stellar year in 2022, they certainly have the capacity to maintain their payout and to enact further increases in the periods ahead. For one, the company has no long term debt. This eliminates all concerns relating to debt servicing.

Furthermore, the company is generating significant free cash flows ("FCFs"). In 2022, for example, they generated about +$185M in FCF. Their payout was just 40% of this. The excess cash, then, was used on their stock repurchase plan.

Looking ahead, management isn't ruling out a potential debt raise, but they are unlikely to need the funding, considering they currently have about +$88M of cash on hand and full availability on their revolving credit facility.

Final Thoughts

MED operates in an industry with a large addressable market. There are approximately 175M people, for example, looking to lose weight and willing to consider dieting, according to recent company presentation materials.

In addition, 63% of U.S. adults have adopted new, positive health habits since the start of the COVID-19 pandemic. Furthermore, 96% of people making these changes report that they plan on continuing embracing these habits.

Favorable demand drivers figure to keep the pipeline open for MED's product offerings. The downside, however, is the competition and the continuously evolving view on diets and programs. The risk that today's diet is yesterday's fad is ever-present in the industry.

MED's "fuelings" are also expensive, with their kits averaging between $400-$500/month. For most, that would be too much to expend, especially in today's environment. And in 2022, that was evident as the company struggled with retention and customer acquisition.

To mitigate these headwinds, the company, among other actions, is increasing promotions and incentives for their coaches. As it is, margins were already down in 2022. And it's likely they will fall further in Q1 of 2023. The lack of full-year guidance also adds an additional element of uncertainty.

The company's pristine balance sheet, which is free of interest-bearing debt, is one notable competitive advantage, as is their significant cash generation potential. Combined, this is enabling the company to enact continual dividend increases, as well as strategic share repurchases.

Shares could rally higher, considering their discount to peers, but the company faces an uphill battle attracting and retaining new customers. For investors seeking new positioning, I view MED as a solid watchlist add but am hesitant on new initiation until the company can share more positive updates on their customer acquisition efforts.

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