MED - Medifast: In Survival Mode Against Diet Pills And The Recession

2023-06-14 04:20:26 ET

Summary

• The heightened awareness of weight loss medications raised concerns regarding the viability of Medifast's business model.
• Operating in a recessionary and inflationary environment has always been tough for any business selling products considered discretionary, and the decline in revenue and net income caused further fears.
• In this article, I will examine the threats from these weight loss medications, as well as its fundamentals to determine if the company is in danger of cutting the dividends.

Introduction

This is my third piece on Medifast ( MED ), and this piece is coming after it slumped 36% from my 12 September 2022 article . This third piece reexamines my previous premises about MED because one cannot afford to be stubborn nor can one afford to be anchored to the past in investing.

If the facts have changed, I am prepared to change my mind. As a shareholder who has been long this company, this article has as much implication for me as it has for others who are either long MED or are considering it.

For readers new to me, or my history with Medifast, I have written about the company twice in 2022 and hence I shall not be rehashing whatever was written about MED's previous successes; you can read those articles (links provided below in the conclusion segment) .

And because this is a no-moat company (in my opinion), I follow its ups and downs more closely than I do with blue chips like McDonald's ( MCD ) or Johnson & Johnson ( JNJ ). This article will examine MED from the following four angles: threats from the FDA-approved weight loss medication, profitability, balance sheet, and safety of the dividend.

Let's get to it.

Firstly, are the FDA-approved weight loss medication threatening to upend the weight loss industry?

Some context will be helpful.

Ozempic (generic name is semaglutide; more on this later ), a weight loss drug manufactured by Danish pharmaceutical company Novo Nordisk, most recently in March 2023 received FDA approval for a once-weekly, increased 2 mg dose of Ozempic injection to improve blood sugar in adults with type 2 diabetes and its usage may help people lose some weight. Wegovy , also from Novo Nordisk, received FDA approval in 2021 as an adjunct to weight loss management. Saxenda, again from Novo Nordisk, received FDA approval in 2014 for the treatment of obesity. Alli from GSK was approved in 2007. And there are others on the market too.

My point is this: FDA-approved weight loss medication is not new.

Some Background On GLP-1

There is a class of weight-loss medication known as glucagon-like peptide 1 or GLP-1 agonists. They are originally intended to help treat type-2 diabetes by mimicking the action of a hormone called glucagon-like peptide 1 to stimulate the body to produce more insulin which helps lower blood sugar levels to help control type 2 diabetes. In the following 2015 study , the authors concluded this,

Through these and other still imprecise mechanisms, GLP-1 in both physiologic and pharmacologic doses promotes satiety, affects mechanistic properties of the GI tract and results in negative energy balance. Additionally, its success in promoting weight loss makes GLP-1 agonist therapy an attractive option in the management of type 2 diabetes.

At that time (2015), the authors noted that although GLP-1 receptor agonists were FDA-approved only for the treatment of type 2 diabetes, clinical trials had shown that they also consistently produce weight loss. They said that,

In patients with type 2 diabetes, GLP-1 agonist infusion in pharmacologic doses enhanced satiation and promoted weight loss. Hence GLP-1 therapy in humans reduces food intake, appetite and hunger and promotes fullness and satiety with the ultimate result of promoting weight loss.

In other words, there is evidence to show that GLP-1 agonists slow down food absorption through the small intestines thus promoting feelings of fullness, and reducing weight.

However, as I said earlier, the existence of weight loss medication is neither new nor revolutionary.

Why Does It Suddenly Matter Now?

In 2022, diabetic patients who depend on sugar-lowering medications like Ozempic and Trulicity were experiencing shortages and delays in getting their life-preserving medication refilled. And it was more than a supply chain disruption issue.

Apparently, there were lots of online chatter about celebrities using Ozempic to lose weight, and tabloids like The Sun and Glamour , and social media influencers continued to keep this in front of their viewers. Even billionaire Tesla CEO Elon Musk attributed his weight loss partially to his use of Wegovy.

Then, WeightWatchers decided to enter the prescription weight-loss business in March 2023, announcing that it would be spending $106 million to acquire Sequence , a telehealth subscription service that connects patients with doctors who can prescribe weight-loss and diabetes drugs like Wegovy, Ozempic, and Rybelsus. This deal is expected to close during the second quarter of 2023.

All these forced Medifast's CEO Dan Chard to address this burning issue in the Q1 2023 earnings call,

The new generation of weight loss drugs are receiving a lot of press attention right now. While weight loss drugs have certainly been around for a long time, there's been heightened recent demand for the class of drugs known as GLP-1s, which have been shown to contribute to significant weight loss and in some cases, have now been approved by the FDA for the treatment of patients with specific BMIs and risk factors.

What Is Medifast's Stance On This?

He was questioned by analyst Linda Bolton-Weiser,

Okay. And then with regard to the drugs, the GLP-1 drugs, I would assume, but correct me if I'm wrong, that it wouldn't make a lot of sense for you to acquire a telehealth platform or something like that , like Weight Watchers did. But correct me if I'm wrong on that. And if that's the case, then do you plan to modify your program such that it's kind of -- is complementary in some way to usage of the drug?

It is interesting to me that he was asked about this because when I examined every transcript from the time Dan Chard was CEO, not once was he asked about the threat of weight loss medication to Medifast's business.

I like his answer.

What is very clear to us though is that sole reliance on weight loss drugs does not address the fundamental lifestyle factors or behaviors we believe are needed to achieve optimal health.

... our most recent national survey show that customers prefer 3:1 a lifestyle and behavioral change solution to their weight management versus a drug therapy.

... 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.

... we have some specific initiatives to help us ensure that we're relevant to our clients who are looking to start their journey to better health and to transform their lives through better health.

He is certain that the right and best way to manage weight is through changes to one's lifestyle and behavior. At the same time, he wants to be able to respond to the changing needs of his customers. Usually, Medifast conducts training and seminars for their coaches at least once a year, usually in the second half of the year, and my guess is the coaches will be provided with updated guidelines to properly advise their clients who are either on these medications or are thinking of taking them, or simply have questions regarding them in general.

And his belief is backed by research . Patients who lost weight while on these medications gain the weight back once they stop taking them.

In this study, 902 participants were injected with semaglutide over twenty weeks. After that, the experiment continued for another 48 weeks with two-thirds (535) continuing the treatment while one-third (268) were given a placebo.

Those who switched to the placebo started to experience an increase in waist circumference and weight.

Should Medifast be worried about this threat from Ozempic and others like it?

There are a few reasons that everyone should take note of, not just investors but folks thinking of taking such medication.

One, as mentioned in the previous segment of the article, once the participants stop taking the medication, they start to gain back the weight they lose. This is not a long-term solution. Taking these medications for the long term can be a bad idea because...

Two, these medications have side effects, some of which are severe. Patients with type 2 diabetes taking Wegovy may experience worsening of their vision. The same expectations of side effects are true for a different medication like Ozempic. The following warning label is on page one of the Ozempic package insert.

The side effects also mean not every person who wants to take these medications can. See the following for a description of people who should not be taking Ozempic and for descriptions of people who should take special heed if they were to start taking it.

In fact, there is already a class action suit preparing to sue the drug company Novo Nordisk for the health problems the Ozempic medication has caused them.

Should Medifast jump onto this bandwagon to suggest/introduce their clients to these medications and become liable, or should they stick to changing their client's habits for the better by eating healthy and exercising regularly?

I should think it is the latter.

Thirdly, these medications do not come cheap.

A check on GoodRx's website shows how pricey Wegovy is. The average cost of one carton with 4 prefilled 0.25 mg (or 0.5 ml) is a staggering $1718.50 (or $20622 a year) and most Medicare and insurance plans do not cover the costs meaning the patient has to pay most if not all the cost.

A check on GoodRx's website for the cost of Ozempic shows that the average cost of 1 injectable pen prefilled with Ozempic (2 mg or 1.5 ml, or 30 days' worth of once-a-week shots) is around $950.

A year's worth of supply will be close to $12000; the average salary for Americans is $55640. How many can afford this approach to lose weight temporarily?

You may wonder if insurance can cover the cost of such medications.

Fourthly, it is unclear whether insurance will cover these medications because their usage can fall under the gray area between something that can be considered as a cosmetic procedure (and hence the insurance companies will not cover these expenses) or medical treatment (which they should but the extent of the coverage depends on the coverage stage: Deductible, post-Deductible, Donut Hole, or Post-Donut Hole ). And even in the latter case of medical treatment, the patient who seeks insurance coverage for the use of these medications has to prove that he/she has fulfilled the myriad of conditions required by the insurer and that the patient has made reasonable efforts to try other treatment methods or lifestyle changes prior to using something like Ozempic. More details are provided in this piece by Wall Street Journal .

Fifthly, these medications are not available over the counter. They can only be given upon a prescription by a doctor, so if a person is not diabetic that individual should not be receiving any prescription to buy the medication. Even Wegovy , which received FDA approval to be sold as a medication to treat obesity in teenagers twelve years and older, has to be prescribed.

To conclude this segment, I believe that until a time comes when these pills are safe enough for consumption and cheap enough for the masses, the threat of weight-loss medication to the weight-loss industry is yet to be significant.

Secondly , is MED still profitable?

Since CEO Dan Chard and his refreshed management team took over the reins at MED, the company's revenue has been growing. Fast forward to the pandemic years when a culmination of factors more than doubled the sales from $713.7 million in 2019 to $1.5 billion in 2021. That kind of growth is unsustainable and a decline in revenue growth rate has to be expected, and that decline has happened across multiple industries and companies, and MED is not spared. Due to a combination of inflationary pressures that increased the cost of materials, shipping, and labor, fewer coaches, and reduced spending by their customers, revenue declined 16.4% year-over-year to $349 million.

Despite all these challenges, Medifast continues to be profitable and reported a net profit of $40 million, a 4.76% decline from the $42 million reported in the same quarter in 2022.

The company expects second-quarter 2023 revenue to be in the range of $250 million to $270 million. That is lower than analysts' consensus estimate of $313.2 million. Personally, for the analysts to expect next quarter's revenue to come close to the 2021 or 2022 numbers is just wishful thinking as circumstances have changed.

Personally, I believe that $250 million to $270 million that was guided is a realistic number, which is possible based on the increased number of coaches now compared to the pre-pandemic times, higher price adjustments of Octavia's products, and better cost management. These are levers that the management can still pull to stay profitable. CEO Dan Chard shared this during the Q1 2023 conference call,

Our Q4 price increase , commission plan optimization measures and cost control actions had a positive impact on our operating margin, helping offset inflationary pressures on our gross margin.

Secondly , is MED's balance sheet strong?

As of the latest quarter, MED reported having cash and cash equivalents of $123.7 million with no interest-bearing debt. That is great. And remember the company remains profitable so it is not burning cash like companies that are unprofitable.

Thirdly , is MED stock's dividend safe, and is MED still a dividend compounder?

During the Q1 2023 earnings call, CFO Jim Maloney had this to say about dividend safety,

We do believe we have sufficient funds for the foreseeable future regarding our cash flows for the dividend. So, we believe that we have significant funds that should cover the dividend.

As we invest in this growth and get back to growth, we believe that the dividend is not at risk at all . So, excess cash flows from organic growth opportunities and the dividend, we still will continue to look at opportunities and stock repurchases.

As of the latest quarter, the company has 10.899 million shares. Assuming the company increases the dividend by $0.01 per quarter for the next 3 quarters and assuming there are no further share buybacks, the company definitely has more than sufficient cash on hand to pay the dividends.

However, Medifast is no longer a dividend compounder. I will say that Medifast now is an income stock that provides an 8.24% dividend yield.

I do not think that management needs to cut its dividend. Not only does the company has sufficient cash, it continues to be profitable. Weight loss business is a recessionary-resistant business. Yes, it is not immune to the effects of inflation on its customers' willingness to spend. However, history has proven otherwise. I quote the following from my previous article :

How would MED perform in a high inflationary environment like now? There is no way to know for sure. In the company's history of submitting SEC filings , from 1996 to 2021 (excluding 2022), the year with the highest inflation rate was 2008 at 4.38%. And MED was still very profitable. As you can see from the consolidated statement of income below, net income increased 62% from September 2007 to the same period in 2008.

Conclusion

Weight loss medications have been around for more than a decade at the least and they have not posed a serious threat to the weight loss industry. Of course, the threat of weight loss medications like Ozempic and Wegovy should not be underestimated but neither should it be exaggerated. Until a time when such medications are cheap enough for the masses and truly safe for consumption with no life-threatening side effects, Medifast's market share should face minimal impact from these medications.

I believe that Medifast as a business is not broken. The business continues to be profitable, is debt free, has ample cash on hand, and there is no danger of a dividend cut. The business survived previous inflationary periods intact and remained profitable through the terrible Great Financial Crisis. And Americans are in a better financial state today than in 2008-2009; no forced foreclosure of homes, low unemployment, and higher net worth due to inflation rising the prices of homes for homeowners.

The question is: Is Medifast a buy, hold or sell?

The answer will be different for different people. Before I share my thoughts on that, it is necessary to provide a brief summary of my previous stance, and I have extracted excerpts from those two below.

In the August 2022 article , I described MED as a Dividend Compounder and in my Bear Case scenario, I valued MED at $97.07; it is now trading at $79.60 (at the point of writing on 12 June 2023).

I concluded the first article with the following:

Granted, MED has only paid dividends for 6 years and that 88.07% dividend growth rate has been on the decline but that is to be expected. Unless a company can also increase earnings at that insane rate, a slowdown in dividend growth is only prudent. However, so long as the dividend growth rate stays above 10% per year, the dividend will double in around 7 years. I will continue to hold it for its outsized dividend payout that provides income for reinvestment.

Investors should understand what MED does. Weight loss management is a multi-decade trend, and MED is the leader in this industry. With a more educated global population showing greater appreciation for a healthy lifestyle, MED's business model of getting coaches to teach clients healthy habits - not just selling products - is unique.

In the September 2022 article , I wrote that MED appeals to different tribes of investors; those seeking growth in capital appreciation, revenue, adjusted operating earnings, and dividend, and those seeking safety in businesses that remained profitable in inflationary times, would have found MED very compelling. In that article, I shared my take on the effectiveness of the Medifast management team.

And in that second article , I shared the following views:

In the short term, stock prices can fluctuate to no end, just like how MED's stock price has fallen by 64% since it peaked in May 2021. I have no crystal ball and I cannot tell you when will the stock price recover. What I can tell you is I have faith in the current management, and in the strength of the business even after factoring in the lower guidance. That is not blind faith but one that is earned through the turnaround efforts of the CEO and his team. Using Chuck Akre's investment philosophy to examine MED really helped me to appreciate the strength of its business from the perspective of its extraordinary business, talented management , and great reinvestment opportunities... Having said that, I will caution that MED is not a buy-and-forget SWAN stock... Weight-loss management services and meal replacements are a dime a dozen so there is no moat in this business. It is not the kind of "wonderful business that any idiot can run" that Warren Buffett likes.

So, is Medifast a buy, hold or sell?

I am currently a shareholder and after evaluating the business and the circumstances, I believe that it is still viable and there is no imminent danger of a dividend cut. Although it no longer fits my Dividend Growth Portfolio , it can belong to my Income Portfolio with the high yield making up for the lack in dividend growth. Therefore, I have my reasons to Hold my shares. To be clear so you do not misunderstand my call to Hold, I am still Buying on dips like with the recent purchase at $79.60 on 12 June, just to improve my cost basis as well as adding to my MED position to build up the income generated by MED.

However, it is no longer a STRONG BUY based on the change from my previous thesis that it was a Dividend Compounder as I believe that management will be moderating the dividend raises for the foreseeable few quarters until the investors can see clear signs of improvements. Unless you are an income investor, you should not consider MED.

For would-be investors of MED who still believe in the business, based on technicals, this may also be a Hold until the next support level, which could be around $79.76.

With the heavy short interest, I will not be surprised if the stock price keeps falling but so long as the business is sound and the dividends keep coming, I will hold my shares. I am not selling my shares as I believe the business model is still intact, and it still meets my other criteria as a profitable business in inflationary times, and the high dividend yield that is sustainable does not hurt at all.

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