NVO - Medifast: Take Advantage Of Pessimism Over Weight Loss Drugs

2023-08-04 00:24:10 ET

Summary

• Medifast has seen a significant decline in its stock price and market cap in the past 2 years, reflecting investors' pessimism towards the company.
• The stock's underperformance may be attributed to inflationary pressures and concerns over new weight loss drugs from pharmaceutical giants Novo Nordisk and Eli Lilly.
• Concerns over weight loss drugs are overblown and the drugs could in fact be complementary to MED's offering.
• With a stable dividend yielding an impressive 6.5%, the stock is also attractively valued, limiting downside risk.

Medifast, Inc ( MED ), a leading health and wellness company specializing in weight loss, weight management and healthy living, has in the past two years fallen out of favor with investors. After the stock reached an all-time-high of $330 per share in May 2021, it has fallen precipitously to the current $100, having recently sunk to lows of $79 in June. As a result, MED’s market cap has shrunk from its peak of $3.8 billion to just over $1 billion, underscoring investors’ pessimistic sentiments toward the stock.

To understand the factors behind MED’s recent underperformance, it's necessary to look at the company’s product offering and business model in the context of the prevailing industry trends and the broader economy.

A successful multi-level marketing business model

MED produces meal replacement plans that help customers lose or maintain their desired weight. While MED sells these products directly to its customers, the business model is based on the recruitment and training of coaches who serve as the company’s sales representatives. The coaches identify potential customers, onboard them, and help them change their lifestyles and behaviors, including integrating MED’s products into their diet and nutrition. In exchange, they earn a commission for this work. The concept is dubbed Optavia. According to the company, there were over 58,000 Optavia coaches in Q1 2023 who had cumulatively helped more than 2 million customers in their weight loss journey.

Optavia is essentially a multi level marketing ( MLM ) business. However, it differs fundamentally from most MLM firms because, even though its coaches are sales representatives who target potential customers, they do not serve as distributors of its products. Optavia coaches do not hold inventory or manage cash. MED independently handles all aspects of the distribution, billings and payments process. This means coaches can focus exclusively on building a strong community where proper use of Optavia products and the corresponding positive results – not aggressive recruitment – are the targeted outcomes. Likewise, MED does not focus on recruiting new coaches merely for the sake of unloading inventory and booking sales, but instead aims to onboard partners who understand the products and are likely to succeed in helping customers get the desired results.

MED’s model has so far been successful as far as customer acquisition and growth of the Optavia network is concerned, with the company reporting that more than 90% of coaches were initially customers. Tellingly, the number of coaches has increased more than fourfold from 13,000 in 2017 to over 58,000 as at Q1. The explosive growth in the number of coaches has enabled MED to reach more customers and supercharge its commercial performance, as the snapshot below of revenues and net income (in USD) since 2017 illustrates.

The big question is: why has MED’s stock underperformed the broader market in recent years, even after the company posted such stellar commercial results?

The plausible reason likely boils down to the health of the broader economy and investors’ concerns over new disruptive weight loss drugs introduced by pharmaceutical stalwarts Eli Lilly and Company ( LLY ) and Novo Nordisk ( NVO ) that could potentially affect MED’s future growth prospects.

Inflationary pressures and concerns over GLP-1 drugs weigh down stock

Surging inflation in 2021 and 2022 had an adverse impact on MED. Despite its revenues growing by almost $70 million between 2021 and 2022, net income declined by as much as $20 million as inflationary pressures led to an increase in costs and erosion of margins. Moreover, with groceries, transportation, housing and other basic necessities costing more, some households have had to cut back on what they view as discretionary spending, including weight loss programs. The effect is that MED’s sales growth has slowed, with analysts’ expecting 2023 revenue of $1.16 billion vs $1.59 billion in 2022. Tellingly, the number of Optavia coaches declined by 5,200 year on year in Q1 2023 . Revenue decreased 16.4% to $349.0 million from $417.6 million for the first quarter of 2022. In my opinion, MED’s weak stock performance in recent years is partly a result of this slower growth amid a challenging macroeconomic backdrop.

Another reason investors have been bearish on MED in my opinion is the rapidly growing popularity of GLP-1 drugs for the treatment of obesity. These drugs are originally intended to treat type-2 diabetes by imitating the action of a hormone called glucagon-like peptide 1 (GLP-1) to stimulate insulin production and lower blood sugar levels in type 2 diabetes patients. NVO’s flagship diabetes drug in the GLP-1 class, Ozempic, has skyrocketed in use since 2018 due to its reported benefits in weight loss. NVO capitalized on this opportunity to develop Wegovy, a higher dose version of the same medication. Wegovy was approved for weight loss in adults in 2021 and for weight loss in children aged 12 and older in 2022.

Similarly, LLY’s GLP-1 drug for Type 2 diabetes Mounjaro has also been reported to be effective in weight loss and the company is working on a formulation specifically for weight loss. It is widely expected that LLY’s GLP-1 drug will gain FDA approval for use in obesity treatment by the end of the year. The market opportunity for the GLP-1 drug class in weight loss is immense. Both NVO and LLY have recorded explosive double digit growth in recent quarters in this category. Patients in the U.S are expected to dish out $10B on obesity medicines in 2027, marking an $8.1B rise or over 378% growth for the period 2023 – 2027, a recent industry report on pharma spending from the drug analytics firm IQVIA Holdings ( IQV ) indicates.

GLP-1 threat is misunderstood and economic headwinds are easing

While it's reasonable for investors to be concerned about the potential impact of the GLP-1 drug class on the growth prospects of companies like MED, I believe the threat is misunderstood. To begin with, it's critical to note that these weight loss drugs are significantly expensive and insurance coverage is still an issue for many patients, particularly in cases where the drugs are indicated for type 2 diabetes but are instead used for weight loss. These drugs also require a doctor’s prescription. In contrast, MED’s meal replacement plans are notably cheaper and do not require a doctor's prescription to buy. Optavia prices range from $395 to $442 per month. A month of treatment with LLY's Mounjaro costs around $975, whereas a month of treatment with NVO's Wegovy costs around $1,400.

In my view, rather than gnaw into the market share of MED, GLP-1 drugs will likely complement the Optavia offering by giving customers access to drug therapy. MED, after all, is about community as well as lifestyle and behavioral change while LLY and NVO are offering drug therapy. These two are vastly different treatment paths. I therefore do not view the emergence of the GLP-1 drug as a real threat to MED.

The decline in the stock could therefore be an opportunity to buy the stock cheaply as the market warms up to the fact that MED has its own unique selling points that are not under threat from LLY and NVO. The fact that inflation is coming down and interest rate hikes are ending soon is also a positive sign as the next economic expansion cycle is now closer, marking a possible reversal in fortunes for MED.

Conclusion - take advantage of low valuation, pessimism

MED is set to announce Q2 earnings next week on Monday. Investors are expecting the year on year slowdown to continue, with the company having guided for revenues of $250 - $270 million vs $453.33 million in FQ2 2022. Investors can take advantage of the pessimism and historically low valuation to build a position, considering MED’s P/E ( FWD ) of 12.74 is 30% lower than the 5 year average of 18.10. Its EV/EBITDA ( FWD ) is 7.20 vs a 5 year average of 11.86. The reason I believe the company is undervalued is that 5 years ago it was a third of its current size in terms of turnover yet it has gotten cheaper over this period due to the prevailing bearish sentiment.

This is likely an overreaction to the slowdown in growth and the emergence of the GLP-1 drug class. To sweeten the pot, MED has grown its dividend in recent years, with the current payout yielding an impressive 6.5%. It also has a stable balance sheet with no long-term debt. The risk/reward profile at current levels looks attractive and investors can take advantage of the low valuation and pessimism to capture enhanced returns in future while earning attractive dividends today.

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