NHTC - Natural Health Trends Is An Expensive Option Bet At Best

2023-03-12 07:40:20 ET

Summary

• NHTC operates a direct marketing or MLM system around nutritional supplements. In China, where it generates most of its revenues, it can only operate a bulk-discount website.
• The company has two times been favoured by direct marketing manias in China. These manias were short-lived as the authorities cracked down on them.
• NHTC saved the profits from the previous demand peaks and has been returning them slowly to shareholders through dividends. Purchasing the stock based on those dividends generates a loss.
• However, the company can also be thought as an option, that returns little or zero in a bad case, but has the opportunity to earn a lot, if a new direct marketing mania occurs.
• I believe that option is expensive, because of hidden and opportunity costs. NHTC is not an opportunity.

Natural Health Trends ( NHTC ) is a worldwide commercializer of nutritional supplements.

The company operates through a system of direct marketing and volume e-commerce discounts that encourage reselling. Its operational history is marked by two important bouts of revenue fueled by Chinese demand that stopped suddenly after regulatory crackdowns.

NHTC's operations are decreasing consistently, and the company is entering negative operating income territory. The company sustains its price through regular dividends of $9 million that are financed by the cash reserves generated in the previous demand cycle (ended in 2018).

The dividend is absolutely unsustainable on an operational basis, and the investor purchasing NHTC is simply changing money between hands. The optionality provided by NHTC is more costly than it seems in terms of hidden and opportunity costs.

The stock is not an opportunity.

Note: Unless otherwise stated, all information has been obtained from NHTC's filings with the SEC .

Business description

Direct marketing of nutritional supplements: NHTC sells nutritional supplements purchased from contract manufacturers through a system of direct marketing and bulk discount e-commerce.

In some countries, where direct marketing and multilevel marketing are legal, the company operates the system through subsidiaries, registering resellers, running promotion campaigns and openly describing its business model.

On other countries (most importantly mainland China), where direct marketing is either illegal or tightly controlled, the company operates using an e-commerce site. The site offers discount on bulk purchase. The products can then be resold by the customers.

The China love story : Today, more than 75% of the company's sales come from China, a number that was close to 90% in previous revenue peaks.

In both occasions, Chinese demand fueled by the introduction of the internet, and then by the massification of e-commerce, spiked the company's sales. Both times, the level of the operation (which probably affected the finances of several people that were unable to resell the company's products) sparked regulatory crackdowns.

NHTC was not the only, or the biggest of the companies involved. In January 2019, the Chinese government initiated the 100-day campaign against healthcare-related direct resellers , that included the closure of a similar operating, much bigger company called QuanJian, a national TV 1 hour program denouncing NHTC's false claims and accusing the company of running a pyramid scheme . The company's CEO of its Chinese subsidiary at the time openly recognized its mistakes and apologized publicly .

Although the company's products can still be found in online stores like Taobao , and one can register to purchase products in the Chinese e-commerce website , the operations are deteriorating every day. Further, the public denouncements continue, for example from a county in Hubei warning that the company's promotions are similar to a pyramid scheme .

Going red : The company's cost structure is simple. It has enormous gross margins (above 75%), and pays approximately 40% of sales to commission salespeople in the countries where the model is legal. When China represents a bigger portion of demand, the commissions decrease, because in that country there are no resellers, only bulk-discount sales.

Although the company still sells $50 million as of FY22, the trend is diminishing, and its non-commission SG&A costs are high, around $16 million since 2020. The effect is that in the last quarters, the company has entered negative operating income territory.

Returning enormous cash reserves : During the Chinese demand spike, the company accumulated more than $100 million in cash, and has slowly returned that money to shareholders in the form of share repurchases first and a dividend now.

Of course, the dividend is unsustainable, but it can attract some investors because the company offers a 15% yield. With $70 million in cash reserves, the company can keep paying the dividend 7 and a half years, as long as revenues do not continue falling and operating income does not fall either.

Valuation

Changing hands : Purchasing the company on its cash reserves implies a financial loss. If the investor buys at these prices and waits to receive the dividends, he would be back at the beginning after 6 and a half years.

Even if the company paid the $70 million, at a current market cap of $65 million, it represents a 7.6% return after almost 8 years, or 0.9% a year. But still, it is unfeasible to return all of the money, because the company has liabilities on its balance sheet for $30 million, and it has 140 employees, to whom it probably will need to pay severance or some form of compensation.

The optionality : On the other hand, the company can be thought of as an option. If the business continues declining, the investor will probably not receive the equivalent of his investment, and would have lost the opportunity cost of using those funds in better investments.

But, maybe the company can reignite its operations after the issue is forgotten in China, just like it did some years ago after the 2007 crackdown. In that case, the company could very well make tremendous profits in a short amount of time.

This is not as impossible as it sounds, particularly for a direct marketing company. People get hurt, then they forget, then they enter the same system again, just like a market mania.

NHTC has been very active trying to clean its name, participating in all sort of charitable activities in China . In fact, and although it sounds crazy, NHTC received the price to Corporate Responsibility in the 2019 Beijing Finances and Economic Summit , the same year in which it was accused of running a pyramid scheme.

Although the possibility is real, in my opinion the cost of the NHTC option is too high. First, the investor has to freeze funds in NHTC stock that is not generating profits, only returning cash, while several risk free investments return more than 4% a year. On the other hand, the investor exposes to the risk of the company deciding not to return the money, because it plans to embark in new business ventures, or because unbooked liabilities (like the severance to its employees) come out.

Moral concerns : Some investor might argue that making money in a company that generates earnings through MLM or direct marketing is morally incorrect.

Conclusions

Today, NHTC is a company clearly trending down in terms of revenues and profitability. In the meantime, the company returns its cash reserves.

This exercise of slowly paying dividends generates no real returns for the investor. However, some investors might consider the optionality that the company can return to previous profitability levels if a mania for purchasing its products occurs again somewhere, but particularly in China.

I believe the possibility exists, but the cost paid for that option is expensive, in terms of cost of opportunity, and risk of unforeseen events and costs.

For that reason, I prefer to avoid NHTC.

For further details see: