2023-10-03 03:13:09 ET
Summary
- Herbalife is struggling to reaccelerate growth amid a weak operating environment.
- Despite management efforts to support profitability, sales volumes are down globally, highlighting the underlying operating weakness.
- We expect shares to remain under pressure, with the setup consistent with a textbook "value trap" in the stock.
Herbalife Inc ( HLF ) remains one of the world's largest multi-level marketing ((MLM)) businesses through an extensive portfolio of wellness products and nutritional supplements. That being said, there is a sense that the company's best days are behind it, struggling to maintain the operating momentum that defined its last decade up to the short-lived pandemic-era boom.
Indeed, the stock is down more than 40% from its 52-week high and now trading near a decade-low. Recent results show a continued decline in sales with earnings further hit by ongoing cost pressures. While recurring profitability and a depressed valuation appear compelling, our take is that the setup in HLF reflects a "value trap" where shares have room to correct further.
In our view, Herbalife's main headwind is poor brand momentum. The company will be challenged to bring back lost distributors that have already tried selling the platform while the novelty of the product catalog wearing off makes it a harder buy for consumers. Ultimately, we're skeptical of any turnaround and expect shares to remain volatile with more downside.
HLF Financials Recap
HLF last reported its Q2 earnings in early August with EPS of $0.74, which came in at $0.05 ahead of estimates, but also down -23% from $0.96 in the period last year. Total net sales of $1.4 billion, declined by -5.7% year-over-year, or -4.2% on a constant current basis.
Adjusted EBITDA at $170 million this quarter is down -13% y/y with the margin of 12.9% contracting from 14.0% in the period last year. Even as average pricing has increased by 3.6%, higher input costs as well as the impact of a stronger Dollar have pressured profitability.
Favorably, revenues here have improved sequentially over the last two quarters but compare to a peak near $1.6 billion in Q2 2021. From a top level, the takeaway here is that the pace of deterioration has at least moderated. For context, HLF was doing about $1.3 billion in quarterly sales back in 2014, so it's been nearly 10 years with flat growth.
That being said, what stands out to us are the declines in sales by region and in terms of volumes, down by -12.6% y/y globally. North America has been particularly weak, with sales down by -11.5% y/y and -21.1% in terms of volumes sold. Asia Pacific also posted a decline in Q2. This is concerning as it includes China, long seen as a growth driver, where management noted country net sales were down by 10%.
Herbalife ended the quarter with $527 million in cash, against $2.8 billion in total debt with a gross leverage ratio of 3.7x. While liquidity conditions are likely stable over the near term, we view the balance sheet as a weakness in the company's broader investment profile.
What's Next For HLF
A major theme during the Herbalife earnings conference call was attempting to project confidence that the company is making progress in its "Transformation Program" that was launched back in 2021. The effort here is to streamline the global operation and cut costs, targeting $90 million in savings, including up to $45 million this year. The latest update is that those goals are ahead of schedule, which helps explain the EPS beat in Q2.
In terms of growth, the company is betting on a return to more "in-person" type of events, which it believes is the best way to showcase the wellness lifestyle. There are also investments being made to enhance the company's digital presence with improved analytics for distributors. On the product side, Herbalife is launching a vegan line and also introducing new ready-to-go drinks.
Overall, all that sounds great, but it doesn't change the fact that the company has lost customers in recent years, and the latest trends suggest people still buying Herbalife products are consuming less. Similarly, the "Sales leaders", which is the internal metric for independent distributors, have trended lower over the past two years.
This is a problem when thinking about the MLM business model that relies on enthusiastic sellers to keep marketing and ultimately drive demand. Once people have tested the selling system and dropped out for whatever reason, it's hard to see many coming back into the ecosystem.
Here we can visualize the declining interest of Herbalife with internet search trends worldwide falling off steadily since a peak in 2020. While its wellness products may have been seen as innovative five or ten years ago, the trend of healthy foods is well into the mainstream at this point. Competition from established players and emerging brands adds to the headwinds.
The argument we make is that it will be very difficult for HLF to re-accelerate growth, to a level that would be needed to mark a real renaissance in the outlook.
According to consensus, a forecast for revenue of $5 billion this year representing a decline of -4% from 2022 is only expected to marginally rebound by 3% into 2024.
On the earnings side, a forecast for EPS to decline by -26% this year to $2.53 is seen as rebounding to $3.44 for 2024. While this profitability improvement is objectively good, the key here is to recognize that much of that is based on "financial engineering" through cost-cutting efforts more than an organic improvement of underlying operating conditions.
The success of any MLM is based on the perception of success, which is important to keep both sellers and end customers engaged. That aspect is missing here in our opinion.
The reason we view HLF as a value trap is that its combination of declining sales, large balance sheet debt position, and an otherwise poor long-term outlook keeps risks tilted to the downside.
Shares trading at a forward P/E of 5.5x or even 4.0x into the 2024 consensus EPS may appear "cheap", but we'd say that this depressed valuation is justified considering the circumstances.
HLF Stock Price Forecast
We lean bearish on HLF, but also recognize that shares are already down nearly 30% from a high above $19.00 in early August following the Q2 earnings report. By this measure, it's likely that many of the negatives have already been incorporated into the stock price, limiting the downside over the near term. Officially, we'll rate shares as a hold but simply recommend investors avoid this name.
The bearish case here is that a couple of quarters of disappointing sales would force the company to either cut prices or invest in promotional marketing, thereby pressuring margins. This would lead to lower earnings estimates as a catalyst for the stock to break down. Weaker macro conditions with a global economic slowdown would also impact demand.
Beyond some short-term technical bounce, the bullish case for HLF would need to start with a path for top-line growth to significantly outperform expectations, which we don't see happening. Monitoring points through 2024 include the trends in EBITDA, as well as the number of active preferred customers as a measure of underlying brand strength.
For further details see:
Herbalife: The Problem Is Poor Brand Momentum