How Low Can Herbalife Go?

Shares of Herbalife (NYSE: HLF  ) hit a 52-week low yesterday. Let's take a look at how it got there and whether cloudy skies are still in the forecast.

How it got here
Investors should take note to never attract the ire of sell-side investor David Einhorn. Despite a warning even from me that Herbalife's business model seemed overvalued, it was actually Einhorn's probing shortly after the company's first-quarter earnings report that has triggered a wave of short-selling and a mass exodus from the stock.

Herbalife's quarterly report was largely more of the same -- the stock beat by $0.07 and sales increased by 21% with the company raising its full-year EPS guidance in line with Wall Street's expectations. Where the wheels fell off the bus was when Einhorn questioned management regarding sales made outside of its network of nutrition partners. The company's response that it doesn't track non-network sales sent investors into an uproar, which has led to some pundits questioning the validity of Herbalife's operations.

Herbalife suffers from high distribution turnover rates. It's set up very similarly to most multilevel marketing companies in that sales representatives are hired and they in turn recruit their own representatives. Herbalife's business model has been found to be illegal in Belgium, according to a report by CNBC's Herb Greenberg. When Einhorn sounded the alarm regarding serious accounting question marks at Green Mountain Coffee Roasters and Lehman Brothers, the Street has no choice but to pay attention.

How it stacks up
Let's see how Herbalife stacks up next to its peers.

HLF Chart

HLF data by YCharts

Despite their recent struggles, nutrition-oriented companies have been solid performers over the past five years.

Company

Price / Book

Price / Cash Flow

Forward P/E

5-Year Revenue CAGR

Herbalife 9.0 11.0 10.9 12.9%
Vitamin Shoppe (NYSE: VSI  ) 4.4 20.3 23.2 12.0%
Nature's Sunshine Products (Nasdaq: NATR  ) 2.6 59.0 8.2 0.3%
Weight Watchers International (NYSE: WTW  ) N/M 11.0 10.8 8.1%

Source: Morningstar, Yahoo! Finance, author's calculations, N/M = not meaningful, CAGR = compound annual growth rate.

I've not minced words in recent weeks that I'm not a fan of the diet/health fitness sector because of the low customer loyalty that permeates the sector. These figures here serve as even more evidence of this.

Weight Watchers International missed Wall Street's earnings estimates in the first quarter as increased marketing expenses weighed down its profits. Nature's Sunshine Products' valuation appears a little more reasonable, but considering that its sales were flat year over year in its latest quarter, do you really want to pay 59 times cash flow? Vitamin Shoppe is perhaps the only truly healthy company in this grouping after it reported 9.6% same-store sales growth in its latest quarter. Herbalife has done what it can to stop the onslaught, including purchasing $427.9 million worth of its own stock, but who knows how reliable these metrics are when David Einhorn is involved.

What's next
Now for the real question: What's next for Herbalife? That question really depends on whether it can clear its name in light of Einhorn's questions and whether it can find a way to lower its distribution turnover.

Our very own CAPS community gives the company a two-star rating (out of five), with 75.1% of members expecting it to outperform. In true contrarian fashion, I am one of those in the minority that has made a CAPScall of underperform on Herbalife and I am up nearly 29 points since that call.

I can't exactly say I told you so because no one outside of Einhorn appears to have seen the problems that are arising now, but I did indeed tell you that high levels of turnover and low customer loyalty in the weight loss/nutrition sector make it a very poor investment. With Einhorn's followers swarming the stock and short-interest rising, I don't see very much to be excited about. Herbalife was an expensive stock prior to this plunge, and it's still not cheap enough for me to merit closing my CAPScall.

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Craving more input on Herbalife? Start by adding it to your free and personalized watchlist. It's a free service from The Motley Fool to keep you up to date on the stocks you care about most.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

Motley Fool newsletter services have recommended buying shares of, and creating a lurking gator position in, Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (16) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 10, 2012, at 3:00 PM, makinmoves wrote:

    You didn't even answer the question, "How low can Herbalife go?". Pretty pointless read.

  • Report this Comment On May 10, 2012, at 4:09 PM, alexalekhine wrote:

    This article demonstrates an almost complete lack of understanding of network marketing.

    Even regular companies have high turnover rates in their sales forces. And that's for companies that actually reject a high proportion of applicants and focus on hiring people with sales experience.

    What would you expect from a company that lets anybody be a salesperson? You would expect higher turnover in the sales force.

    But that doesn't even address what Einhorn asked about. The way HLF is set up, it is in EVERY customer's interest to sign up as a distributor/sales person. That's because it gets them discounts on their purchase price and, if they ever sign up anyone else, they capture a portion of the revenue from that person's sales.

    Here's the REAL question: Why do companies like Avon (going on 75 years) and HLF (over 30 years) continue to be able to grow and expand and attract sales people for decades and decades. The answer is that it's not because there is a shortage of people who will become distributors.

  • Report this Comment On May 10, 2012, at 4:11 PM, alexalekhine wrote:

    I forgot to mention: what exactly is expensive: Herbalife is likely to generate nearly $500 million in free cash flow this year. What multiple of free cash flow is appropriate for a company where free cash flow is growing at more than 20% per year?

  • Report this Comment On May 10, 2012, at 8:01 PM, TrackUltraLong wrote:

    makinmoves,

    I don't have a specific dollar target in mind, but the answer to your question is lower. As long as allegations remain of company wrongdoing (which have yet to be proven), I could see the stock dipping into the $30s.

    TMFUltraLong

  • Report this Comment On May 10, 2012, at 8:05 PM, TrackUltraLong wrote:

    alexalekhine,

    I appreciate the comments, but I have to disagree with one aspect: Since when is Avon growing? The last time I looked that company was struggling with turnover and declining sales volume which were only being boosted back to breakeven by raising prices.

    In fact, I just wrote about Avon here:

    http://www.fool.com/investing/general/2012/05/09/why-avon-pr...

    To also answer your cash flow question, my concerns are 1) can these figures be trusted, 2) will these figures stand the test of the Einhorn inquisition, and 3) even at 10.7 times cash flow, that's a good 20% higher than its historical average.

    Herbalife could easily fall further based on what I'm seeing.

    TMFUltraLong

  • Report this Comment On May 11, 2012, at 8:26 AM, ishouldBworking wrote:

    Maybe I am missing something but Herbalife couldn't produce these numbers from sign up fees alone, if they did that would mean that almost everyone of us is a member. So it has to come from product sales. Would distributors in any business continue stacking inventory that they can't use or sell? I haven't seen anything that says Herbalife allows its distributors to buy inventory on an in house line of credit, so they are paying for these products out of pocket, and coming back for more. I'm new at this so again maybe I'm just missing something.

  • Report this Comment On May 11, 2012, at 9:18 AM, getliquid69 wrote:

    Don't forget the CEO raiding the stock for 90 mil a year. It's a joke! More like HerbaScam, CEO walks away with 100s of millions, Distributors=Chump Change.

  • Report this Comment On May 11, 2012, at 9:26 AM, boisemon wrote:

    A couple of things. Herbalife doesn’t hire distributors, they are not employees. Also, did Einhorn ask these questions because he is concerned that stockholders could lose money? Or was it to benefit himself? Well since he opened his mouth, people lost money. So is he is benefiting from this? If he is so good at what he does, why didn’t he warn everybody about J.P. Morgan Chase?

  • Report this Comment On May 11, 2012, at 9:27 AM, ishouldBworking wrote:

    Still doesn't answer the question. Unless they are completely fudging the books every quarter (which could be true but till now unproven), then the cash coming in is real. You can't survive 30 years by selling a product that no one will buy twice.

  • Report this Comment On May 11, 2012, at 11:06 AM, yermammy wrote:

    Re: "no one outside of Einhorn appears to have seen the problems that are arising now". Um, exactly what "problems are arising now"? As far as I can tell there have been absolutely no new "problems" since Einhorn's conference call cameo.

  • Report this Comment On May 11, 2012, at 1:30 PM, cruisemercedez wrote:

    your low target of low 30 is just plainly sickly. did you notice the dividend is 30 cents this quarter, and likely to increase? that would put its dividend pay to 4% per year. and talking that its cash flow is "cant be trusted" is just plain stupid, its been generating positive cash for past many years, and paying increasing dividends on time year to year. I actually wonder if you are paid to write up something this silly.

  • Report this Comment On May 11, 2012, at 2:12 PM, ganeshsastri wrote:

    Einhorn should Chase JP Morgan. I have been a user of Herbalife Products. I have no complaints and in the country where I buy there is generally a queue to buy its products. Some relevant questions would be: How much returns are there from sales? How much bad debt is there? Based on past statements, HLF has been growing its revenues and net income and also paying dividend and buying shares. That's proof of the pudding.

  • Report this Comment On May 11, 2012, at 3:00 PM, getliquid69 wrote:

    If I were in the HLF CEO position I wouldn't be so blatant about raiding the stock for 90 mil a year boiseman, that's the kind of thing that is turning our country in to the 99% hatin on the 1% and gettin guys like Einhorn to raid these companies. I shorted HLF at $62 and held to $70 (painful) but I was able to see some of the things Einhorn saw and was patient and got paid off. Besides who needs 90mil a year to live? Time to bring these CEOs back down to earth.

  • Report this Comment On May 12, 2012, at 2:08 PM, boisemon wrote:

    I am not a 1% or a 99%, but maybe the 99% are upset because people like Mr. Einhorn can say what he wants so people can get “paid off”. Herbalife has been doing great even in hard times so they must be doing something wrong. He may be right or wrong and who wouldn’t believe him. Either way right or wrong the damage has been done. As for the turnover, have you ever notice that restaurants and fast food places are always hiring? It is not because they are growing, it is turnover, so if I were you I would stay away from them.

  • Report this Comment On May 12, 2012, at 4:47 PM, Macijauskas wrote:

    Let's clear something. David Einhorn is a famous short-seller, but he didn't say "I am short in Herbalife". My opinion is that because Herbalife is at about 5-8bil market cap company, just the presence of David Einhorn in the conference call was enough to drop the stock down. I use some Herbalife products, there are high quality nutrition products and as costumer, I would like to use these products for the rest of my life. Because the sales-type was mentioned, the person who gives me products is not a proffessional salesman, but this type of selling "person to person" is quite convinient. I bought HLF stocks last year at 65$ before 1/2 split (current price of 32.50$). Then again at

  • Report this Comment On May 12, 2012, at 4:53 PM, Macijauskas wrote:

    52.50$ and then again at 58,65,71$. I've made so much money from these stocks, I just lost some of my profits from the drop 70-->62. Now I rebought at 45$ and my opinion is that I am in front of a huge opportunity. Looking all the financial reports from this company, personally I can't find something wrong. I think there is a David Einhorn interview on Wednseday, when we'll be able to have the whole image. I just don't think that Einhorn would prove something, maybe he would just talk about network companies and nothing else. So I don't think this stock can reach 100$, but there is good possibility to reach again high of 70-80$.

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