3 Key Takeaways From Herbalife's Mixed Week

Herbalife shares rose on a positive fourth-quarter report as a new crackdown in China threatens the company's leading growth market.

Feb 23, 2014 at 8:00AM

Herbalife (NYSE:HLF) shares were up 4% aftermarket last Tuesday following the fourth-quarter and full-year earnings report. The company reported a double-digit sales growth in a climate where service-oriented Weight Watchers (NYSE:WTW) reported a double-digit sales drop. But the week's news wasn't all good for Herbalife after its competitor Nu Skin Enterprises (NYSE:NUS) brought more scrutiny to direct sales company operating in China-Herbalife's largest growth market. Did the fourth quarter set the stage for a solid 2014, or will the pyramid scheme accusations catch up with the company?  

Herbalife Shake Mix

Source: Herbalife.

Herbalife reported a 20% year-over-year revenue growth to $1.27 billion with $1.28 adjusted EPS, which came in slightly under the analyst revenue estimate of $1.3 billion but met on EPS. The company also used the release to raise the first-quarter forecast from $1.24-$1.28 to $1.25-$1.29.

But the details of the quarter were a bit harder to parse. Not to mention, the potential crackdown in China could cast a dark cloud over Herbalife's year. What were the key takeaways from the fourth-quarter report?  

Overseas growths 
Herbalife has a peculiar way of reporting its regional segments. Instead of using a traditional and handy metric such as revenue, Herbalife users volume points. 

What's a volume point? Herbalife offered this lengthy but important definition in its latest 10-K: 

A key non-financial measure we focus on is Volume Points on a Royalty Basis, or Volume Points, which is essentially our weighted average measure of product sales volume. Volume Points, which are unaffected by exchange rates or price changes, are used by management as a proxy for sales trends because in general, an increase in Volume Points in a particular geographic region or country indicates an increase in our local currency net sales while a decrease in Volume Points in a particular geographic region or country indicates a decrease in our local currency net sales.

We assign a Volume Point value to a product when it is first introduced into a market and the value is unaffected by subsequent exchange rate and price changes. The specific number of Volume Points assigned to a product, and generally consistent across all markets, is based on a Volume Point to suggested retail price ratio for similar products... 

So the numbers given in the earnings release for the geographic regions are proprietary measurements that aren't equal to specific financial sales figures. And that makes it tricky to know exactly what those numbers are supposed to mean in terms of revenue.

In terms of volume points, the strongest segments in the fourth quarter were China with year-over-year growth of 103%, and Central and South America, with 25% growth. Asia Pacific was the only region down in volume points, with a 4% drop. Domestically, volume points increased 7%.  

China accounted for only about 7% of total volume points. But the growth potential of that segment caused investors to get nervous earlier this year when Chinese authorities began investigating an Herbalife competitor. And it's not the only controversy that's still swirling around the company. 

Controversy pileup
Bloomberg reported Tuesday sources stating the China's State Administration for Industry & Commerce drafting new rules that would crack down on on how direct-sales companies operate in the country. The rules come in the wake of an investigation into Nu Skin, an American company selling personal products and nutritional supplements. An official Communist Party newspaper had accused Nu Skin of operating as a pyramid scheme, and the State Council advocated for severe restrictions on businesses operating under similar model. And Herbalife operates under a similar model.

The China issue came up during the fourth-quarter conference call, and Herbalife CEO John DeSimone said, "I think, we're comfortable that we're in compliance with today's regulations and we're also comfortable that if the regulations mature, that we can be in compliance with wherever they go..."

Herbalife also remains at the center of pyramid scheme accusations from hedge fund manager Bill Ackman. The Pershing Square Capital Management CEO took a notorious short position in Herbalife with the belief that shares would drop to zero.Ackman's bet has dropped 49% in the interim. And other big name investors -- including Carl Icahn and George Soros -- have invested in Herbalife with belief in its growth potential. 

So, there's still a lot of controversy surrounding the company. However, China's more of an immediate threat than Bill Ackman. 

Foolish final thoughts 
Herbalife remains one of the more polarizing stocks around. Setting aside the question of whether or not the company's a pyramid scheme, the volume point method of segment reporting is annoying at best. And the Chinese crackdown still has the potential to put the squeeze in one of Herbalife's fastest-growing regions. But the company has the benefit of having products to sell, which should keep it ahead of the failing service model of Weight Watchers.   

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Brandy Betz has no position in any stocks mentioned. The Motley Fool owns shares of Weight Watchers International and has the following options: long January 2015 $50 calls on Herbalife Ltd.. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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