Dieting is big business in many developed economies, and more so in the U.S. where 70% of adults are considered overweight and close to 35% are obese. The weight management industry in the U.S. is a $60 billion-per-year business. It's little wonder that many companies, such as Weight Watchers International (NYSE:WTW) and NutriSystems (NASDAQ:NTRI), have sprung up to exploit this huge opportunity.
Not all diet companies are created equal, and many diet fads have come and gone. Weight Watchers, however, stands out as one of the few that have stood the test of time. The company has been around since 1963. It employs a unique approach to weight loss that involves using support groups that encourage people to change their eating behavior and a system that awards points to different foods based on the nutrients they contain. The company's method differs from those employed by rivals, which primarily sell specialized foods and meal replacements.
About half of the company's revenue comes from membership fees from its meeting business. Each week, more than a million members attend 40,000 meetings both in the U.S. and abroad. Weight Watchers also sells a raft of diet products such as nutrition bars, snacks, and cookbooks at its numerous meetings. These account for 20% of its sales, while the rest come from its website weightwatchers.com and its 1.9 million subscribed members.
Despite its impressive track record, Weight Watchers' shares have come under fire lately, after tanking 50% over the last 12 months mainly on concerns about the company's declining revenue. The company reported first-quarter fiscal 2014 revenue of $409.4 million, which was better than the consensus estimate of $399.2 million but close to 17% lower than its revenue for the first quarter of fiscal 2012. EPS came in at $0.38, which was way better than the consensus estimate of $0.09 but a worrying 56% drop compared to the EPS for last year's comparable quarter.
Loss of subscribers
The company's management attributed the heavy top- and bottom-line declines to a drop in the number of subscribers. The company finished the quarter with 3.6 million subscribers, 14% lower than the 4.2 million it recorded a year earlier. The drop in EPS resulted from escalating costs, with the company's cost of goods sold as a percentage of sales rising from 42.2% in the year-ago quarter to 45.6%. Operational costs, including sales and marketing as well as general and administrative expenses, shot up from 36.8% of sales to 42%.
Weight Watchers seems to be suffering from a lack of innovation in its core meeting business, coupled with cut-throat competition from free calorie-counting mobile apps and activity monitors. Free diet apps are primarily to blame for the company's declining enrollment.
Change is happening
However, change is afoot. Weight Watchers' new CEO James Chambers initiated a revival plan that targets $2 billion in annual revenue by 2018, about 33% more than the $1.5 billion expected for the current fiscal year. His blueprint calls for stepping up investments in the company's core business, driving new innovation, and growing by offering more services to corporate customers and their employees.
Weight Watchers is counting on the corporate market to ramp up its flagging revenue. The company plans to quadruple its corporate sales from $75 million currently to $300 million by 2018. Excess weight is responsible for 10% of healthcare costs, and the company hopes to convince employers that it can save them substantial amounts of money on healthcare costs by enrolling overweight employees in its programs. The company is also after male members, since over 90% of its members are currently women in their 40's and 50's.
Meanwhile, the company's dividend suspension is in the best interest of shareholders, and will help the company use its $200 million free cash flow to pare back its heavily leveraged balance sheet. Weight Watchers has $2.35 billion in net debt, much of which resulted from an ill-timed tender offer the company made for its own stock in 2012, when the shares traded at $80. The company hopes to trim its debt level from its current four times EBITDA, or earnings before interest, tax, depreciation, and amortization.
This is not the first time that Weight Watchers has faced serious disruption in its business. The company saw a considerable revenue decline in 2004 occasioned by the Atkins Diet. However, the company has its strong brand working in its favor, which is a huge plus in an industry riddled with fads and false claims. Although the company has itself to blame for missing out on the mobile revolution, its clinically proven weight management program is highly unlikely to become commoditized, and will make it easier for members who have jumped ship to come back after experimenting [unsuccessfully] with fads.
Weight Watchers is quickly ramping up its traditional line of programs, and recently released a new offering targeted at employers with employees who have Type 2 diabetes. The company plans to acquire Wello, a fitness start-up that connects consumers with personal trainers and fitness consultations through online video chats, and this offers an intriguing way for the company to integrate aspects of in-person and online meetings.
The company also plans to open up a platform that will integrate with leading activity monitors and other API-focused wearable technologies on the market to capitalize on current industry trends.
Morningstar estimates that the company will take about two years before the company can effect a full turnaround and return to its 2012 EPS of around $4.
Is NutriSystems a better buy?
NutriSystems is actually faring a lot worse than its larger peer. The company has seen its revenues decline since 2009, with its top line falling 32% from $524.6 million to $358.1 million over the 2009-2013 period. Its net income has fallen a jaw-dropping 74% over a similar time-frame, from $28.8 million to just $7.4 million. The company is recording fewer new customer starts, while its on-program price cuts, designed to retain customers, are taking a big hit on its bottom line.
Foolish bottom line
Weight Watchers is undertaking a drastic business model restructuring to help it keep up with industry trends and reach a wider demographic. The company's powerful brand and time-tested methods are likely to appeal to more customers over the long run in the fickle and fad-driven weight-loss business.
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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Morningstar. The Motley Fool owns shares of Weight Watchers International. 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.