Source: Nu Skin
Shares of personal care company Nu Skin Enterprises (NUS 2.48%) have fallen nearly 46% year-to-date as controversy surrounded the company's key market: China. An official investigation led to a softer punishment than investors expected and the first-quarter report in May was decent. All of this begs the question: Can Nu Skin return to strengthening fundamentals-or will competitor Herbalife's (HLF 4.41%) U.S. investigation cause problems for both companies?
Nu Skin is a multi-level marketing, or MLM, company that produces a wide range of beauty products and dietary supplements. The company has a checkered past with authorities and has paid out fines to the Federal Trade Commission for making unsubstantiated claims. Those claims also cost Nu Skin money in China where fees for both the claims and the sale of unregistered products added up to $540,000.
The bottom line of investors is: Has Nu Skin put the legal problems behind for organic growth-or should investors remain nervous?
Importance of China
China accounted for nearly 42% of the $671 million in first-quarter revenue registered by Nu Skin. The region showed year-over-year revenue growth of 63%, which seems fantastic until glancing at the 248% growth seen in the fourth-quarter report. What happened?
Nu Skin volunteered to essentially cease the training and launch of new sales representatives in the country as Chinese authorities investigated the MLM nature of the company. Growth of "sales leaders" accordingly slowed between quarters from 232% in the fourth to 41% in the first. But the investigation-ending fines-and warning to knock it off with the unproven claims-were a lighter punishment than investigators were expecting.
Take a look at how Nu Skin's total return price changed between January's announced voluntary shutdown and the fine announcement in late March:
NUS Total Return Price data by YCharts
The price crept back up until the first-quarter report, which wasn't bad with all things considered but still triggered a drop. If Nu Skin stays out of legal trouble, the financials should return to solid growth levels by the third- or fourth-quarter report.
Unfortunately the other white elephant in the room is Herbalife and whether or not Nu Skin can put its troubles behind it while its peer MLM organization is under investigation.
Source: Herbalife
FTC, Herbalife and Nu Skin
Activist Investor Bill Ackman had his wish come true in March when Herbalife announced the FTC's civil investigation into the company's MLM structure. Ackman has long argued that the nutritional supplement company operates as a pyramid scheme and is therefore an illegal operation. Results of the investigation likely won't come to light for some time but a different recent court decision had some investors-and the company itself- optimistic about Herbalife's chances.
If Herbalife does end up with hefty fines and/or some sort of operational penalty, Nu Skin shares would plummet regardless of whether the latter was actually a target of the investigation. The same already happened to Herbalife when Nu Skin came under investigation in China.
Take a look at Herbalife's total returns for the same period:
HLF Total Return Price data by YCharts
Herbalife dropped in January albeit not as steeply as Nu Skin and fell again in March when its own investigation came to light. Expect to see a similar correlation with Nu Skin shares if Herbalife receives any bad news from the FTC.
Do the legal issues decide which company would prove a better investment?
Nu Skin versus Herbalife
Call it a draw when it comes to legal issues for now, though this would change if Herbalife received an FTC penalty that dwarfs the Chinese punishment for Nu Skin. What should serve as the deciding factor for investors intent on a MLM holding?
Investors can compare the basic metrics of the companies. Nu Skin has a market cap around $4.4 billion with a forward P/E of 10.8 and a dividend yield of 1.73%. Herbalife has a $6.3 billion market cap, 8.5 forward P/E, and a 1.3% yield.
The case for Herbalife worsens with a deeper look. I've previously expressed nervousness about how Herbalife breaks out its regional segments according to a proprietary metric called volume points rather than straight up revenue. This reporting method makes for difficult analysis both when comparing to competitors and figuring out exactly what those volume point growths represent monetarily.
Foolish takeaway
Nu Skin shares may suffer for a few more quarters as China gets back to business and Herbalife faces down the FTC. The problem with MLM companies tends to be a total lack of economic moat-or some sort of business advantage over a health food store or beauty counter. Investors wanting in on a MLM company with solid metrics and room to grow would do better looking into Nu Skin over Herbalife.
