Correct me if I'm wrong, but by all accounts the following statistics would make any consumer goods investor drool.
- Since 2010, this company has increased revenue by 18% per year!
- Over the same time frame, earnings per share have jumped 26% per year!
- Currently, this stock trades for just six times earnings, and eight times free cash flow.
While these figures all seem enticing, investors who have been around awhile know that when something seems to be too good to be true, it usually is.
Such is the case with health and nutrition products company Herbalife (NYSE:HLF), which I believe investors should ditch heading into 2015. Found out why below.
Ever since activist investor Bill Ackman disclosed that he had taken an enormous short position in Herbalife, the company's stock has been one of the most polarizing on Wall Street.
Before getting into what makes Herbalife so unappealing, let's get a few things straight. First, I'm not suggesting you ditch the stock because the product doesn't work. I've read in various sources that Herbalife products, when combined with other healthy lifestyle choices, can make a significant difference for customers. I'm also not claiming that there aren't thousands -- if not millions -- of people out there who consume Herbalife's products.
So what's the problem?
Pyramid scheme or not, the company's in for some tough times
By definition, a pyramid scheme is any enterprise that focuses more on the recruitment of new members than the selling of any product. In the case of Herbalife, Ackman has shown that the company's results are based on focusing on poor and minority populations -- promising riches in return for becoming sales associates.
In essence, Ackman's point is that rising revenues are because newer sales associates are buying more of the product in order to get in the game. That's very different from sales rising to do increased demand from end users.
Eventually, he believes, the pyramid will tumble.
In the end, I don't think it matters if any regulatory agency declares Herbalife a pyramid scheme. The important thing is that the Federal Trade Commission, FBI, and Department of Justice are all looking into the claims.
Based on the evidence that Ackman has provided, as well as a damning video that recently surfaced from a meeting including Herbalife executives in 2005, the company will need to fundamentally change its structure to avoid being shut down.
Some of those changes have already taken hold. It is now more difficult to become a sales leader within the organization. For an organization that already has a very high churn rate, such a move could discourage even more potential sales associates from staying with Herbalife. Further, there are now caps on how much product new customers are allowed to buy. I'm guessing these are only the first in what will be a series of changes to the company's structure.
Already, cracks emerging
Consider Herbalife's growth rates, by geographic region, between 2010 and 2013. Then compare them to the growth rates over the most recent quarter (the orange bars), after all three organizations had officially announced the beginning of their investigations.
With the exception of China and the Europe, Middle East, and Africa region, growth has come to a screeching halt. Taken together, those two segments also account for just one-quarter of all company revenue.
No matter the outcome of the government investigations, Herbalife cannot remain he company it once was, and I wouldn't touch shares with a 10-foot pole right now.