Shares of GNC (NYSE:GNC) largely bounced back after getting gutted the other day, but the shadow of a federal probe into dietary-supplement companies deepens the pall that's been hanging heavy over the stock. While the vitamin retailer itself isn't part of this investigation, its products have been scrutinized by state authorities this year and Oregon sued it last month for selling supplements allegedly made with illegal substances.
Even though one of the companies the Justice Department charged with fraud represents only a negligible amount of GNC's sales, half of its revenues do come from third-party supplement makers, which could be jeopardized if the investigation expands.
All pain, no gain
On Tuesday, the Justice Department said top-selling workout supplement maker USPlabs fraudulently sold to retailers its Jack3d and OxyElite Pro supplements, falsely claiming they were from plant extracts when in reality they contained a synthetic stimulant from China. The indictment handed down against USPlabs said it had generated $400 million in sales between 2008 and 2013. SK Laboratories, which makes supplements for USPlabs, was also charged.
The vitamin retail sector was hit hard by the news. GNC initially plunged 23% on the announcement a press conference was going to be held detailing the indictments, but recovered when it wasn't part of the probe and closed out the day down 6%. Vitamin Shoppe (NYSE:VSI), Herbalife, and NuSkin Enterprises all closed lower as well.
Investors in GNC, Vitamin Shoppe, and other supplement retailers have a right to be worried however. The forces arrayed against them have been mounting and it now seems they're being deployed.
A growing litany of complaints
Congress first called TV medical personality Dr. Oz to account for his endorsement of weight-loss supplements, which was followed by New York State Attorney General Eric Schneiderman sending cease-and-desist letters to GNC, Target, Wal-Mart, and Walgreens for selling store supplements that didn't have the active ingredients in them listed on the labels. While GNC refuted the AG's allegations, saying all its supplements were tested according to FDA guidelines, it has been subject to lawsuits by consumers over misrepresentation, and Vitamin Shoppe was also hit by a false advertising lawsuit (which was subsequently dismissed).
But GNC should have been aware that trouble was brewing. USPlabs has been under investigation for some time, going all the way back to 2013 when an outbreak of hepatitis on Hawaii was traced to the supplement maker's OxyElite Pro. The FDA itself has been keeping tabs on the company since at least 2010, when complaints of adverse reactions to its supplements suffered by teens began surfacing.
A healthy start
Vitamin Shoppe may be better situated. While its stock has lost more than 40% of its value this year, it got a new CEO this year who has experience at both Weight Watchers and Walgreens, and it acquired vitamin manufacturer FDC Vitamins. While that integration has not gone smoothly so far, it plans on moving as much as 40% of its private label products to it, which will not only ameliorate some of the concerns consumers may hold about these third-party manufacturers, but should enhance its profitability as well.
Investors, though, have no need to bulk up on the supplement retailers now, even though their stocks are lower. The worry that's spread across the sector is well founded as the Justice Department filed civil cases against five additional companies and the Federal Trade Commission filed lawsuits against three separate supplement makers.There's no telling where these cases will lead next or what lawsuits they'll spawn.
GNC, Vitamin Shoppe, and the other retailers may very well come out of this better than they were as consumers seek out brand names to purchase from, but there's no need to rush in as there is still a lot of dust to settle.
Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.