Why are direct sales companies so unloved?

That's the question I'm asking myself after studying Nu Skin Enterprises (NYSE:NUS), which by all appearances is a terrific, cash-generating business. Like last Thursday'sTupperware (NYSE:TUP), Nu Skin is a direct sales company with a low P/E, a solid dividend yield, and no love from analysts (average rating: hold).

We're in part four of our series on consumer non-cyclicals, a.k.a. boring companies that are likely to fare alright even in a slow economy. Nu Skin qualifies with its business of selling beauty-related products and nutritional supplements. After all, even when times are tough, people want to look good and stay healthy. Also, as a direct seller, Nu Skin stands to benefit from general unemployment (we're at 6.4% and rising) as people look to alternative job opportunities such as direct sales.

That's the context for my interest in Nu Skin; now for some company background. Provo, Utah-based Nu Skin has been around since 1984 and profitable every year since 1996 (as far back as I ran the numbers).

Sales over the trailing twelve months amounted to $967.6 million, with more than half of that coming from Japan alone, and the remainder from countries throughout Asia, North America, and Europe. Like Tupperware, this is a truly international company, with 86% of sales generated outside the U.S. (note that if the dollar continues to fall in value, Nu Skin will be a beneficiary.)

Three fundamental positives jump out at me:

1. Expanding sales, free cash flow, and number of distributors
The health of Nu Skin's business starts with maintaining and growing its sales force of independent distributors. These are the people hawking the company's products and encouraging friends and relatives to also become distributors. As of year-end 2002, "active" distributors -- that is, those who have purchased within the past three months -- stood at 566,000, up from 558,000 in 2001 and 497,000 in 2000.

With this type of solid growth in the number of distributors, expanding sales and free cash flow is almost a foregone conclusion. Sales in 2002 were $964 million, up from $886 million in 2001 and $880 million in 2000. Similarly, free cash flow reached $84.6 million in 2002, up nicely from $59.3 million in 2001 and $20.4 million in 2000.

2. Cash-efficient business model
Along with being consistently profitable, Nu Skin has generated positive free cash flow each of the past seven years. This is a reflection of the direct sales model's superb capital efficiency.

The model starts with 80% gross margins. From there, most of the company's operating expenses are variable based on commissions earned by distributors. If distributors don't sell, they don't get paid -- it's just that simple. Finally, the company outsources its manufacturing so very little capital expenditures are necessary, besides typical computer and office equipment. Add it all up, and it's a formula for consistently positive free cash flow.

3. Committed to rewarding shareholders
Of course, the value of free cash flow is really a function of what management does with it. Shareholders don't get much benefit from free cash flow if it just piles up on the balance sheet. But in Nu Skin's case, almost half of the cumulative free cash flow generated over the past three years has been put to good use in funding dividends and share buybacks.

Between 2000 and 2002, Nu Skin repurchased and retired about 6.7% of outstanding shares. Nor did the company negate this effort by issuing a boatload of stock options. Average option dilution has been a low 0.9% over the past three years.

In addition, beginning in 2001, Nu Skin initiated a quarterly dividend of $0.05 per share. Since then, the company has twice increased the dividend -- to $0.06 in 2002 and then to $0.07 in early 2003. At a current share price of $10.55, that amounts to a yield of 2.65%. Today, with more cash than debt, Nu Skin appears to be in good position to continue this balanced effort of share repurchases and increasing dividends.

And so finally I return to my original question of why a company like Nu Skin would be so unloved as to warrant a P/E of 13.4 and a price-to-free cash flow of 11.7? I've searched, and I can't find a good answer -- which leaves me only one conclusion: The company is under-appreciated, and the stock is undervalued.

On Thursday, I'll be back with another contender from the consumer non-cyclical sector.

Do you like the notion of finding under-appreciated stocks before the herd catches on? Then you'd like Tom Gardner's Motley Fool Hidden Gems , where you'll find Matt Richey as next month's guest analyst.

Matt Richey (MattR@fool.com) is a senior analyst for The Motley Fool. At the time of publication, he had no position in any of the companies mentioned in this article. The Motley Fool is investors writing for investors.