Sunday, January 17, 2010

Slim Pickings - Buy WTW

As the market has marched higher, the number of good stock ideas crossing my desk has naturally fallen. Compounding the problem, many of my favorite holdings are hitting their price targets and being shown the door.

NutriSystem (NTRI) is one example. I bought the company in May 2009 at $15 a share. With 30 million shares outstanding, its market cap hovered around $450 million. Not bad considering the balance sheet sported $70+ million in cash and zero debt. And free cash flow in recent years has easily topped $60 million a year. As demand fell due to the Great Recession, cash flow remained high at NTRI, owing to a flexible business model that uses very little capital. This allowed the company to maintain a 70 cent a year dividend, which translated into a very attractive (and well-covered) yield.

Being ahead of my time has never been a problem, but I was clearly an early adopter with NutriSystem. Some 6 months after my initial purchase, the stock was unchanged at best. This, despite the financial attributes and progress within the business.

In October, SmartMoney magazine's Jason Kephart did his part to highlight the situation. In the Under the Radar column, he said:
While weight-loss company NutriSystem (NTRI, $14) doesn't have trouble keeping its customers, it recently has had problems persuading more people to join up to shed pounds. The firm's second-quarter revenue dropped 32 percent, and net income was down nearly 60 percent from the same period a year earlier. Since NutriSystem uses other companies to manufacture and distribute its meals, the company can cut costs quickly, says analyst Pinheiro. NutriSystem has no debt and $64 million in cash on its balance sheet and sports a 5 percent dividend yield. "Right now the company has little downside," Pinheiro says, adding that a jump in consumer spending could help spur the stock.
Validation isn't worth much if it's wrong, but in this case, the analysis was dead-on.

NutriSystem didn't wait for the consumer to come to them, it went to the consumer. NTRI signed new distribution deals with the likes of Walgreen's, Sam's Club, and Wal-Mart. The stabilization of the business and the prospect for renewed growth did wonders for NTRI shares. By December 1st, NutriSystem was trading over $25 a share. By Christmas, it was over $33 a share. And I became a seller. By year-end 2009, my NTRI shares were gone.

At $450 million, NutriSystem was a bargain with no expectations of growth or prosperity. With a $1 billion market cap, it was a bargain no more. Growth had become a foregone conclusion, a necessity.

Others have clearly arrived at the same conclusion. In 3 short weeks, NutriSystem has fallen to $25.64 a share. The current $800 million market value seems fair (but not undervalued). Cash has grown to nearly $100 million. The dividend is 2.7 percent. And I predict solid (though not spectacular) free cash flow in the near future.

Investors should consider NutriSystem if it's share price gets slimmer.

In the meantime, I've been buying shares of Weight Watchers (WTW). More leveraged than NTRI, it nonetheless enjoys the same operational benefits: high margins, strong free cash flow, and low capital expenditure requirements.

One difference: Weight Watchers' management is consistent and effective on the stock repurchase front. Outstanding shares have fallen nearly 30 percent in the last 6 years!

What a concept - share buybacks that actually shrink shares outstanding?!? Most companies only use repurchases to offset options dilution: a pure wealth transfer from shareholders to company employees. WTW operates differently. They use repurchases to build shareholder wealth.

Today, Weight Watchers' shares total a whopping 77 million. Nearly 60 percent of these shares are owned by Luxembourg -based Artal Group, meaning the effective float is even smaller. WTW shares trade around $29 a share, putting the current market value at $2.2 billion.

Given the free cash flow generating ability of this firm, fair value is closer to $3 billion, perhaps more. Intelligent capital allocation is a bonus.

For proof of Weight Watcher's economic weight, look no further than its working capital (current assets - current liabilities). Few companies operate with negative working capital. When they do, it is often temporary - a short-term accounting anomaly.

But there is a rare group of cash flow aristocrats that consistently operate with negative working capital. Weight Watchers is a member of this elite club.
Another member: The Coca-Cola Company (KO).

This distinction should earn WTW premium pricing. At the current quote, they get no credit. Free cash flow should approach $3 a share this year. A free cash flow multiple of 10-11 is ridiculously low.

In fact, Weight Watchers trades at a discount to NTRI despite being a far more stable company. Fluctuations in operating cash flow, margins, etc are far lower. Despite being in the same industry, the companies are very different. Some 60 percent of WTW's revenues come from meeting fees. The social and motivational aspects keep many customers coming back even after their weight-loss goals are achieved.

In these lean times (pun intended), Weight Watchers is doing just fine. For proof, just read this recent story out of Sweden: Weight Watchers Clinic Floor Collapses. Clearly, there are plenty of portly people seeking out WTW's services. As for the so-called "collapse", someone really should talk to the Swedes about their building codes!

Like most value investors, I'm finding fewer bargains in the current environment, but they do exist.

Weight Watchers is worth a look. In fact, this is a company that should interest Warren Buffett. Instead of overpaying for capital intensive railroads, Berkshire used to buy high cash flow, household names like Weight Watcher's. Perhaps it will again.

Thanks for allowing me to weigh in with this opinion,

The Lonely Value Investor

Disclosure: The author owns shares of WTW.


  1. Buffett also buys moats. Are you really saying Weight Watchers' moat compares to Burlington Northern's?

  2. Burlington Northern generates very little free cash flow. $1 billion a year or so? For that Buffett is paying $30-$35 billion? Round numbers.

    I'm getting $200 million in fcf in a lousy year vs. a $2.2 billion market cap.

    And WTW's net margins are higher than BNI too.

    BNI is a good company, not great. And Buffett overpaid. Sad, but true.

    Wasn't it Buffett who used to argue that it was better to have a smaller company with higher rates of return on invested capital than a bigger company with lower rates of return?

    WTW wins on all measures, especially given the ridiculous valuation being assigned to BNI.

  3. Better cash flow to enterprise value for sure, agreed.

    But better moat? Come on...

  4. The negative working capital of Weight Watchers proves my point. I stand by the assertion.

  5. It's been a long time since your last update. Anyway, thanks for your new one! Well, I think even if it has a better moat, if you pay too much, the return may not be that good(Maybe Buffett does not seek superb returns anymore, because of his huge scale). But if you have a very good moat and you can pay much less, it may become a better investment. We can't say this one is the best for sure. It's a trade-off relationship.

  6. It has been too long since my last post. Thanks for the insights, Warren.