Weight Watchers (NYSE:WTW) stock hit a 52-week low August 2 on dismal second-quarter results. The weight-management company faces increased online competition. While the outlook for 2013 is getting gloomier by the day, it still expects to make at least $3.55 per share this year. This begs the question of whether you should you buy its stock?
The Bad News
When a stock drops 19% in just two hours of trading you know there's something not quite right. So let's go over the negatives of its second quarter report:
Weight Watchers announced that CEO Dave Kirchhoff was leaving the company to pursue other opportunities. Normally, when a CEO departs a company after having served in the position for almost seven years and in other positions for another seven before that it's not a problem. However, when the announcement comes after bad earnings you have to wonder about the timing.
Revenue in the second quarter declined 3.9% on a constant currency basis to $465.1 million. Most of the decline was a result of weakness in its North America and UK meetings business. This is something that's been happening over the past few quarters as more of its revenue is generated online. The company uses "paid weeks" as its key metric for assessing its business. In recent years Weight Watchers has transitioned from a pay-as-you-go weekly membership to a monthly pass. Over 75% of its meeting paid weeks are monthly passes. In Q2, its paid weeks from meetings declined by 10.4%.
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The decline in paid weeks for meetings goes hand-in-hand with a decline in attendance. In the second quarter its attendance dropped 14.7% year-over-year to 11.9 million. Like traffic in a retail store; lower numbers is not what you want to see. Paid weeks are what retailers call conversion.
One of the most disturbing numbers in the second quarter was actually positive. Its online paid weeks increased by 4.4% year-over-year to 31.8 million. In the same quarter last year its online paid weeks increased 30.2% to 30.4 million. Between 2008 and 2012, its online paid weeks increased at a compounded annual rate of 30.1%. Given the number of active online subscribers--which it converts into revenue through paid weeks--grew by just 1.1% in the quarter, it appears that its internet business has stalled and the online competition mentioned in the opening has something to do with it.
Its net income in the first half of 2013 declined 14% to $113.7 million. Included in the decline was a $21.7 million charge for the early extinguishment of debt. In April, Weight Watchers announced that it had consolidated its $2.4 billion in long-term debt into two loans and one revolver--$2.1 billion, $300 million and $250 million--down from six loans and two revolvers. To do this it's added approximately $18 million per annum in interest expense.
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The man taking over as CEO is Jim Chambers, a 30-year veteran in the food business, hired in January as COO. In the past Chambers has been a chief executive of both Kraft Foods' (Nasdaq:KRFT) U.S. snacks business as well as Mondelez International's (Nasdaq:MDLZ) North American Cadbury operations. In his job as COO for the last seven months, he'll be more than able to handle the new responsibilities.
In terms of paid weeks on the meetings side of the business it's important to look at the numbers more closely. They declined by 10.4% in the first quarter and 9.3% in the first half. Those aren't good to be sure. If you look at it from a revenue standpoint--it's not the end of the world. Its revenue from meeting fees in the second quarter was $231.2 million, down $17.3 million in the same quarter last year. However, the revenue per paid week was $9.55, 35 cents higher than a year earlier. It might be losing attendance and paid weeks but it's managing to keep the revenue flowing in the right direction. (L8)
Jim Chambers biggest task as CEO is to get its online business back on track. What that involves I haven't a clue. However, its internet business is still a gold mine. Its gross margin for its internet revenue in Q2 was 87.5%, only 50 basis points less than in Q2 2012. I'm sure there are cost control initiatives that can't recapture any lost margins. More important is reigniting its growth engine and the 30% year-over-year increases shareholders have become accustomed to. That's going to take time.
In fiscal 2012 Weight Watchers repurchased 18.3 million shares of its stock for $82 each reducing the total count by 18% to 60.9 million. On $100 million in net earnings, the buyback adds 38 cents in additional profit per share. Unfortunately, if it had waited a year, it could have saved itself about $800 million. This should be considered outgoing CEO Dave Kirchhoff's biggest mistake while in the top job. It's incumbent upon Jim Chambers that he avoid the same mistake…for shareholder's sake.
As recently as March 2012, Weight Watchers stock was over $80. Only once in its 12-year history as a public company has its stock traded below $30 and that was for two years starting in October 2008 through October 2010. Otherwise, it's performed decently enough. (L11)
Weight Watchers expects to deliver at least $3.55 per share in 2013. That's a P/E around 11. Historically, it's never had a P/E below this bellwether number. When everyone else is fearful--you should be fearless. I don't know what Jim Chambers has up his sleeve to right the ship but I really don't see it being nearly as difficult as a 20% plunge would seem to suggest.
If you've got 18-24 months--I'd be a buyer of its stock. Obesity's not getting solved with a few free apps and an activity monitor. Weight Watchers definitely has its work cut out for it. Herbalife (NYSE:HLF) was dead in the water at the beginning of 2013--look how it's turned around. Weight Watchers is a much better company. Long-term it will do just fine.
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