Medifast Moving Up Fast

Evidence suggests Americans spend $40 billion a year on weight-loss programs that usually don't even work. A 2006 New England Journal of Medicine article about people who use weight-loss programs found that one year after the program, the majority of people regain one-third of the lost weight. In three to five years, all of the weight was back on. This is great for the companies that sell this stuff, not so good for the dieters.

I'm not sure who to believe in this battle, but I do know that weigh loss company Medifast (NYSE:MED) has an ever-expanding list of potential clients, and could be poised for success.

Selling to the wrong People
Medifast's history dates back to the 1980s when it sold weight-loss products to healthcare professionals who recommended them for obese clients. By the 1990s, it was close to bankruptcy, as insurance companies were no longer covering its products. Revenue had sunk to $3.9 million by 2000 and staff from more than 200 down to 11. It was then that Brad MacDonald, now chairman, switched horses choosing to market to consumers instead of physicians. The move stopped the death march, and its been upbeat ever since.

Current CEO Michael McDevitt joined the company in 2001 as controller. Once on board, he convinced MacDonald to boost the marketing budget and start a multilevel marketing program called Take Shape for Life. In 2003, Take Shape for Life's first year (2003) generated $15 million in revenue. In the second quarter ending June 30, 2008, its direct sales segment generated 44% of the $27.5 million in total revenue. The turnaround is almost complete. (Find out how to read income statements in Understanding The Income Statement.)

Multi-Channel Distribution
Its original game plan didn't work. Focusing on one group of customers almost killed it, so Medifast is branching out in an effort to avoid past mistakes.

It now has four channels of distribution:

1. Direct-to-consumer, through the web, phone or email
2. Take Shape for Life MLM, an independent physician led network
3. Medifast Physicians, through the implementation of the medifast program
4. Medifast Weight Control Centers, currently 10 corporately owned weight management centers

In 2007, sales were $84 million. Direct-to-consumer revenue generated 56% of the total, Take Shape for Life another 33% and physicians and the brick and mortar clinics the remaining 11%. The diversified business model has grown revenue from $25.4 million in 2003 and operating income to $5.7 million in 2007 from $3.6 million in 2003.

An analyst at Canaccord Adams who covers the stock suggests a multi-channel approach, while expensive, is the way to stand out from the masses. The two analysts covering the stock have a full-year earnings per share (EPS) estimate of 36 cents. In 2009, that should jump to 50 cents per share with a long-term growth rate estimate of 25% according to Zacks estimates. Northland Securities (a third analyst) initiated coverage on August 13 with an 'outperform' rating. The Street seems to be impressed.

All Good Things Come to an End
Medifast's competitors include Herbalife (NYSE:HLF), Weight Watchers International (NYSE:WTW) and NutriSystem(Nasdaq:NTRI). All of three have higher operating margins (15%, 27%, and 15% respectively), but that's okay. Even with a tight operating margin around 7.5%, Medifast's still positively stands out in a very crowded and intensely competitive marketplace.

Times are good at the company and management is positioning it for the future. On August 7 it announced second quarter earnings. Revenue was up 25% year-over-year from $22 million in 2007 and the diluted earnings per share were up 57% from 7 cents to 11 cents. The Take Shape for Life division experienced a 79% increase in sales; Medifast Weight Control Centers were up 61% and its overall gross margins were strong at 75.8%. Medifast's multi-channel distribution is starting to pay dividends. Company guidance calls for 8-10% revenue growth and 30-35% earnings per share growth in 2008. With the economy sputtering, I'd take these numbers any day. (For related reading, check out Getting The Real Earnings.)

Bottom Line
Medifast was No.47 on the Fortune Small Business 100 in 2008. In the last 10 years, its stock has dipped under a dollar and moved all they way up to $25, twice. It's under $8 now, and it is up 11.6% in the last 52-weeks versus -12.47% for the S&P 500. Both its PEG ratio and price-to-sales are less than 1.1, which is excellent for a growing business. I see the positive movement in its stock in 2008 as the foundation for an even greater move once Medifast's revenue rises above the $100 million mark sometime in 2010. Then we'll know it has arrived.