It doesn't matter how much doctors and nutritionists may decry supplements, they are popular and people want to believe in them. That has underpinned good growth in a sector with none of the patent worries of pharmaceuticals and minimal FDA interference. It has also led to solid stock market performance for traditional store-based retailers like Vitamin Shoppe (NYSE:VSI) and GNC (NYSE:GNC) as well as multi-level marketing firm Herbalife (NYSE:HLF). (For help on choosing stocks, check out How Investors Can Screen For Stock Ideas.)
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Growth in a Bottle in Q2
Herbalife continues to rack up impressive growth. Revenue rose 28% in the second quarter, with organic growth on the order of 20%. There are several metrics that investors can use to evaluate the underlying momentum of Herbalife's business and regional volume points is one of them. By this standard, volume rose more than 17% in the second quarter, with exceptionally strong growth in Asia-Pacific, Mexico, and Central/South America. Results in North America and Europe were more sedate (mid-single digit growth), while the China numbers were actually down about 9%. Overall reported revenue from China was flat, though.
Herbalife maintains an interesting bifurcated margin structure. Gross margin is impressive at over 80%, and Herbalife reported that it grew about 40 basis points this quarter. Operating margin, though, is more modest in the high teens, but still grew 50 basis points this quarter, as operating income jumped nearly 32%.
A Stealth Emerging Markets Play?
Herbalife is quite clear in laying out where it earns its revenue and profits, but that does not mean that regular investors pay all that much attention. To most Americans, I suspect Herbalife is just another nutritional supplement company that advertises on TV and sells some weight loss products. Maybe a few more people know about its distribution strategy.
What casual observers may not realize, though, is that about 80% of the company's sales come from outside the U.S. China in particular has been a healthy growth market and the company has gotten good traction with its "Nutrition Clubs". It's also noteworthy that Herbalife's products are not particularly cheap in these emerging markets, but the notion of improving one's health through supplements seems to really resonate.
Herbalife is holding up well under competition. USANA Health Sciences (NYSE:USNA) does overlap in some of Herbalife's overseas markets, but does not boast the same sort of revenue growth. Otherwise, Herbalife competes against some large overseas OTC companies like Hypermarcas and a host of smaller players and traditional providers.
People Want What They Want
Weight management products are a significant part of Herbalife's sales and that does not seem likely to change. Weight Watchers (NYSE:WTW) may have the studies to back up its approach, but that doesn't mean it appeals to all potential customers - ditto for Nutrisystem (Nasdaq:NTRI). Given that the FDA seems very uncomfortable with pharmaceutical-based approaches from the likes of Vivus (Nasdaq:VVUS) and Arena (Nasdaq:ARNA), it looks like Herbalife can continue to benefit from a market with a lack of convenient alternatives.
The Bottom Line
If Herbalife can maintain this kind of growth, the shares are almost certainly too cheap. The trouble is, though, that the record of companies like Herbalife is not very good - companies like this have repeatedly emerged, posted stellar growth, and then flamed out. It's absolutely fair to point out that just because it happened to others does not mean it will happen to Herbalife, but it should lead investors to take in a little more skepticism into their projections and valuation analysis. (To help you discover if this stock is right for you, read Cheap Stocks Can Be Deceiving.)
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