Nautilus Finally Weighs In

By Will Ashworth | March 08, 2011 AAA

Nautilus (NYSE:NLS), maker of Bowflex fitness equipment, recently announced its first operating profit in 14 quarters, breaking a losing streak that dates all the way back to June 2007. Once upon a time, it could do no wrong and then the bottom fell out. Its stock dropped like a stone from over $40 in 2002 to little more than a buck in 2010. It was bleak indeed. Turnaround specialist Edward Bramson entered the picture in January 2008 and today it appears on the road to recovery. We'll look at why now may be a good time to buy.

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Walk Then Run
Nautilus finished 2010 with total revenues of $168.5 million and an operating loss of $9.6 million. When it was trading above $40 in 2002, revenues were $585 million and operating income $151 million. It was making as much in operating profits as it's generating today in revenues and, as such, it's easy to understand why the stock price cratered. Baby steps are necessary if it wants to return to its heyday of the late 1990s and early 2000s. To get there, it will have to deliver a full-year of profitability, not just one quarter. But it's a start.

What Still Needs Fixing
Management took a giant step in early 2010, when it sold its commercial business in two separate transactions, one for $10.9 million to Xiamen World Gear Sports Goods and the other for $2.8 million to Med-Fit Systems. Despite a net loss on the deals, the move allowed the company to focus on its retail and direct businesses. It's about time. I owned Nautilus stock between 1999 and 2002 and always wondered why it wanted to wade into the highly competitive commercial fitness business. Many have lost their shirts trying to sell to and service fitness clubs. The deal was a case of addition by subtraction. Having said this, it's definitely not out of the woods. While its retail segment delivered revenue and operating profit growth in 2010, its direct segment saw revenues drop 21% to $96.7 million with an operating loss of $10.8 million.

Management has suggested the decline was a result of lower Bowflex sales due to the reduced availability of consumer financing during the first three quarters of 2010. Apparently, financing approvals with General Electric's (NYSE:GE) Money Bank division improved late in the year. This might be true but it won't succeed long-term if it has to rely on financing in order to get consumers to buy its products. Not only that, but its direct segment has to do a much better job on margins. Advertising rates have been lower than historical norms the past couple of years and yet it still couldn't make money from Bowflex. This needs to change.

Future Strategy
Bramson indicated in the Q4 earnings release that it will focus on cardio based products in the future because it's the largest segment of the fitness market. This makes a lot of sense, although I worry the decision seals the fate of Bowflex strength products - once its bread and butter. Future quarters will tell us if this is in fact the case or, more likely, that its growth will come from the Bowflex Treadclimber on the direct side and from ellipticals, stationary bikes and treadmills on the retail side. If the fourth quarter results are any indication, the strategy is working. The direct segment's operating loss was 73% lower in the final quarter of the year on a 2.3% decrease in revenues. A few more positive quarters and the direct segment will also be operating profitably.

Nautilus and Peer Group

Company Market Cap-to-Cash P/S Current Ratio
Nautilus (NYSE:NLS) 6.8 0.51 1.45
Cybex International (Nasdaq:CYBI) 3.3 0.11 2.14
Callaway Golf (NYSE:ELY) 8.7 0.49 3.11
Polaris Industries (NYSE:PII) 7.1 1.37 1.38
Arctic Cat (Nasdaq:ACAT) 2.4 0.53 2.49

Valuation
Nautilus isn't making money at this point, so any discussion about the value of its stock won't revolve around earnings. Instead, we'll look at some other metrics detailed in the above table. Nautilus fares about average in all three categories when compared to four of its peers.

In June 2010, I wrote an article about Polaris and Arctic Cat. At the time, I thought Arctic Cat was the better stock. I still do. In fact, I think it's the best stock of all five. However, this is about Nautilus and so I'll mention two things I think should give you pause before passing on the fitness equipment company.

First, its direct segment had a net margin of 23.6% in 2002 when its stock was trading above $40. Even if it only boosts its operating margin to half the 2002 level, it'll add approximately $21.1M in operating profit. Second, CEO Edward Bramson bought the first 6.2 million of his 10 million shares back in July 2007 at an average cost of more than $9 a share. There is no way he's going to stop until he's got a return on his investment. He's motivated to fix this and I think he can.

Bottom Line
While the first or second quarter could bring bad news, I don't see the stock falling below $2 again. However, if the next two reports bring continued improvement, $9 could be just around corner. The risk is reasonable at this point. (If you don't realize how "big" small-cap stocks can be, you'll miss some good investment opportunities. Check out What Is A Small Cap Stock?)

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