The combination of an asset-light business model and a strong brand can be tremendously powerful, and Weight Watchers (NYSE:WTW) clearly has the sort of returns on capital that bespeak a quality business. Unfortunately, operational stability has proven elusive and the company's decision to launch a large buyback is going to stretch an already stressed balance sheet even further. (For related reading, see A Breakdown Of Stock Buybacks.)
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

A Slightly Soft Fourth Quarter
Although Weight Watchers' reported fourth quarter results were OK, they were not as strong as the sell-side projected. Sales grew almost 13%, but were a bit shy of expectations despite being around a 60% jump in online revenue. Total paid weeks did climb nearly 34%, though, and North America's meeting revenue rose about 8%.

Profitability was good, but not quite good enough. Gross margin rose more than three and a half points (a lucrative Internet business helps here), while adjusted operating income rose just above 24% and operating margin expanded two and a half points despite a 29% increase in marketing expenditures. With all of that said, expectations were already demanding and Weight Watchers met its quarter only through a lower than expected tax rate.

Attendance Proves Wiggly
It probably shouldn't be surprising that a diet or weight management company would see erratic attendance - people try it a while and quit, or stick with it just long enough to reach particular goals. That said, North American attendance growth slowed in the fourth quarter - up 5.5% versus better than 13% growth in the third quarter - which was not only better than guidance (flat), but solid given the tough comp created by the Points Plus launch a year ago.

Ex-U.S. attendance is still more difficult. The small U.K. business is doing pretty well, with attendance growth accelerating to 13% in the fourth quarter (versus a 10% growth in the prior quarter), while attendance on the continent was down about 4% (better than the 15% drop in the third quarter).

Weight Watchers Seems to Be Addicted to Debt
One of the curious moves coming out of this quarter was the announcement that management is launching a share repurchase worth up to $1.5 billion. The company will be allocating $720 million to a modified Dutch auction (with pricing between $72 and $83), and then spending a matching amount repurchasing shares to maintain Artal Holdings' stake at 52%.

Remember that Weight Watchers already had negative equity coming out of this quarter, and the company intends to fund this largesse with still more debt. This should be a controversial move. I get that Weight Watchers has an asset-light model that generates prodigious margins and returns on assets or capital. But I've also seen many great businesses commit deferred suicide by gorging on cheap debt that couldn't be productively applied to growing the business. (To learn more, read How Buybacks Warp The Price-To-Book Ratio.)

Can Competitors Touch Weight Watchers?
Debt concerns aside, does Weight Watchers really have any organized competition that's worth fearing? Nutrisystem (Nasdaq:NTRI) and Nestle's (OTCBB:NSRGY) are really the only other organized competitors that fill a similar niche, and Weight Watchers is well ahead of them - so much so that insurers like UnitedHealth (NYSE:UNH) will pay for Weight Watchers in some cases.

There are a host of companies trying the nutrition angle - whether it's supplement companies like Medifast (NYSE:MED) and Herbalife (NYSE:HLF) (who don't have clinical data to support their approaches), or the nutrition businesses of larger concerns like Abbott Labs (NYSE:ABT) or Kellogg (NYSE:K).

Should any of these companies really worry about Weight Watchers? Based on what we've all seen so far, the answer would seem to be "no." Sure, a pill, shake or other nutritional "magic bullet" might be a threat, but nobody seems inclined at this point to put one into clinical trials and the current pharmaceutical approaches in the pipeline still have an uncertain path to the market.

The Bottom Line
I don't think I could ever be comfortable owning a company where management seems so willing to lever up the business - were the U.S. economy to hit another rough patch or an alternative approach like a safe and effective pill to come out, repaying that debt could become problematic.

That said, Weight Watchers has a great brand, excellent online growth potential and a shareholder base that thus far hasn't been too bothered by the balance sheet. Assuming that above-average online sales continue and pull up free cash flow conversion with them, these shares are probably around fair value. (For additional reading, check out The 4 Basic Elements Of Stock Value.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. Investing

    Three Companies That Will Benefit From Online Gaming

    Certain companies stand to benefit from the increasing popularity of the online gambling industry in the U.S., as well as its expanding legalization.
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  8. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  9. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!