Everybody knows that obesity is a huge problem in America, but it's devilishly hard to make money here on a sustained basis. The sales of various diet drugs and devices have largely disappointed their developers, and even those companies that have steered clear of the FDA process (supplements and "nutritional products") have struggled to make the money that investors expected. That puts Weight Watchers (NYSE:WTW) in a curious place - although Wall Street has gotten a lot more rational about this name (and the stock has badly underperformed this year as a result), it's still not necessarily a compelling stock today, even though it may be the best-positioned company in the market.

Forex Broker Guide: Using the right broker is essential when competing in today's forex marketplace.

Less Bad Is Good Enough for the Third Quarter
Weight Watchers didn't have a great third quarter by objective measures, but the company did perform better than expected and Wall Street is first and foremost a relative expectations machine. Revenue was up less than 1% as reported, but up nearly 3% in constant currency terms. Revenue from meeting fees declined almost 3% on an almost almost 4% drop in meeting paid weeks, while in-meeting product revenues declined 11%. Online remains a strong source of growth, however, as revenue jumped 22% this quarter. Due in part to the strong online revenue growth, Weight Watcher's revenue mix shifted in a more positive direction, and the company's gross margin saw an improvement of nearly 150 basis points (BPs). Operating income was down 5%, however, in part on higher marketing expenditures.

Cycles Produce Hope and Uncertainty
Weight Watchers certainly didn't report great attendance numbers this quarter. North American attendance fell more than 9%, while attendance in the United Kingdom fell almost 18%. Continental Europe was a bright spot, with nearly 5% attendance growth, but it's a smaller part of the overall operation. At least insofar as North American attendance is concerned, the declines seem at least partly attributable to the company going through the tail end of a program cycle. The company has talked about a "major program innovation" coming soon, but details are scarce at this point - likely because rivals like Nutrisystem (Nasdaq:NTRI) and Nestle (OTC:NSRGY) would certainly love to know what's coming.

Unfortunately, this is just how it is with Weight Watchers - its attendance revenue is cyclical and the company has to keep up its marketing efforts and identify new spokespersons to carry the brand forward. On a better note, online continues to grow and holds the hope of being more stable/sustainable. Likewise, the company's increasing focus on business-to-business (B2B) opportunities could offer more sustainable growth in the future as businesses look to cut employee health costs.

Drugs Likely Won't Change Much
Although there has been ample hype for the new weight loss drugs from Vivus (Nasdaq:VVUS) and Arena (Nasdaq:ARNA), I am increasingly skeptical that they are going to change much of anything in the weight loss market. Although Vivus's Qsymia is effective, the side effects are not trivial and the early prescription data hasn't really provided upside surprises. When Arena's Lorqess launches (likely in early 2013), I expect it will likewise disappoint the bulls.

This is hardly a new trend in the obesity market. There's a good reason that there aren't any blockbuster obesity drugs on the market today and why most Big Pharma players have largely quit trying. Moreover, Allergan (NYSE:AGN) recently announced that it would likely divest its Lap-Band business. Even though Allergan has supported this product with strong marketing (and Allergan is pretty good at marketing) and the device produces solid placebo-adjusted weight loss, it just isn't selling as well as Allergan hoped. Now it's not as though Weight Watchers is immune to this; plenty of people join Weight Watchers and quit relatively quickly once they realize it's not a cheap quick-fix to lose weight. Rather, I simply think that these alternative approaches aren't really a substantial threat to Weight Watchers anymore at this point.

The Bottom Line
It's very challenging to model the weight loss industry, but I've tried and I believe Weight Watchers might have about 5% share. While that certainly sounds like a lot of untapped potential for the company, I would caution investors about getting too optimistic that Weight Watchers will capture that quickly or easily. There are a lot of things about Weight Watchers' financials that give me pause, including the company's large debt load and negative net worth. Curiously, however, sell-side analysts have become significantly less aggressive with their growth assumptions, and expectations may at last be pretty rational here. Nevertheless, the company's large debt load wipes away a lot of the cash flow-based fair value for the stock, and I still do not believe Weight Watchers is a compellingly cheap stock today.

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

Related Articles
  1. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  2. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  3. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  4. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  5. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  6. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  7. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  8. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  9. Sectors

    3 Cyclical Industries To Exploit in 2016

    Learn about the three industries at the down end of their business cycles, and discover how these industries may improve in years to come.
  10. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  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 >>
Trading Center