I generally try to consider both the positives and negatives of every stock I analyze, but that has gotten increasingly difficult with Weight Watchers (NYSE:WTW). I have long had my issues with this management team, and I believe management errors have finally started to take their toll on the valuation. While I do believe the brand carries considerable value and that this could be a highly attractive business if run properly, I have little confidence that this team can do it.
Fourth Quarter Results Pretty Mediocre
Although Weight Watchers' fourth quarter performance was better than expected, the absolute numbers weren't all that impressive.
Revenue rose about 2% as reported, better than the more or less flat performance expected by sell-side analysts. Meeting revenue fell more than 3% on weaker attendance across the board, but higher revenue-per-attendee appeared to drive better than expected results. Online was also pretty solid, with revenue growth of a little less than 18%. Product revenue was flat for the quarter.
Margins were mixed. While the strength in the online business helped, gross margin improved about 30 basis points and missed sell-side targets. Although the company increased marketing spend less than expected, SG&A expenses were up more than 20% and operating income fell more than 7%. So although Weight Watchers did beat EPS expectations by 9 cents, about three of that came from lower taxes, and the rest came from revenue.
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Guidance and Attendance Numbers Suggest Trouble
Although it's important to note that meeting revenue was better than most analysts expected, I think the attendance numbers should give investors pause. North American attendance dropped more than 14% after a 9% drop in the third quarter, while paid weeks declined by more than 7%. Attendance in the United Kingdom was down nearly 22%, and attendance in continental Europe was up just 1% (after climbing 5% in the third quarter).
Management had plenty of things to blame for these trends, as well as the poor guidance. Apparently meeting recruitment came in well below plan and the company's marketing plans were knocked off track by Jessica Simpson's pregnancy.
I think this is only part of the problem, though. I think Weight Watchers has failed to develop compelling new products that add value to the user/client experience. I think that could be particularly dangerous in the online business, where dieters can increasingly choose free apps or ad-supported website in lieu of paying $19 a month for a subscription.
Whatever the causes, the outlook for 2013 is pretty grim. Against a prior sell-side average estimate of $4.75 per share in earnings for Weight Watchers, management guidance gave a midpoint of $3.75.
This Is a Hard Business for Everybody
While I clearly don't think much of Weight Watchers management, I will acknowledge that weight management/weight loss has proved to be a very difficult business for almost everybody who has tried. Nutrisystem (Nasdaq:NTRI), for instance, has done even worse in terms of both operating and stock market performance. Arguably the only strong name in the space is Nestle (OTC:NSRGY) and its Jenny Craig business, but Nestle doesn't provide much detail and Nestle's nutrition business is exceptionally well-run by most standards.
I'll be curious to see whether recently approved weight loss drugs have any meaningful impact on Weight Watchers. Both of the drugs developed by Arena Pharmaceuticals (Nasdaq:ARNA) and Vivus (Nasdaq:VVUS) have serious drawbacks (Arena's with efficacy and Vivus with safety), but I don't doubt that potential Weight Watchers customers will be tempted to try these drugs. While I don't expect either to be a blockbuster, both could make 2013 a little more challenging for Weight Watchers.
SEE: 5 Must-Have Metrics For Value Investors
The Bottom Line
As I said in the beginning, I believe that the basic Weight Watchers model can work - particularly if the company can do more to forge ties with health insurance companies and large enterprises looking to improve employee health and overall healthcare costs. Barring something major (like a change in the CEO), though, I don't have that much confidence that the company will do better.
With a debt-laden balance sheet and perhaps only mid-single digit free cash flow growth over the long term, I'd give these shares a pass.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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