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Is Nature’s Sunshine Breaking Through the Clouds?
Posted by: Magic Diligence (IP Logged)
Date: March 28, 2012 09:42AM
Nature's Sunshine (NATR) is a direct selling, multi-level marketing (MLM) firm. Herbal products account for about half of sales, including remedies for better circulation (Cardio Assurance), blood pressure (Blood Pressurex), and immune system function (Liquid Chlorophyll). Vitamins, Minerals, and Supplements comprise another 43% of sales, catering to a wide variety of both general and targeted outcomes. Personal care, including skin and hair products, round out the portfolio. Nature's Sunshine is an international firm, with 45% of sales originating outside of the United States. MLM companies are nothing new to Magic Formula® Investing (MFI). The direct marketing model involves individuals (known as distributors) recruiting additional distributors to buy and market products, and to recruit further distributors to build out a network. Essentially, this is a low cost way to build both an advertising and distribution network, leading to high returns on capital. The downside is that turnover is very high (over 55% of NATR's distributors do not renew), government regulations can be restrictive, and both the general public and investing community have a less-than-positive view of the business model. Let's face it, being hounded to buy (and then sell) stuff by a relative or friend is a real pain in the posterior.
That said, the track record of these companies in MFI is pretty stellar. USANA Health Sciences (USNA), probably Nature's Sunshine's closest analog, is up 40% since it appeared in the screen last fall. Herbalife (HLF), Nu Skin (NUS), and Pre-Paid Legal (PPD) all more than doubled after appearing in MFI. Can Nature's Sunshine be the next success story?
I believe it can. Since new management came on board in 2010, the firm has dramatically improved its cost structure, cutting poorly designed promotional programs, eliminating unnecessary overhead, and terminating an unprofitable collaboration with NutriPlus LLC. Since then, operating margins have climbed to over 10%, from prior, hideous levels under 4%. All of its main public competitors (USNA, NUS, and HLF) carry operating margins around 13%, so there is probably a few points of improvement still possible here. This is the first step of the turnaround, and it is well underway.
The second step will be to re-ignite revenue growth. Sales growth here has been lukewarm to say the least - sales remain about the same as 2007 levels. Europe and Asia/Pacific have been growing at 15% rates, while the Americas remain flat, a trend that will probably continue. While Nature's has operations in 51 countries, there remains room to grow. China remains untapped, a market behind much of Herbalife's success. India is also virgin territory. I see some additional large markets in Europe that could be entered, including France and Belgium. Over the long run, there are plenty of possibilities for growth here. It will be a matter of execution.
Failure to execute on the growth and margin opportunities is the biggest risk here, and it is a big one as the industry is crowded with larger and more well-known companies and brands. Nature's Sunshine has historically been a second-rate player. This leaves the company vulnerable to competitors poaching their top distributors and their networks. I believe that over the long run, NATR will need to raise their volume incentive payouts to over 40% of sales (from about 36% today), closer to what the competition pays.
Also, cash flows have been spotty. Over the past 5 years, the firm has converted an alarmingly low 17.4% of reported operating earnings to free cash flow, far below the 75-80% average for the industry. This is something to keep a close eye on, as it often signals irregularities in accounting, inventory management, or tax accrual payments.
Assuming modest growth, the firm reaching a 12% operating margin, and a slightly below-industry earnings multiple, I see Nature's Sunshine being worth $26 a share, about 52% above the current price of $17. The stock is on a good run right now and there should be continued upside going forward, but it is too similar to current pick USANA Health Sciences to add to the Top Buys list.
Steve owns no position in any stocks discussed in this article.
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Stocks Discussed: NATR, USNA, HLF, NUS, PPD,