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One Nutritional Stock with Great Fundamentals Being Ignored by the Market

October 27, 2011 | About:
USANA manufactures nutritional and personal care products which focus on reducing the risk of chronic degenerative disease to promote long-term health. The customer can be classified into two types. First are Associates who are independent distributor of the products, and can use the product for personal use. Second are Preferred Customers, who strictly buy products for personal use only. Currently it has 222,000 active Associates and 68,000 active Preferred Customers.

The company is using the network marketing system, similar to franchise business to do marketing and sales of its products, similar model with Avon (AVP), Herbalife (HLF), Nuskin (NUS) and Amway (this company is not listed yet). Those companies have very high market valuation due to its growth in both revenues and earnings overtime. Here is the relative valuation of these marketing companies today:

P/E P/B P/CF
Herbalife 20.7 11.7 16
Avon 10.9 4 14.7
Nuskin 24.6 6.1 17.5
USANA 10.8 3.4 7.6
Industry 15.7 3.5 13.2


We can see quite clearly that USANA is trading at the large discount compared to the relative valuation of its bigger competitors in the same field and with the industry average. 40-50% for the earnings multiple and cash flow multiples. Besides, it is cheap compared to the historical company of its own as well. On the rolling five-year average basis, USANA P/E stays at 17.2, and P/CF is at 12.6, double the current valuation right now.

For profitability, USANA for the historical period of 10 years has increased its sales, from $114 million to $518 million at the end of 2010, with the annual compounded growth rate of 16.3%. The operating margin fluctuated around the range of 9=18%, whereas the net margin is on the 6-12% range over the last nine years. Along with that, the return on equity is quite high, with only little help from leverage. The Dupont model has shown us that:

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Net Margin 1.92 6.36 10.41 11.28 11.9 11.03 10.71 6.98 7.68 8.82
Asset Turnover 3.23 3.59 3.84 3.99 4.51 4.31 4.05 3.7 3.55 3.16
Financial Leverage 2.43 2.16 1.47 1.5 1.61 1.66 2.82 3.85 1.66 1.4
Return on Equity 16.05 52.13 66.65 66.75 83.34 77.91 91.7 84.98 63.19 41.59


The normalized net margin for the last 10 years stayed at 8.7%, and the normalized ROE is at 62.4%, and gradually the firms reduce the level of financial leverage, which makes the ROE less attractive than before, but still at the very high number of 41.9

For financial health, Debt/Asset ratio is at 27%, with no bank debt, both long- and short-term debt and the level of cash 12% of the total asset. With the market capitalization of $511 million, adjusting to debt and the level of cash on hand, its enterprise value is at $482 million only, driving the multiples valuation even lower.

For cash flow, it consistently got positive growing cash flow over the last 10 years in both operating cash flow and free cash flow.

USD million 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
CFO 10 16 35 38 48 61 57 46 32 66
CPEX -7 -3 -5 -7 -4 -11 -26 -16 -4 -4
FCF 3 13 31 31 44 49 31 30 28 62


Over the historical 10 years, the CFO has increased from $10 million to $66 million, and the FCF increased from $3 million to $62 million, with the annual compounded growth rate of 20.7% and 35.4%.

Even with the high growth rate like that, if we assumed very, very conservatively regarding to its historical growth in free cash flow, the discounted free cash flow will look like this based on very conservative assumptions:

1 2 3 4 5 6
Year 2011 2012 2013 2014 2015 Terminal Value
FCF 67 72 78 84 91 4,600
PV FCF 61 60 59 58 57 2,597
Value 2,890


Assume that the FCF will increase 8% continuously for the next five years and then increase 1% to infinity, with the discount rate of 10%. Doing inverse calculation to get the discount rate and the growth rate for the company, the enterprise of $360 million would match the assumption of significantly high discount rate of 20%, the growth of 4% for the next five years and no growth afterwards. Clearly, at the enterprise of $360 million, it is ridiculously undervalued.

In terms of management, it is reported that it doesn’t have a lot of stakes inside the company, but there are two positive signals in terms of guru buying and insider buying. First is the CEO has bought the stakes in August 2011, and until now the price had advanced nearly 40%. In addition, Magic Formula guru Joel Greenblatt began to buy the stock in March, and increased holdings in June.

In terms of catalyst, there are two things which might increase the share price in the company. The first one is the confidence of investor into the network marketing companies, as people sometimes shield away because of legal scrutiny for direct selling operation. Second is the notice of other smaller funds/investors into the company, it seems like this company is being ignored in the stock market. If the fundamental is still growing (even at the slower rate than before) and it reflects in the share price, the investor of today would have high probability of getting a whole lot of gains.

This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 3.5/5 (13 votes)

Comments

Adib Motiwala
Adib Motiwala - 3 years ago
Anh,

I also looked at this company a few months back mainly attracted by the valuation and fundamentals. However, after spending more time I was not comfortable with the business model of direct marketing. There is a lot of churn in their independent distributors. Each of them have to buy the product for personal use ( whether they use it or not). To make more money than they spend, they have to sell to their network.

The other over hang was the acquisition in China and how it would impact their existing business...

Adib
ken_hoang
Ken_hoang - 3 years ago
Hi Adib,

Thanks for your comments. Actually the direct marketing is being criticized for several countries because of the bad products or the collapse of the system. But when the product is good and the system is sustainable, the manufacturers will be most beneficial. Why so? as you said, because each of person in their network has to buy the product for their personal use. So actually the independent distributors are first tier consumers.

For China, the most important thing is getting the license, and china is big market. Several successful companies such as Nuskin, Avon and Amway has been very good in acquiring big markets and they have done quite well. the acquisition, how it played out, is still uncertain though. But definitely tapping into chinese market would be extremely beneficial.

ken_hoang
Ken_hoang - 1 year ago
I sold it too soon at around $40 in 2012. An expensive cost of omissions.
ken_hoang
Ken_hoang - 1 year ago
it was now $85

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