I’ve was very impressed by one of the Value Strategies on GuruFocus.com, which is Undervalued Predictable Companies. As following the site, it is the most outperforming the S&P compared to other strategies since Inception. Whereas the Buffett-Munger Screener top 25 returned 64.5% since 2009, the Top 25 Undervalued Predictable Companies returned a breathtaking 87.4%.
The way GuruFocus ranked the predictability level based on the consistency of the revenue per share and EBITDA per share over the past 10 years, and on the correlation between stock performance and the predictability of the business. Indeed, as Warren Buffett say, in the short term, we should not care about the movement of the stock price. But over the long run, the stock price does reflect the fundamentals of the business. For stocks receiving a 5-star ranking, the average annualized gain in the period of 1998-2008 was 12.1% and only 3% that were in loss in that 10-year holding period. So I begin to search for 5-star predictability, combined with sustainable earnings and cash flows, trading at reasonable prices that plunged for a year.
One of the stocks that catches my eye is Medifast (MED, Financial). It has a five-star predictability ranking. At the end of December 2010, it was trading at $30 per share, and now it is hovering around the $15.8 level, a discount from the high of nearly 50%. For the last 10 years, the stock price has been on a roller coaster in a wider and wider range.
MED was incorporated in 1993, operating mainly via five of its wholly owned subsidiaries, Jason Pharmaceuticals, Take Shape for Life (TSFL), Jason Enterprise, Jason Properties and Sven Crondall. It is engaged in the production, distribution and sale of weight management and disease management products and other consumable health and diet products. The products were primarily manufactured in its FDA-approved facility in Owings Mills, Md. It has different distributions channels:
· First is Medifast Direct, where customers can order Medifast products directly through the company’s website or from its in-house call center. Then the products can be shipped to the customers' homes.
· Second is via Take Shape for Life, the personal coaching division of MED. The coaching network consists of independent contractor health coaches, who are trained to provide coaching and support to clients on MED weight-loss programs. The coaches will earn compensation on products sales by referring clients to the website or in-house center to purchase products. It is one of the network marketing methods and TSFL is a member of Direct Selling Associations.
· The third channel is Medifast Weight Control Center, the brick-and-mortar clinic channel of MED with locations in Texas, Florida, Maryland and Virginia. Currently it has a total of 39 locations in operation. The good thing here is the company began the franchise model for its clinic in 2008. Now it has 22 franchise operations already.
· Last but not least, MED uses physicians to distribute its products as well. These physicians carry an inventory of Medifast products and resell them to patients. MED’s management estimates more than 20,000 physicians nationwide had recommended Medifast as a treatment for their overweight patients since 1980, and over 1 million patients have used its products via physicians’ recommendations.
For the operating performance for the last 10 years, it has had consistent growth in revenue and fluctuating but on the rising trend operating income and net income. Operating margin and the net margin is staying at 12% and around 7%, respectively.
Any investor would feel very good when looking at 10-year historical ROE. Most of the time MED had double-digit returns on equity, iresulting from the consistent increase in asset turn over since 2004, with the net margin fluctuating around 4-7% whereas the financial leverage for the last five years was around 1.3.
In addition to the level of profitability and operating performance, MED has produced an increasing level of operating cash flow over time, and the free cash flow has begun to turn positive over the last two years.
In terms of financial strength, MED has quite a conservative financial structure, with D/A just a little bit more than 30%, including only around 4% of total assets in debt. The majority of liabilities items are accounts payable and accrued expense. In the asset side, it has $18.5 million in liquid cash, and investment securities worth $18.5 million as of September 2010. Adjusting the level of debt and cash, the enterprise value of MED is around $230 million.
Currently, in the stock market, MED is valued at 10.8x P/E, 3.4 times book and only 6.5x operating cash flows, lower compared to both historical valuation and the industry average. Competitors such as Herbalife (HLF, Financial), and Weight Watchers International (WTW, Financial) or NutriSystem (NTRI, Financial) are trading at more than 17x P/E, and around 5x-12x book value (except WTW because it has negative book value).
In terms of guru trading, MED falls into the portfolio of Joel Greenblatt; he began to buy the stock for around $21 per share and added more when it fell to the $18 level. However, with the insider holding of 11%, it was not so significant but not so little for us to ignore. The insiders have kept selling the shares out, especially when it was at the $29 to $35 level.
There is even one director selling out at $15.12, but the amount of shares is negligible; we should not take it into consideration much.
In conclusion, the business of MED seems very intriguing, with the overweight products being delivered in four outstanding channels including franchise systems. The growth of revenue, operating income and cash flow combined with the conservative structure in its balance sheet would give investors a good sleep at night. And especially because the valuation is much lower compared to the peers in the same industry and to historical valuation, the current price is attractive to initiate a long position.
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
The way GuruFocus ranked the predictability level based on the consistency of the revenue per share and EBITDA per share over the past 10 years, and on the correlation between stock performance and the predictability of the business. Indeed, as Warren Buffett say, in the short term, we should not care about the movement of the stock price. But over the long run, the stock price does reflect the fundamentals of the business. For stocks receiving a 5-star ranking, the average annualized gain in the period of 1998-2008 was 12.1% and only 3% that were in loss in that 10-year holding period. So I begin to search for 5-star predictability, combined with sustainable earnings and cash flows, trading at reasonable prices that plunged for a year.
One of the stocks that catches my eye is Medifast (MED, Financial). It has a five-star predictability ranking. At the end of December 2010, it was trading at $30 per share, and now it is hovering around the $15.8 level, a discount from the high of nearly 50%. For the last 10 years, the stock price has been on a roller coaster in a wider and wider range.
MED was incorporated in 1993, operating mainly via five of its wholly owned subsidiaries, Jason Pharmaceuticals, Take Shape for Life (TSFL), Jason Enterprise, Jason Properties and Sven Crondall. It is engaged in the production, distribution and sale of weight management and disease management products and other consumable health and diet products. The products were primarily manufactured in its FDA-approved facility in Owings Mills, Md. It has different distributions channels:
· First is Medifast Direct, where customers can order Medifast products directly through the company’s website or from its in-house call center. Then the products can be shipped to the customers' homes.
· Second is via Take Shape for Life, the personal coaching division of MED. The coaching network consists of independent contractor health coaches, who are trained to provide coaching and support to clients on MED weight-loss programs. The coaches will earn compensation on products sales by referring clients to the website or in-house center to purchase products. It is one of the network marketing methods and TSFL is a member of Direct Selling Associations.
· The third channel is Medifast Weight Control Center, the brick-and-mortar clinic channel of MED with locations in Texas, Florida, Maryland and Virginia. Currently it has a total of 39 locations in operation. The good thing here is the company began the franchise model for its clinic in 2008. Now it has 22 franchise operations already.
· Last but not least, MED uses physicians to distribute its products as well. These physicians carry an inventory of Medifast products and resell them to patients. MED’s management estimates more than 20,000 physicians nationwide had recommended Medifast as a treatment for their overweight patients since 1980, and over 1 million patients have used its products via physicians’ recommendations.
For the operating performance for the last 10 years, it has had consistent growth in revenue and fluctuating but on the rising trend operating income and net income. Operating margin and the net margin is staying at 12% and around 7%, respectively.
| USD million | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 |
| Revenue | 5 | 12 | 25 | 27 | 40 | 74 | 84 | 105 | 166 | 258 |
| Operating Income | 1 | 2 | 4 | 3 | 4 | 8 | 6 | 8 | 19 | 32 |
| Net Income | 1 | 3 | 2 | 2 | 3 | 5 | 4 | 5 | 12 | 20 |
Any investor would feel very good when looking at 10-year historical ROE. Most of the time MED had double-digit returns on equity, iresulting from the consistent increase in asset turn over since 2004, with the net margin fluctuating around 4-7% whereas the financial leverage for the last five years was around 1.3.
| 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | |
| Net Margin % | 10.7 | 19.5 | 9.27 | 6.32 | 6.07 | 6.86 | 4.58 | 5.15 | 7.22 | 7.61 |
| Asset Turnover | 1.55 | 1.86 | 1.49 | 1.09 | 1.42 | 2.2 | 2.08 | 2.23 | 2.91 | 3.28 |
| Financial Leverage | 2.96 | 2.15 | 1.48 | 1.39 | 1.39 | 1.31 | 1.35 | 1.34 | 1.27 | 1.31 |
| Return on Equity % | 59.8 | 84 | 22.4 | 9.85 | 12 | 20.3 | 12.7 | 15.4 | 27.3 | 32.3 |
In addition to the level of profitability and operating performance, MED has produced an increasing level of operating cash flow over time, and the free cash flow has begun to turn positive over the last two years.
| USD million | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 |
| CFO | 1 | 2 | 2 | 2 | 3 | 6 | 8 | 5 | 20 | 29 |
| FCF | 1 | -2 | -2 | 0 | 2 | -2 | 0 | -2 | 15 | 17 |
In terms of financial strength, MED has quite a conservative financial structure, with D/A just a little bit more than 30%, including only around 4% of total assets in debt. The majority of liabilities items are accounts payable and accrued expense. In the asset side, it has $18.5 million in liquid cash, and investment securities worth $18.5 million as of September 2010. Adjusting the level of debt and cash, the enterprise value of MED is around $230 million.
Currently, in the stock market, MED is valued at 10.8x P/E, 3.4 times book and only 6.5x operating cash flows, lower compared to both historical valuation and the industry average. Competitors such as Herbalife (HLF, Financial), and Weight Watchers International (WTW, Financial) or NutriSystem (NTRI, Financial) are trading at more than 17x P/E, and around 5x-12x book value (except WTW because it has negative book value).
In terms of guru trading, MED falls into the portfolio of Joel Greenblatt; he began to buy the stock for around $21 per share and added more when it fell to the $18 level. However, with the insider holding of 11%, it was not so significant but not so little for us to ignore. The insiders have kept selling the shares out, especially when it was at the $29 to $35 level.
There is even one director selling out at $15.12, but the amount of shares is negligible; we should not take it into consideration much.
In conclusion, the business of MED seems very intriguing, with the overweight products being delivered in four outstanding channels including franchise systems. The growth of revenue, operating income and cash flow combined with the conservative structure in its balance sheet would give investors a good sleep at night. And especially because the valuation is much lower compared to the peers in the same industry and to historical valuation, the current price is attractive to initiate a long position.
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
