As the market continues to hold near all-time highs and at historically-stretched valuations thanks to easy monetary policy, it has become increasingly harder to find great companies trading at compelling enough prices to warrant the investment of our hard-earned capital. Because of this, many investors today have found themselves either putting any cash back into the high-priced market hoping the ride continues upward, or simply sitting on the sidelines with a pile of cash waiting for the much-elusive correction to finally arrive.
Unfortunately, both options pose risk-reward profiles that might not be suitable for the long-term financial success of many investors. In the current market environment, it is imperative that we keep our portfolios lean, making sure we stay away from fattened stocks while not starving our portfolios of gains all together. Fortunately, we can do just, through the addition of the undervalued, nutrition-packed Weight Watchers International, Inc. (WTW) to our investing diet.
The rise of a weight management juggernaut
What started as one woman’s confession of a love for cookies (and who can blame her?) to her friends one night in her Queens apartment ultimately led to the globally recognized weight management solutions and support company we know today.
Weight Watchers was founded in 1961 as a result of Jean Nidetch’s gathering with her friends and their mutual commitment to losing weight and supporting one another along the way. The group soon discovered that weight loss was much more than just dieting and that long-lasting results also required a similar support system to offer encouragement and help one another stick to their weight loss goals.
The success of the group of women paved the way for the incorporation of Weight Watchers in May 1963, where the first public meeting in a loft in Queens drew a crowd of over 400 people despite no formal advertising. The business soon expanded as several former members began opening franchises in other locations, stretching across the U.S. and internationally. Throughout its growth, the company focused on delivering and setting the highest standards in weight loss and control programs, continually refining its programs to meet the needs of its consumers.
Weight Watchers was so successful through its efforts that H.J. Heinz Company purchased the company in 1978. Under H.J. Heinz, the company began offering entire food product lines designed to fit into the Weight Watchers program, which could now also be used by nonmembers as well, further fueling the growth of the company.
In 1999, H.J. Heinz put the company up for sale. It was purchased by Artal Group S.A. in a leveraged buyout for $735 million – $223.7 million of cash from Artal with the rest financed through debt. Artal Group is the investment fund managed by The Invus Group, Ltd., a private equity firm formed in New York by Raymond Debbane, engaged by Artal Luxembourg S.A. to manage money for several wealthy European families.
After acquiring the company, Debbane and Artal Group reorganized the company’s management and strengthened its strategic focus. The success over the following years led to the company’s IPO in 2001, in which Artal Group offered 23.6% of the company’s common shares to the public while retaining control.
Since then, Weight Watchers has become a global-branded consumer company and the world’s leading commercial provider of weight management services through its global operations. Branded products and services include self-conducted meetings, digital weight management products provided through its website and mobile apps, products sold at meetings and through retail channels, as well as magazine subscriptions and other publications. Most of the company’s revenue originates from its subscription services for its monthly commitment plan for Weight Watchers meetings and its online products.
2011 marked the company’s most profitable year, generating $1.82 billion in revenue with $305 million in net income (diluted earnings per share of $4.11/share). Weight Watchers was actively returning capital to its shareholders through its $0.70/share annual dividend and its share repurchase program. In the preceding years, the company reduced its share count from 105.5 million shares outstanding at its IPO down to 73.6 million shares outstanding as of January 31, 2012. Better yet, the company also just initiated a new share repurchase plan to buy additional shares between $72-$83/share – this plan would ultimately be responsible for reducing the share count by an additional 18.3 million shares. Shortly after releasing these results in early 2012, the company’s shares changed hands at prices in the low $80s.
Market challenges send WTW shares down like the weight of its customers
When everything seems to be going right is usually the exact moment things take a turn for the worse. It’s important for us all as investors to realize this and to be aware of the possibility. Weight Watchers presented just this case coming out of 2011 and leading into the next few years. From the low $80s, the stock has now dropped to the current price of $5.49/share as investors impatiently waited (and gave up) on the company’s second wind.
2012 was a year of slightly increasing revenues for Weight Watchers, with a decrease in member meetings being offset with an increase in online revenues. However, the company saw an increase in its interest expense, thanks to the new debt taken out to finance the share repurchases in 2012. This led to the decrease in the company’s net income, starting the trend of declining net income which has still yet to be broken.
Unfortunately, enrollments continued to decline and in-member and online meetings fell precipitously in the wake of a more challenging marketplace. Despite the company’s new initiatives to attract new members, the increased competition from low-cost mobile-based applications and activity monitors continued to eat away at the company’s member base. This negative recruitment trend has only added fuel to the fire of the company’s decreasing revenues and income.
Management – led by CEO James Chambers and CFO Nicholas Hotchkin, and with the full support of Artal Group with Mr. Debbane as chairman of the board – has since acknowledged its late recognition to the change in the consumer’s focus from strictly food, nutrition and diet to one more based on integrated lifestyle and fitness approaches. As such, the company has focused on new innovations and partnerships addressing this change in consumer preference, including the selling of Fitbit products, as well as for consumers being able to sync their online accounts with several popular activity-tracking monitors like Fitbit, Jawbone and Apple’s (AAPL, Financial) Health app.
Additional avenues for growth opportunities are now being explored by the management team as well. With rising healthcare costs a concern for many employers and employees, efforts continue to be made to incorporate the company’s services and products into the corporate markets to lower healthcare costs and increase the overall well-being of employees. Addressing the healthcare market at large, Weight Watchers recently announced a new partnership with Humana, Inc. (HUM) to offer its weight management services as a part of coverage under certain employer-sponsored health plans.
Initial product and service enhancements and promotions failed to generate an amount of new member recruitment to offset the trending decline for the previous winter cycle – Weight Watchers’ business is highly seasonal and geared towards this time of year – but management has been quick to admit where the struggles have been, the lessons learned from the efforts to overcome the obstacles through consumer market testing, and the resulting moves necessary for the successful turn-around efforts for the company. Management has further shown its commitment through new product and service innovations and clearly have adjusted their focus to what the consumer is wanting as well as keeping their eyes and ears open to other potential avenues of growth such as those in the healthcare industry.
Company Financial Summary
Earnings
Weight Watchers recently announced earnings quarter ended April 4, 2015. While we will eventually work our way to these earnings results, let’s first focus on where the company ended 2014.
Per its 10-K/A filed on March 13, 2015, the company ended 2014 with the following earnings activity:
The following charts and information also show (1) the growth in the company’s revenues and net income (shown as trailing twelve months), (2) the company’s earnings per share (EPS), and (3) other key profitability and growth metrics, per GuruFocus:
As previously discussed, revenues started topping out in 2012 before the negative recruitment trends took its toll on the top-line in the more recent years. Net income actually topped out in 2011, due to the increased interest expense from the new debt used to buy back shares. However, this decrease in share count actually led to the increase in EPS between 2011 and 2012, before its top was reached. Since then, both revenues and net income have been on its downward trajectory, awaiting for signs of the company’s turn-around taking effect. Q1’s results stay true to the trend line and remain in-line with the company’s projected $0.40-$0.70 in diluted earnings per share for the full year 2015.
Financial Position
Weight Watchers had the following summarized balance sheet as of the quarter ended April 4, 2015:
The following charts and information also show (1) the change in company assets, liabilities, and equity, and (2) other key financial position and strength information, per GuruFocus:
Perhaps the most noticeable changes in the company’s financial position over the past 10 years are from the two major debt issuances in order to fund the share repurchase programs in 2007 and 2012. This also gave rise to the company’s large deficit in equity due to the large amounts held in treasury from repurchasing shares at or near all-time highs in the company’s history.
However, the more pressing issue on most investors’ minds is whether the company can maintain liquidity if and when it should return to financial growth and prosperity. Management has remained committed to maintaining liquidity, citing that the cash generated from its $1.15 billion revenue forecast, its cost-savings plan, and its cash on hand of $211 million will provide sufficient liquidity to meet its April 2016 debt maturity obligation of $228.7 million. This comes on the back of cutting company dividend in October 2013 to preserve capital resources as well.
Cash Flows
Turning our attention to the company’s cash flows, the following table summarizes the operating, investing and financing cash flows for 2014 as compared to the results from 2013:
In addition, the following chart from GuruFocus shows the changes to cash flow over the past 10 years:
As you would imagine, the decrease in revenues and earnings of course will eventually show up in the cash flow statement as well. This is reflected with the change in operating cash flows from $323.5 million in 2013 to $231.6 million in 2014, a year-over-year decline of 28.4%. Cash used for investing activities has held steady given the company’s efforts in revamping its products and services as part of the overall turn-around plan. Cash used from financing has decreased to better levels, marked in part by the dividend cut in late 2013. Keep in mind this will change moving into next year though when $228.7 million of debt comes due in April 2016.
Valuation
So far, we’ve discussed many of the background and ownership of Weight Watchers, along with the operating results the company has attained and the risks the company (or an investor) faces moving forward. However, we all know that the factual information alone does not determine investing success. Perhaps the more important factor is the price an investor will pay in relation to such facts and circumstances. Accordingly, we will now turn our focus to the valuation metrics of Weight Watchers in determining whether this company poses a safe place for an investor to park his or her capital to generate a reasonable financial return.
To start, let’s take a look at several of the most common valuation metrics based on the current market price of $5.49/share, as compared to the historic measure of these ratios. In the following in the following tables and charts, we will look at the price-to-earnings (P/E) ratio, the price-to-sales (P/S) ratio, and the price-to-free cash flow (PFCF) ratio, all based on the trailing twelve month (TTM) data.
As seen in the top picture, Weight Watchers boasts several of the best valuation metrics in not only the industry as a whole, but also in its own history. Granted, it’s important to realize this is in large part due to the deteriorating financial results of the company over the past few years. The being said, and under the realization that if/when the company regains financial momentum, most of these metrics will generally revert to their mean in the long-term. This should be promising to investors that any capital invested today is being used to obtain some of the greatest amounts of earnings, sales, etc. per dollar invested than at most any other time throughout the company’s history.
This is even more evident when viewing each individual chart, which shows the corresponding price at the 10-year median ratio. For example, Weight Watchers currently shows a P/S ratio of 0.2 in the above chart. However, the 10-year median ratio is 2.972. If the company was trading at a price representative of this median valuation ratio, the share price would be approximately $75/share, or an astounding 13 times higher than the current market price. Similar results can be seen in the other valuation metrics shown in the charts above.
Based on these factors, it appears that the market’s fears of the risks in the company’s turn-around have created a large amount of downward pressure on the stock price of Weight Watchers. However, as we have all heard Warren Buffett’s words, it is best to be greedy when others are fearful, and I believe the valuation metrics seen above are a perfect example of the (perhaps overblown) fears the market has currently priced into the shares today.
Additional considerations
While the valuation metrics certainly seem to more than justify the current operating risks facing Weight Watchers, we as investors should look and ask for even more in establishing a margin of safety for our invested capital. I believe that Weight Watchers offers a few other considerations to take into account, which may give more credence to an investor’s decision to invest.
First, being that Weight Watchers is a company controlled through Artal Group’s majority ownership, we should definitely try to find out more behind the controlling shareholder.
As mentioned, Debbane still remains Chairman of the Board for Weight Watchers and continues to be very much involved in the direction and focus of the company. Perhaps more importantly, Debbane has a knack for turning investment decisions into large profits. Actually, before Weight Watchers, he used Artal to invest in Keebler Foods in 1996, putting down about $61 million. After two years, Artal sold the stake in Keebler for about $1 billion, pulling a nice return in for his investors.
Debbane has already made his investment in Weight Watchers back several times over, making the initial commitment back from the sale of shares in the company’s IPO. He has generated around $3.8 billion in proceeds from selling stock in the IPO and the two share buyback plans and from collecting dividends on his controlling stake before the dividend was cut in 2013.
Even so, that does not mean Debbane is going to sit around and watch his fund’s position go to $0, particularly after adding over 694,000 shares to his position at an average share price over $21/share. Given his ability – and track record – to buy companies at cheap levels and then to profit from them once they have grown, what is to make the situation with Weight Watchers any different? After all, he’s done it once so far. With shares changing hands at these historically low levels and right before any effects of the company’s turnaround has been seen, it is not outside the realm of possibility that Mr. Debbane could put together a take-private bid for the shares he does not already own with a very generous premium to the market price.
Regardless, it is easy to see that Debbane and Artal Group are committed to Weight Watchers’ success, and as an investor it’s never a bad idea to be on the same side with someone holding such a profitable track record with his holdings.
While take-private deals are few and far between, the other consideration is much more prevalent in the public markets – the ever-so-present possibility of a short squeeze. As of May 15, approximately 43% of the public float is shorted, with Nasdaq showing this would take over seven days to cover based on the three-month daily average trading volume. This is a tremendous amount of shares to be short, and any positive news being able to trigger a swift upswing in price as investors shorting the stock begin to cover their positions, purchasing at even higher prices.
Investment strategies
Given the facts and the undervalued nature of the shares at today’s prices, the question a potential investor may be asking is how should one capitalize on this opportunity?
Of course the easiest answer and the one applicable to most investors would be to purchase shares with available capital at or around the current market price. Given that the share price has been suffering here in the past few weeks and have been following a downward trend, an investor may want to set their order with a limit price slightly below the current price in case the shares may be attained at even lower levels.
To those investors wishing to attain a bit more returns from using capital to invest in Weight Watchers, an option-writing (i.e. option selling) strategy may be the right one for you. I typically use these strategies myself when entering and exiting positions in order to generate additional returns. As always, it’s important to note that options involve risk and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss accordingly.
For those willing to purchase, say, 100 shares of Weight Watchers at the current market price, would you be even more willing to purchase those same 100 shares at a month or so from now at a price even lower than the market price? What if you could get paid to wait and purchase the shares at the lower price? Even better, right? This is essentially what writing cash-secured put options accomplishes.
Instead of paying $5.49/share today, one could instead agree to buy the shares at $5.00/share on July 17, 2015, by selling 1 put option (1 option contract equals 100 shares). This represents a discount to the current market price of about 8.93%. In agreeing to do so, an investor could currently be paid a premium of about $0.30/share (bid: $0.20 – ask: $0.40, absent of transaction fees) immediately. If the shares close on July 17th at a price below $5.00, you would purchase the 100 shares at $5.00/share, or $500. However, you would also have the $30 collected in premiums for selling the put options, leaving your true net cost at $470 for purchasing the shares, or $4.70/share. If the shares close on or above $5.00/share on July 17th, the option expires worthless and you get to keep the $30 you were paid in premiums. This represents a gain of 6.00% on the $500 of capital that would have been used to acquire the shares, or about 54.75% on an annualized basis for the 40 days of the option’s life. You could then follow up the next month by writing similar options to try and acquire the shares at a discounted price again.
However, you might not want to wait that long to acquire the shares, in fear of the shares running up in price in the short-term. Fear not, because an option-writing strategy can still be used. If you already own the shares or want to purchase the shares at today’s price, but still want to make sure you generate returns even if the stock price just hovers around its current levels for a while, you can actually juice your yield even more by writing covered call options.
Say you purchase 100 shares today at the market price of $5.49/share. However, you want to generate additional money while you wait for your shares to appreciate in value. To accomplish this, you could sell 1 call option to sell your 100 shares at $6.00/share on July 17, 2015. This represents a premium of 9.29% to the current market price. In doing so, you could currently receive about $0.30/share (bid: $0.25 – ask: $0.40, absent of transaction fees) just for agreeing to sell your shares at this price. If shares of Weight Watchers take off and rise above $6.00/share by July 17th, you’ll sell your shares at $6.00/share and receive $600 in proceeds. Additionally, you’ll get to keep the $30 in premiums you collected for selling the call option. If the shares close on July 17th below $6.00/share (even if your shares rise to $5.99/share), the call option will expire worthless and you’ll again get to keep the $30 in premiums for selling the call option. You would keep your 100 shares, and would still have generated a gain of about 5.46% on your allocated capital ($30 / $549), or an annualized gain of about 49.86% based on the 40 days of the option contract’s life. Just as before, you could then sell additional call options against the shares the next month in an attempt to generate additional returns.
Regardless of your investment strategy, this article has hopefully illustrated the undervalued nature of shares of Weight Watchers and has provided a few alternatives in how to capitalize on this mispricing offered to us by the market today.
Author disclosures
I am long WTW through my holdings of the company’s common shares. At current levels, I am also selling short-term put options at strike prices lower than the market price to potentially take advantage of acquiring additional shares at cheaper prices.
