(Published Feb. 23 by Bob Ciura)
Shares of consumer products company Nu Skin Enterprises (NUS, Financial) crashed 11% after the company missed analyst expectations on both sales and earnings per share for the fourth quarter.
Nu Skin has struggled mightily over the past three years. In January 2014, the company was hit with an investigation by Chinese regulatory authorities into the firm’s business practices.
But it’s not all bad news – Nu Skin’s earnings are growing, and the stock has a 3% dividend yield.
Plus, Nu Skin raised its dividend by 1.4% after providing its earnings report.
This makes 16 years in a row of annual dividend hikes. Nu Skin is a group of 272 stocks with 10+ years of consecutive dividend increases, known as the Dividend Achievers.
You can see the full Dividend Achievers List here.
Nu Skin has come a long way since the investigation, and has made meaningful strides in turning around the China business.
The stock could be a buying opportunity due to its low valuation and growth potential.
Business overview
Nu Skin was started in 1984 by five founders. It was initially a skin-care products company. It realized rapid success from its popular products, and use of a direct sales force.
Through various acquisitions, the company expanded its portfolio. It now has a balanced business model between skin care and nutritional products.
Source: ICR Presentation, page 5
Today, Nu Skin generates annual sales in excess of $2.2 billion. It offers more than 200 products in 50 markets around the world.
The direct-to-consumer model has received scrutiny lately. Allegations have been raised that it can lead to a firm generating more revenue from signing up new salespeople than by selling the products themselves.
The 2014 investigation in China began when regulatory agencies became concerned that the company could be structured as a pyramid scheme.
This caused Nu Skin’s share price to crash 33% in a single day when the investigation was announced since China is a major market for the company.
Source: ICR Presentation, page 7
Nu Skin was once one of the market’s darling growth stocks.
In 2013, shares soared from $41 to $136. But the investigation brought Nu Skin’s momentum to a screeching halt.
By the end of 2014, the stock was back to $42.
After vigorously defending itself, the company has worked its way back from the investigation and gradually restored its business in China.
Source: ICR Presentation, page 8
Revenue in China rose 8% in 2016.
However, there remains a considerable amount of volatility in the company’s financial performance.
Growth prospects
For the fourth quarter, Nu Skin reported adjusted earnings per share of 79 cents. While that represented 27% year-over-year growth, the result missed analyst expectations by 1 cent per share.
Revenue came in at $531 million, which was down 7% year over year, and fell well short of forecasts. Expectations were for $553 million.
Despite the weak fourth quarter revenue, the company still achieved earnings growth for the full year. Earnings per share rose 13% to $2.55 in 2016.
At the midpoint of management’s outlook, 2017 could bring another 25% in earnings-per-share growth.
Nu Skin expects revenue to grow 4% to 6% this year, thanks to new product releases and continued growth of its legacy portfolio.
The company is also benefiting from cost cuts. Profit margin expanded roughly 50 basis points in 2016.
In addition, earnings per share will see a boost from share repurchases. Since the core business is profitable, Nu Skin uses excess cash flow to buy back stock.
Last year, the company reduced its diluted share count by 5%.
Competitive advantages and recession performance
The most important competitive advantage for a beauty and nutritional products company is brand strength. Fads come and go, but strong brands stand the test of time.
Nu Skin prides itself on its Innovation Center, where it develops new products. It has massive R&D facilities in the U.S. and Shanghai.
The company’s investments in R&D have paid off. Nu Skin has introduced several new products over the past several years, which have generated billions in sales.
Source: ICR Presentation, page 15
The company can afford to spend generously on R&D, because of its consistent profitability and strong balance sheet.
At the end of 2016, Nu Skin held $368 million in cash and short-term investments on its balance sheet, compared with $334 million in long-term debt.
Source: ICR Presentation, page 6
Nu Skin’s focus on product innovation has provided the company with durable competitive advantages.
Since beauty and nutritional products are surprisingly resistant to recessions, Nu Skin performed very well during the financial crisis.
Its earnings per share during the Great Recession of 2007-2009 are shown below:
- 2007 earnings per share of 87 cents.
- 2008 earnings per share of $1.02 (17% increase).
- 2009 earnings per share of $1.40 (37% increase).
Valuation and expected total returns
Nu Skin shares currently trade for a price-earnings (P/E) ratio of 19 on a trailing basis. The stock has a P/E ratio of 15, based on management’s forecast for 2017.
These are reasonable valuation multiples, given the Standard & Poor's 500 Index has a P/E ratio of 26.
This could indicate the stock is undervalued. It is not surprising to see why, given the 2014 investigation in China.
The market loathes uncertainty. It is customary to see an elevated level of regulatory risk result in a lower valuation multiple.
However, this could be a value opportunity, since the company seems to be past its issues in China.
Future returns will also be comprised of earnings-per-share growth and dividends. A modest forecast for future returns could be:
- 3 to 5% organic revenue growth.
- 1% earnings growth from margin expansion.
- 2% earnings growth from share repurchases.
- 3% dividend yield.
Under this scenario, future returns could reach 9% to 11% annually, excluding any gains from an expanding valuation multiple.
Final thoughts
While the stock market as a whole is nearing all-time highs, companies that miss fourth-quarter expectations like Nu Skin are getting punished.
Situations like these could present a buying opportunity.
Nu Skin’s sales fell in the fourth quarter, but overall the company had a good year in 2016. Sales rose in China, which is a good sign that the worst is over.
There remains a certain level of skepticism regarding the direct-to-consumer business model. But until proven otherwise, Nu Skin’s performance remains solid.
Value and income investors could see reason to like Nu Skin, for its modest valuation and 3% dividend yield.
Disclosure: I am not long any of the stocks mentioned in this article.
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