Usana Health Sciences, Inc. (USNA, Financial) appears on not one, but three, different GuruFocus screens: Undervalued Predictable, Buffett-Munger, and Peter Lynch. As reported by Vera Yuan in the June edition of the article How Many Stocks Can Pass GuruFocus Value Screeners? getting through three screens puts USNA in an elite group; it's just one of 15 stocks out of a field of 16,884 stocks to make it. USNA also made it through the same triple screening process in May and April.
On the other hand, USNA attracts the interest of lots of short sellers, as the following chart shows:
Like Herbalife (the subject of a major announcement by guru and short seller Bill Ackman, Pershing Square Capital Management, on July 22, 2014), Usana uses multi-level marketing (also called MLM or network marketing) to drive its sales. And like Herbalife, Usana has many critics who say MLM will will be - or should be - the death of it.
So, what is Usana Health Sciences and what should we know about it? More specifically, is this a true value opportunity? We'll try to answer that question in this article.
History
- 1992: company founded by Dr. Myron Wentz, a microbiologist and immunologist, to manufacture nutritional supplements, foods, and personal-care products;
- 1996: listed on NASDAQ;
- 2004: listed on S&P Small Cap 600 Index;
- 2010: receives license to begin operating BabyCare in China;
- 2011: begins trading on the New York Stock Exchange (NYSE);
- 2013: begins operating in Colombia, its 19th international market.
This history based on information provided at the Usana website.
Usana's Business Model
Research, develop, and sell proprietary products;
Focus on products that promote long-term health and reduce the risk of chronic degenerative disease;
Market those products through direct sales by independent, commissioned sales people (like Tupperware, for example). It reports that it prefers this approach because, "We believe that network marketing is an effective way to distribute our products because it allows person-to-person product education and testimonials, as well as higher levels of customer service, all of which are not as readily available through other distribution channels."
The company has two types of 'customers': ‘‘Associates’’ and ‘‘Preferred Customers.’’;
Associates are independent distributors and consumers of products; they number 265,000 worldwide; new Associates must purchase a starter kit at cost at a cost of about $30.00 and meet modest monthly sales quotas;
Preferred Customers purchase products strictly for personal use and are not permitted to resell or to distribute the products; 78,000 worldwide;
Customers must pay when they purchase products, minimizing accounts receivable for Usana;
32% of revenue in 2013 came from Auto Order, a monthly subscription program;
Sales are segmented by region: (1) North America and Europe and (2) Asia Pacific (the latter is further subdivided); The following shows sales for the respective regions and subregions:
In 2013, just over 78% of sales came from markets outside the U.S.A.
Based on information in the 10-K report for 2013.
Growth Strategy
"Our primary objective, both on a short- and long-term basis, is to strengthen and grow our active customer counts throughout the world." Initiatives to drive that objective include the following:
- simplification of the pricing structure (including an overall 10% price reduction),
- increasing compensation for newer Associates, and changing the commission qualification requirements;
- market-specific strategies included a price reduction in several of its mature markets.
The company reports these initiatives "created pressure on our operating results" but that targeted metrics have improved as a result.
Ongoing international development is aimed at finding new customers in currently untapped markets.
It does some online selling, but apparently does not plan to grow the business that way; and, has restricted online cross-border sales.
Management
- Founder and Chairman of the Board: Myron Wentz, Ph.D., has been with the company since its inception in 1992. Sole owner of Gull Holdings, Ltd, which owned more than 47% of Usana Health Sciences' stock at the end of 2013 (note the difference between shares outstanding and the float);
- Chief Executive Officer: David Wentz, also with the company since 1992, is a member of the Direct Selling Association, and has served as its chairman;
- Chief Legal Officer and General Counsel: James Bramble, who has also run political campaigns for candidates for the Utah State Legislature;
- Chief Financial Officer: Paul Jones, also manages investor relations;
- Board of Directors: Chairman Myron Wentz and four independent directors;
- Independent Directors: Robert Anciaux, age 68, director since 1996, managing director of a consulting and management investment firm in Belgium; Ronald S. Poelman, age 60, director since 1995, partner in a law firm; Jerry G. McClain , age 73, director since 2001, investment and real estate entrepreneur; and Gilbert A. Fuller, age 73, director since 2012, former CFO of Usana (director profiles from Forbes.com).
- ISS Governance QuickScore: 5/10, with 1 being a good score and 10 being a poor score. Usana Health Sciences receives red flags for Board Composition, Composition of Committees, Use of Equity, and Audit and Accounting Controversies; it receives two green stars, for Voting Issues and Voting Formalities.
USNA by the Numbers
Ownership
Based on information at the GuruFocus website, USNA is owned by the following:
Gurus: four gurus followed by GuruFocus have stock, only one of which (Jim Simons (Trades, Portfolio)) is a substantial holding:
Institutional Investors: 56% of the float;
Insiders: 9% of the float; and as noted above, founder Myron Wentz owned just over 47% of the company as of year end, 2013, through his Gull Holdings, Ltd. That means insiders own approximately 56% of the outstanding shares, a major commitment;
Shorts: 30.6% of the float, which is high, but not as high as it has been in the past:
Multi-level marketing companies, like Usana and its competitor Herbalife (HLF, Financial), continue to attract detractors, who claim the companies operate thinly disguised pyramid schemes. We'll discuss this further in the Outlook section.
Financial Strength
As the following visual summaries show, Usana Health Sciences scores a 9/10 for financial strength and 9/10 for profitability & growth:
GuruFocus also posts one severe warning sign, which is that the company has a high level of short sellers, which would indicate many investors expect the price to fall, rather than rise. We will address the shorting issue in the Outlook section of this article.
Valuations
As we noted at the beginning of this article, Usana Health Sciences comes up on three value screens: Undervalued Predictable, Buffett-Munger, and Peter Lynch.
Undervalued Predictable: As the GuruFocus calculator shows, the current price sits well below the discounted cash flow value:
Turning to the Predictable side, GuruFocus backtesting has found 4-star stocks, like USNA, gain an average of 9.8% per year, and only 8% are in a loss position after 10 years.
Buffett-Munger refers of course to Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio), the titans who built Berkshire Hathaway. They say this about their key metric, "We use PEPG as indicator. PEPG is the P/E ratio divided by the average growth rate of EBITDA over the past 5 years." In addition, they want stocks with a high predictability factor. USNA's EBITDA growth rate over the past five years has been an impressive 23.20%, while its trailing P/E is 13.20. And, as noted, it gets a 4-Star rting for predictability.
Peter Lynch: This screener focuses on the relationship between the share price and a theoretical P/E of 15. According to the GuruFocus visual valuation summary, Usana should be priced at $133.01 (when the current price is to the right of the dotted vertical line, the stock is undervalued, and when price to the left of the dotted line, it is considered overvalued:
Risks
As the preceding information and data showed, this company has quite consistently delivered earnings to investors through its roughly two-decade history. Operations do not seem to have been a problem.
The biggest problem, for Usana and its peers, is multi-level marketing. This marketing channel has been attacked over and over, since it gained prominence in the years after World War II. Its critics call it a pyramid scheme and even a Ponzi scheme.
Most recently, that ghost of markets past was resurrected by Bill Ackman of Pershing Square Capital Management who brought his nearly two-year campaign against Herbalife to a crescendo on July 22nd (2014). Unfortunately for Ackman and his reported $1-billion short bet on Herbalife, the market soundly repudiated his thesis. Investors immediately bid up the price of the company's shares.
USNA existing shareholders also saw a benefit, as the price of their stock rose strongly as well. Had the market accepted Ackman's claims, though, Usana might well have been seriously sideswiped.
In addition, short seller Citron Research and several class action lawfirms have set their sites on Usana. In a report from November 2012, Citron alleges that Usana is illegally operating in the People's Republic of China, "Multi-Level Marketing companies and their pyramid compensation schemes are completely illegal in mainland China. The MLM companies resort to one version of hanky-panky or another to show outscale growth rates from within China, which they add into their results to maintain their multiples."
The report goes on to allege that Usana management is not being forthright with investors and the Securities & Exchange Commission about the issue, "...management is lying about all this. But at a minimum, they aren't disclosing the real risks of their business to investors or the SEC."
On July 15, 2014, Citron renewed the attack, saying, "It is Citron’s belief that as much as 1/3rd of USANA’s revenue and half its revenue growth are dependent on widespread illegal MLM operations in China." In the wake of that announcement, several law firms interested in a class-action suit reported they were investigating the claims.
Usana disagrees with Citron, and the matter has not yet been resolved one way or another
Outlook
Is the future becoming impossible, then, for Usana and multi-level marketing companies?
I would argue it is not. While critics may frequently take aim, few of their shots have hit the target. There have been many investigations, but the big names keep on selling.
And, who would realistically expect a regulator or politicans to tell tens of thousands or hundreds of thousands of direct sellers that their livelihoods are being taken away. Critics, including disgruntled sales people, may get a few tweaks to the system, but no one is going to ban multi-level marketing.
For companies like Usana, and their investors, putting up with the critics and lawsuits will likely continue to be a cost of doing business, but not a prohibitive cost. And on the other side of the coin, it may give the direct sellers a moat of sorts, discouraging at least some newcomers.
And for those of us looking at value opportunities, it means leaving these fireworks behind and getting back to the basics: revenue, earnings, and share prices.
We will get a look at USNA's latest numbers next Tuesday, July 29th, after the market closes. At that time, it will release its second quarter 2014 results, and will follow up with a conference call the following morning.
Conclusions
While it may be controversial, Usana Health Sciences appears to be solid, well-managed company with outstanding growth, on both the top line and the bottom line. Insiders own some 56% of the company's outstanding shares, so they're maintaining their commitment.
Usana has earned a place on three different value screens at Gurufocus, a distinction shared by just 15 out of almost 17,000 different companies. That's backed up by high scores for financial strength, profitability, and growth.
Prices, though, will likely remain volatile as the various complaints and investigations work their way through the various systems. And, along the way, some will likely take a piece of the earnings pie, leaving investors worse off.
But for those who can live with the ups and downs, this is a company with outstanding potential and worth further study.
