Buy This High Growth Nutritional Supplement Retailer

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Goldman Sachs recently reported that they have increased their rating on nutritional supplement retailer, GNC Holdings (NYSE: GNC). The firm has upgraded GNC from “Neutral” to “Buy,” and has increased the company’s price target from $44 to $50. A Goldman Sachs analyst commented:

The story’s underlying appeal relates to wellness exposure / rapid category growth; an emerging global presence in a potent category; heavy private brand representation that protects margins and provides shelter from online incursions; a new marketing campaign; and shareholder-friendly capital allocation.

Right now there are no companies with a dominating position in the nutritional supplements industry, making it an industry of investors’ paradise. A growing health consciousness, fueled by increasing research and mass communication, has opened the door to every age level, and has helped nutritional supplements shoot well pass the $10 billion mark. In this post I will share why I believe GNC Holdings is a compelling growth story in this industry.

Company Overview

Pittsburgh-based GNC Holdings, formerly known as General Nutrition, operates a chain of health and wellness stores throughout the United States and internationally. The company is a global specialty retailer of health and wellness products including vitamins, minerals and herbal supplements ("VMHS") products, sports nutrition products and diet products.

The company's well-known brands include Mega Men, Ultra Mega, GNC Total Lean, Pro Performance, and Pro Performance AMP, as well as internationally recognized third-party brands. The company sells many of its nutritional products through its more than 5,900 retail locations in the United States in addition to more than 2,100 store-within-a-store locations at Rite Aid pharmacies. It also has distribution and franchise locations in 56 countries around the globe.

2012 Financial Highlights

  • The company grew its customer base adding 1.1 million Gold Card members, and 2.2 million email addresses. They now have nearly 6 million active Gold Card members and more than 11 million email addresses.
  • In each quarter of 2012, domestic retail same-store sales exceeded 20% on a two-year basis.
  • Online GNC.com posted its fourth consecutive year of revenue growth greater than 25%, expanded operating margins, conversion rate increased 50 bps, and unique visitors were up nearly 20%.
  • LuckyVitamin.com also grew revenues by more than 25% on a pro forma basis; leveraging GNC’s merchandising and marketing capabilities. EBITDA margin rate expanded as the business capitalized on an expected supply chain efficiencies.
  • Canadian operation posted a strong year on the strength of new product innovations.

GNC’s High Gross Margin leads to a Solid Balance Sheet 

GNC’s product line includes a lot of proprietary products. The increased prevalence of proprietary products naturally increases their gross margin because the company is vertically integrated. GNC manages their whole supply chain from acquiring materials, production, inventory and distribution. They own the trucks and lease out all the real estate. Proprietary production allows them to cut out the middle men and achieve a higher gross margin on products.

The trend in operating margins can be summarized by the following quote from GNC's 10K:

A significant portion of our business infrastructure is comprised of fixed operating costs. Our vertically-integrated distribution network and manufacturing capacity can support higher sales volume without significant incremental costs. We therefore expect our operating expenses to grow at a lesser rate than our revenues, resulting in positive operating leverage.

GNC’s Competitors

GNC generates an impressive FCF (free cash flow), which is significantly higher than nearest competitors. As I stated above, GNC has been maintaining a strong gross margin, which translates into a robust FCF. 

GNC Free Cash Flow TTM data by YCharts

GNC's advertising campaign creates an impression of favorable prices. In reality, rival Vitamin Shoppe (NYSE: VSI) offers lower prices. Vitamin Shoppe is a New Jersey-based retailer of nutritional supplements. They also operate stores in Canada under the name "VitaPath."

Vitamin Shoppe also has better customer service, as voiced by many individual polls online. However, overall service includes convenience, as detailed in this report. By pursuing a policy of a larger number of smaller stores, GNC is more convenient for a majority of potential new customers and current customers, with 5,988 stores compared with Vitamin Shoppe's 543 stores in 37 states. GNC also attracts customers through exclusive deals with supplement producers. GNC has been able to gain exclusive access to certain products, which is extremely important in an industry, where consumer tastes can change rapidly.

USANA Health Sciences (NYSE: USNA), another competitor of GNC, offers a healthy food product line comprising of low-glycemic meal replacement shakes, snack bars, and other related products that offer consumers macro-nutrition. GNC has been lagging behind USANA in offering such a product line.

USANA also manufactures the number one pharmaceutical grade and athlete approved multi vitamin and mega antioxidant products, multi minerals, nutritional supplements, weight loss and weight management, energy products, anti-aging and beauty products. These supplements provide a foundation of nutrition for various age groups including baby boomers. The company also offers targeted supplements supporting needs such as cardiovascular health, skeletal, muscular and tissue health, and digestive health.

The Bottom Line

GNC has been delivering positive earnings surprises ever since its initial public offering in April 2011, resulting in a more than two-fold growth in its stock price. With an average earnings surprise of about 20% over the last six quarters and a long-term growth projection of about 18%, this health supplement retailer is a solid pick for growth.

 


Anindya7 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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