GNC vs. Vitamin Shoppe: The Better Buy

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

The vitamin supplement industry is expected to grow by 4% a year through 2015 according to the Nutrition Business Journal (NBJ), with the vitamins and sports segments expected to grow even quicker. Taking advantage of this trend towards personal health are two companies that stand on the forefront of the supplement industry. GNC Holdings (NYSE: GNC) and Vitamin Shoppe (NYSE: VSI) are the two largest players in the industry, with Nature’s Bounty and BodyBuilding.com following far behind. Together those four companies only control 14% of the entire supplement industry's market share. This highly fragmented industry will likely see consolidation in the near future. Both GNC and Vitamin Shoppe are prepared to take advantage of this despite having surprisingly different business models.

Business Models

Vitamin Shoppe has 545 corporately owned, domestic stores, with no international exposure and no franchised locations. GNC on the other hand has 7,777 locations. 5,988 of the stores are domestic, with the majority of these being corporately owned. The remaining 1,789 stores are international and are primarily franchised locations.

Vitamin Shoppe tends to choose larger store front locations in high traffic, high visibility areas. They rely heavily on walk in traffic. GNC on the other hand tends to choose smaller locations that are often tucked away in strip malls or shopping malls. They rely more heavily on advertising than Vitamin Shoppe.

Both companies also have an online presence, but GNC’s e-commerce platform is far larger than Vitamin Shoppe’s. Vitamin Shoppe has only one website vitaminshoppe.com, while GNC owns the names gnc.com, drugstore.com and luckyvitamins.com. GNC is pushing website sales far harder than Vitamin Shoppe is. Additionally GNC is far more vertically integrated than VSI. GNC has their own product lines, and manufacturing lines. These factors have allowed GNC to have better profit margins of 8.5% compared to VSI’s 7.4%.

Additionally GNC has several partnerships that have helped them grow their revenues. Both Petsmart (NASDAQ: PETM) and Wal-Mart (NYSE: WMT) owned Sam’s Club buy wholesale supplements that GNC manufactures. Additionally GNC has a “store within a store” partnership agreement with Rite-Aid (NYSE: RAD) that allows GNC to sell their products inside of Rite-Aid’s stores. To date there are over 2100 Rite-Aid store within a store locations.

Growth

Both companies are growing earnings and revenues significantly, but they are growing both these metrics in different ways.

GNC is only planning to grow its store count by about 4% a year. They are growing their earnings by moving customers from lower priced products to higher priced products, cross selling products to pre-existing customers, building a customer base that creates frequent repeat sales, and by increasing the prominence of their online presence.

Higher Priced Products

GNC tends to price their products higher than other vitamin shops. Additionally their employees are paid a commission based on sales. This encourages staff to push customers towards higher priced, higher margin products.

Cross Promotion

GNC has been working to create and market more new products that allow for cross promotion between brands. One area where the company is really showing growth is in their Vitapak product line. In their most recent conference call the CEO, Joseph Fortunato, in reference to the Vitapak line stated “40% of sports customers are now purchasing Vitapaks…. We own and dominate that space”. Later during the call he stated that customers are purchasing three or four items on each visit where they used to be purchasing only one or two.

Repeat Sales

During their most recent conference call Fortunato also said that part of their strategy involved “incremental increases in sales”. GNC has been trying to increase the number of times a customer visits a store or visits their online store after they make an initial purchase. To encourage customer loyalty they have implemented a Gold Card membership. This membership costs $15 a year and gives the member a 20% discount on all products the day they join as well as a 20% discount on the first seven days of each month for the entire year after they purchase the card. This program has had massive success as 50% of retail sales are now from Gold Card members with members spending on average twice as much as non-members.

Online Presence

GNC is heavily pushing online sales by labeling many of their products with the address of their website gnc.com, as well as emailing Gold Card members with updates on products linking back to gnc.com. Last year gnc.com saw sales growth of 34.1%.

Though GNC’s online presence presents a tremendous opportunity to the company it also poses a threat. Many franchisees feel that GNC is trying to increase corporate sales from their websites and corporate locations at the expense of their franchisees sales. There have been several lawsuits over the years by franchisees claiming that GNC has been unfairly competing against them by opening up corporate locations close by and pushing customers to direct sales from gnc.com rather than the customer’s local franchise owned locations. Franchisees also feel competition from the Rite-Aid store within a store locations. If these franchisees continue to feel disenfranchised then GNC may have problems in the future trying to grow their store count.

Vitamin Shoppe however does not have these problems. Because all of their locations are corporately owned there is no conflict of interest between the company and franchisees. This allows Vitamin Shoppe to myopically focus on its own goal, which is to grow its store count, and increase earnings.

Vitamin Shoppe is primarily growing by increasing its store count. Unlike GNC’s measly growth of 4% a year VSI is growing its number of stores by over 10% a year. Over the last 5 years (from the beginning of FY 2007 to 2012) GNC has nearly doubled its store count from 232 to 533. This growth in store count has helped GNC grow its EPS almost 20-fold from $0.08 in 2007 to $1.56 in 2012. In addition to store count growth VSI is also increasing its direct sales via its website, and the number of repeat purchases their stores receive, albeit not by as much as GNC.

Healthy Awards Program

Vitamin Shoppe has a customer loyalty program similar to GNC’s gold card. Under this program members receive one point for each dollar they spend at a Vitamin Shoppe location. At the end of the year they are mailed a gift certificate whose value is determined based on how many points the member has accumulated. Unlike GNC’s Gold Card the Healthy Awards Program is free to join. Currently they have enrolled over 4.6 million members.

Direct Sales

Last quarter Vitamin Shoppe increased its sales from vitaminshoppe.com by 15.5% compared to the same quarter last year. This gain in website sales revenue has been partly offset by a decline in catalogue sales. The net effect on direct sales from these two segments has been an increase in revenues by 11.8% over the same quarter last year. This growth, though strong, is significantly below GNC’s direct sales growth.

Maturation of Stores

In their most recent 10-K filing Vitamin Shoppe stated that:

“[Our] stores typically require approximately four years to mature generating lower store level sales in the initial years than our mature stores. As a result, new stores generally have a negative impact on our overall operating margin and sales per square foot. As our recently opened stores mature, we expect them to contribute meaningfully to our operating results.”

Since almost half of VSI’s stores have been opened within the last four years it is likely that we will see Vitamin Shoppe’s EPS continue to grow significantly over time. This opportunity for growth may not be fully realized in the stock’s current share price.

Product Prices

Missing from Vitamin Shoppe’s growth strategy is an increase in product prices. Unlike GNC Vitamin Shoppe tends to charge a lower price than many of its competitors. Additionally employees are not payed based on commission so there is no incentive for the employees to move customers from lower priced products to higher priced products. This may hurt VSI’s margins, but could also be a source of potential growth in the future if Vitamin Shoppe chooses to switch to a compensation-based model.

Valuation

Multiple and Growth

GNC trades at 21.91 times earnings with a foreword PE of 15.86. Vitamin Shoppe on the other hand trades at 30.5 times earnings with a foreword PE of 22.86. Despite the higher multiple VSI is expected to grow at about the same rate as GNC, with VSI’s 5 year growth rate estimated at 21.28% and GNC’s at 20.04% per year. This makes GNC undervalued relative to Vitamin Shoppe.

Managements Use of Cash

Both companies throw off a significant amount of cash, and both companies have seen dilution through grants of options and shares to employees. GNC however has been using its cash to buy back shares. Recently the company has announced a $300 million share buyback program that will more than offset any dilution seen through the exercise of their stock options. VSI on the other hand will see their shares significantly diluted in the future. The company has granted two million options on the company at an average strike price that is about a third of the companies current share price. If (When) these options are exercised VSI should see their company’s shares diluted by more than 6.5%.

GNC is financing both the dividend and share buybacks largely through debt. VSI on the other hand has used its cash exclusively for organic growth and to pay down its debt. The company currently does not pay a dividend, however it is likely that it will in the future now that its debt has been completely payed off. This gives Vitamin Shoppe a much better financial standing than GNC, but the fact that GNC is buying back shares and paying a dividend might make GNC a better buy. The high debt levels of GNC put the company at risk in the event of a financial catastrophe, however because interest rates are so low today, it may make financial sense for the company to finance its activities through debt.

Conclusion

Both companies appear to be a buy, however, based on the lower earnings multiple, the past consistency of growth, and the higher margins that GNC commands for their products GNC looks like the better buy. The company does however have some major concerns going forward; problems with franchisees, large levels of increasing debt and the size of the company itself may threaten the company’s success in the future. As long as management is able to deal with these issues effectively GNC’s share price should continue to go up as both revenues and earnings increase.


 Kyle has a position in both Vitamin Shoppe and GNC. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend PetSmart. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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