Are Direct Sales Dying?
AnnaLisa is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Direct selling is hard, hard work. There’s a great line in ‘Glengarry Glen Ross,’ the movie about hapless real estate salesmen: “Put. That. Coffee. Down. Coffee’s for closers only.” Unfortunately, the salesmen pushing Rio Rancho Estates in the movie probably have it easier than the independent salespeople selling Nu Skin Enterprises Inc . (NYSE: NUS), Avon Products Inc (NYSE: AVP) and Herbalife Ltd (NYSE: HLF). On Learnvest, a financial website for women, one writer detailed her experiences selling for Mary Kay, and it inspired me to start working on this subject of multilevel marketing and person to person sales. That was Monday.
Tuesday August 7, dawns and Citron Research does one of their pieces on Nu Skin, basically stating that it is operating a pyramid operation in China, which is illegal, and that the company is in danger of being thrown out. And the stock dives. Wednesday dawns and the stock has fallen further and a litigation boutique is trolling for Nu Skin shareholders. Now I hate to pile in on a stock when it’s already down due to a Citron Research or streetsweeper article. They did a lot of damage to Questcor Pharmaceuticals earlier this year, unfairly in my opinion. But in the case of Nu Skin, an anti-aging and nutrition product developer and distributor, I have to agree that the stock has problems going forward.
What's Wrong With Multi-Level Marketing
Multilevel marketing is one of the more annoying modern evils, along with the designated hitter rule, speed cameras and emails from Nigeria. The former Mary Kay saleswoman said that after exhausting friends and family what’s left is the dreaded cold calling. Girl Scouts can tell you this is hard work even with a superior product and people who are inclined to buy from you. When you are selling direct you have to have an almost superhuman confidence, the personality to sell ice in the Arctic to people dying of hypothermia and an immunity to rejection.
In multilevel marketing/direct selling the salesforce does all the heavy lifting (and often has to buy the inventory) until they can recruit other people to become salespeople and make the real money. And thus the cycle starts. That’s why I would never buy any companies that structure their salesforce this way. It is simply unsustainable, especially in developed nations where the social bonds are not as strong as they were decades ago, where people are mistrustful of strangers and where alternatives to buying these companies’ products are so widely available. These companies are making money now but the majority of it is coming from Latin America and China. As China and Latin America are traditionally more family oriented and more open to supporting family members' business initiative, these strategies can conceivably work for a while until a salesperson's familial and social network is exhausted.
Nu Skin gets over a third of its revenues from China and the company reported better than expected numbers in July. The company pays a dividend of 1.60% and has a reasonable P/E of 13.66 (even more reasonable since it started diving.) The company rebutted the Citron Research piece stating that Chinese officials regularly check their business and had offered new licenses. Nu Skin hit an all time high of $62.02 on March 26 and has steadily been drifting lower since then, mostly on sympathy with the Herbalife stock decline after David Einhorn called into question their sales numbers to end customers and distributors at the earnings press conference in May. This is exactly the kind of problem that the woman who worked for Mary Kay had; she had to buy all this inventory and was stuck with it. And the only people making money were the ones who had salespeople under them doing the work.
Herbalife, which markets nutritional and personal care products like Nu Skin, surprised with better than expected numbers, particularly from China. There are, of course, advantages to this model. No bricks and mortar overhead, no salaried sales staff and someone (all too often the salesperson) ends up buying the products, which leads to bigger profits and margins. Word of mouth is a very effective way to sell, maybe the best. And this is not a screed against these companies' actual products but just the method of distribution.
Of note, another problem with Herbalife is their ‘Nutrition Clubs,’ which seem to operate with the secrecy of Prohibition speakeasies as no signage is allowed that would advertise them to possible customers, where no evidence of sales is to be visible from the street and where customers have to pay a fee to attend. And these clubs are supposedly generating a third of their sales. I just don’t buy that unless they’re putting bathtub gin in those herbal shakes.
Herbalife has a 14.00 P/E, pays a 2.20% dividend and is headquartered in the Cayman Islands. The company just took on another line of credit, so has debt of $559.51 billion to total cash of $286.17 billion.
To be fair, Happi Magazine (the publication of the Household and Personal Products Industry) just published their top 50 leading US companies in the global HAPPI industry list for the first half of the year, and surprisingly Nu Skin was number 19 with sales of $964 million beating out Tupperware at number 22 with $676 million and Herbalife at number 43 with $127 million in sales.
What About Avon?
Avon finished number four on the HAPPI top 50 list, just after Procter & Gamble, Colgate-Palmolive and SC Johnson, with $7.7 billion in sales. It seems that Avon, purveyor of beauty and personal products, is somewhat working even with a 20th century business model. And Avon, after all, was desirable enough for Coty to want to buy it out not so long ago. Avon was actually founded in the 19th century in 1886 and still probably has one of the most recognizable brands with its famous Avon Calling ad campaign of the last century.
It’s paying a hefty 5.90% yield but has a P/E of 28.26. It has been trading lower since 2009 while most personal products companies have been gradually trending higher. The analyst community has been downbeat on this name and they see growth continue to erode. Quarterly earnings growth is at -70.10% year over year. It also has $3.54 billion in debt and $1.31 billion in total cash.
The Final Takeaway
There are companies tinkering with multilevel marketing in ways that can work and that are not based on a greater fool theory. Having inventory gathering dust in a salesperson's basement isn't making anybody money. If end users aren't buying then it is a pyramid and Herbalife and Nu Skin, in particular, are vulnerable. If they get thrown out of China, however unlikely that is, all bets are off.
You may like these companies’ products. Go ahead and buy them and take them off the hands of the long suffering salesperson. Just don’t invest in these stocks. Their earnings and dividends can look OK, but building a company’s fortunes on the willingness of salespeople to buy inventory up front and flog the products to friends, family and neighbors only to have to finally sell them off at a yard sale is just not a solid business model. There are so many better stocks in the world. Go pound the pavement and find them.
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