Weight Watchers Goes on a Crash Diet

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Weight Watchers (NYSE: WTW) recently put itself on a crash diet. Instead of shedding unwanted pounds, however, the company lost nearly a fifth of its market cap in a single day. What caused this steep crash? Did overweight people in America and around the world simply give up on weight loss programs, or is the 50-year old company struggling with growing pains, as hungry, aggressive competitors nip at its heels? Let’s take a look at Weight Watchers’ financials and see if the company can put on some pounds again.

The classic weight loss program

Founded in 1963 and with a presence in 30 countries around the world, Weight Watchers is the largest weight loss program in the world. The company’s current program is called “PointsPlus,” which counts calories as points to help members improve their eating habits. Membership programs traditionally consist of regular food deliveries and face-to-face or online meetings to track member performance. 

Fourth Quarter Earnings

For its fourth quarter, the company posted a net profit of $58 million, down from $63.7 million in the prior year quarter. However, excluding one-time benefits and charges, the company earned 96 cents per share, up from 86 cents per share a year earlier. Meanwhile, revenue rose 1.7% to $407.9 million.

Both its top and bottom lines exceeded the Thomson Reuters forecast, which called for earnings of 87 cents per share on revenue of $398 million.

Looking ahead, Weight Watchers expects to earn $3.50 to $4.00 per share for the year, missing the Thomson Reuters’ consensus of $4.75. Three primary concerns caused its guidance to be slashed: competition, marketing and recruitment.

Increased Competition

The company attributed its lowered guidance to increased competition from Nestle SA, Jenny Craig, Nutrisystem (NASDAQ: NTRI) and Medifast (NYSE: MED), which all offer weight-loss programs. To combat these rivals, Weight Watchers increased its marketing expenses by 5.8%, which caused overhead costs to rise 21%. The company has aggressively used new, expensive TV campaigns and online ads targeting men in the United States, which have made little impact.

Expensive, Ineffective Marketing

CEO David Kirchhoff admitted that the company’s current marketing has been ineffective in recruiting new members, especially in the United States and the United Kingdom. “Our January ads lacked the persuasion we needed,” he stated bluntly. He also blamed decreased spending power in these markets. “Consumers saw their paychecks shrinking by mid-January. Suffice it to say the timing was less than ideal for us,” he told analysts.

Recruitment and Attendance

However, the real reason for Weight Watchers’ slide was another key figure: attendance. During the fourth quarter, Weight Watchers’ attendance dropped 14%. The company expects this trend to continue, and expects an additional “mid-to-high teen” decline in attendance in the first quarter of 2013.

In other words, fewer people are signing up, so investors can expect a big revenue and earnings miss in the first quarter. On the bright side, Weight Watchers’ smaller online service posted 4.5% growth, which represents a possible avenue of growth and expansion.

The Foolish Fundamentals

But before we proclaim that it’s time to sell or short this stock, we need to compare its fundamentals to two smaller rivals -- Nutrisystem and Medifast.

Nutrisystem originally sold weight loss products and offered consultations at its brick and mortar locations, but now only sells products on a direct-to-consumer model on television, and at retail outlets such as Costco and Kroger.

Medifast was founded by William Vitale, M.D., who sold his products directly to other doctors who prescribed them to patients. With the strong, credible backing of medical institutions, Medifast products became extremely popular after they were offered to the public.

Let’s see how these two companies, with their different business models targeting the same demographic, compare to Weight Watchers on a fundamental scale.

<table> <tbody> <tr> <td> </td> <td>Market Cap</td> <td>Forward P/E</td> <td>5-year PEG</td> <td>Price to Sales (ttm)</td> <td>Price to Book</td> <td>Profit Margin</td> </tr> <tr> <td><strong>Weight Watchers</strong></td> <td>$2.35 billion</td> <td>9.57</td> <td>1.28</td> <td>1.65</td> <td>N/A (negative book value)</td> <td>14.45%</td> </tr> <tr> <td><strong>Nutrisystem</strong></td> <td>$239.77 million</td> <td>23.48</td> <td>3.66</td> <td>0.61</td> <td>3.50</td> <td>0.27%</td> </tr> <tr> <td><strong>Medifast</strong></td> <td>$338.32 million</td> <td>13.89</td> <td>1.16</td> <td>0.98</td> <td>3.87</td> <td>4.43%</td> </tr> <tr> <td><strong>Advantage</strong></td> <td> </td> <td>Weight Watchers</td> <td>Medifast</td> <td>Nutrisystem</td> <td>Nutrisystem</td> <td>Weight Watchers</td> </tr> </tbody> </table>

Source: Yahoo Finance

Weight Watchers is a fundamentally strong stock, cheaper than its industry peers with much higher profit margins. However, fundamentals should also be scaled against financial growth over the past five years to accurately gauge the company’s health. Let’s measure the top and bottom line growth of these companies.

<img src="http://media.ycharts.com/charts/b58a37075dc1562f833e0ffda76c9e28.png" />

WTW Revenue TTM data by YCharts

Although Weight Watchers has grown revenue 20.96% over the past five years, its diluted earnings per share has soared 61.48%. This was attributed to its strong operating margins, which have consistently stayed above 25% during that period.

Yet it’s painfully clear that Medifast is the major growth stock in this industry. Medifast’s smaller size also makes it a more exciting growth stock than Weight Watchers. Although Weight Watchers is still faring better than Nutrisystem, it’s clear that the company needs to spur growth soon.

Lastly, we need to check the company’s cash and debt levels. Medifast’s growth in this department simply leaves Weight Watchers and Nutrisystem in the dust, as seen in this next chart.

<img src="http://media.ycharts.com/charts/c9b39b79fd8b316de3c94d87e2353eda.png" />

WTW Cash and Equivalents data by YCharts

To top off this mediocre cash growth, here are two other figures that might be hard to digest.

Weight Watchers only has $80.59 million in cash reserves, but is shouldering $2.415 billion in debt -- not exactly much breathing room for new marketing initiatives to attract new subscribers.

The Bottom Line

Weight Watchers’ rising overhead costs, declining subscriptions and increased advertising budgets all point to declining free cash flow around the corner. Those nasty problems make its robust fourth quarter earnings and revenue irrelevant, and caused the company to lose too much market weight. If Weight Watchers can scale back on its face-to-face services and capitalize on the growth in its fully online services, then it may be able to pack on the pounds again. 

Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. You can follow Leo Sun on Twitter at https://twitter.com/leokornsun for more investing ideas.

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