Don't Give Up on Direct Selling Yet

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

It’s useful to follow successful fund managers on the street, as their insights are backed by their research teams. However they themselves cannot guarantee returns and mistakes are bound to happen. Bill Ackman, one of the top few successful fund managers, recently revealed that he had short positions in Herbalife (NYSE: HLF). The announcement led to the tumble of Herbalife and direct selling companies weren’t spared either. However I believe that this is a buying opportunity, and investors should take advantage of the selloff. Here are a few reasons to support the claim.

According to FTC, “Multi-level marketing (MLM) is a purported income opportunity, in which persons recruited into a pyramid of participants make on-going purchases of products and services, and recruit others to do the same, and they still others, etc. – in an endless chain of recruitment and personal consumption, in order to qualify for commissions and bonuses and to advance upward in the hierarchy of levels in the pyramid. Product purchases become the means of disguising or laundering investments in what is in fact a product-based pyramid scheme.”

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Debt/Equity</p> </td> <td> <p>ROE</p> </td> <td> <p>Gross Margin</p> </td> </tr> <tr> <td> <p>NuSkin</p> </td> <td> <p>38%</p> </td> <td> <p>38.9%</p> </td> <td> <p>83.7%</p> </td> </tr> <tr> <td> <p>Herbalife</p> </td> <td> <p>135%</p> </td> <td> <p>104%</p> </td> <td> <p>80.1%</p> </td> </tr> <tr> <td> <p>Avon Products</p> </td> <td> <p>228%</p> </td> <td> <p>7.10%</p> </td> <td> <p>60.86%</p> </td> </tr> </tbody> </table>

Financial Metrics indicate that Herbalife enjoys one of the highest ROE and gross margins amongst the peers. But according to Ackman, Herbalife is an unsustainable pyramid company. Its top sales leaders get most of the compensation, and according to Ackman, its revenues are masked by entering new markets. This makes it hard to evaluate Herbalife, and it makes sense. Ackman also showed evidence that Herbalife makes money only through its network, and that once it stops expanding, Herbalife would collapse exponentially. Avon Products (NYSE: AVP), another MLM company, recently cut its dividend payout by 73%. Its revenues and profits have been shrinking for the last 5 years, and its payout ratio is still 341%, which appears to be unsustainable.

However NuSkin (NYSE: NUS) seems to be beaten down unnecessarily. An investment research firm Citron had claimed that NuSkin is an illegal pyramid scheme operating in China. The management didn’t take long to produce evidence which shows that it’s not a pyramid company.

Firstly NuSkin has obtained all the necessary licenses and permissions from Chinese authorities, to operate in the country. Also in an MLM model, the company pays only commissions to its distributors, but NuSkin provides regular salaries with healthcare packages. If a company hires sales force and opens up new stores, it won’t be called a pyramid scheme. The management plans to triple its stores in China, over the next 5 years.

Its current ratio equates to a respectable 2.3x and its P/FCF comes out to be a healthy 9.18x. This indicates that NuSkin won’t have any problems in repaying its unplanned short term liabilities. Additionally the company is not burdened with debt as its debt/equity stands at a modest 32%. Its shares trade at a forward P/E of 8.52x with a PEG of 0.68x, indicating that its shares are undervalued with respect to its earnings and growth prospects. NuSkin also enjoys the highest gross margins amongst the peers, yields 2.42% with a modest payout of 22%. Analysts expect its annual EPS growth to average around 14.7%, which means that the stock could double in value in less than 5 years.

In my opinion, investors should stay distant from Herbalife and Avon Products as both of them operate under a typical MLM structure. Given the fact that they cannot keep growing forever, in order to sustain themselves, should discourage investors. NuSkin however has been beaten down by the pessimism of The Street, and it makes a great investment option due to all the mentioned reasons.



PiyushArora has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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