Supplements Gaining Respect
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On October 30, the German drug company Bayer : BAYRY.PK) agreed to buy Schiff Nutrition International ) for $1.2 billion or $34 per share in cash. Schiff is a leading manufacturer of vitamins, nutritional supplements, and nutrition bars globally, focusing on the areas of joint care, heart health, immune support, and probiotics. The rich price tag values the company at 4.6 times FY2012 sales and 87.6 times FY2012 net income. Schiff joins Bayer’s Healthcare Group, which generated sales of €17.2 billion in the most recent fiscal year. Bayer is betting heavily on a continuation of recent sales growth trends, with Schiff forecasting 43-46% sales growth during FY2013.
During FY2012, Schiff generated net sales of $258.9 million and net income of $3.7 million, increases of 21.2% and 8.6%, respectively, over the prior year. The gross margin expanded to 46.1%, the highest level of the past few years and above the five year average of 40.6%. Meanwhile, operating and net margins of 9.8% and 5.3%, respectively, were in line with the prior year and below the five year averages. During 2012, the company grew primarily through acquisitions, purchasing two probiotic brands and the Airborne brand of immune support products. These purchases were in line with the company’s strategic move toward more profitable, branded products and away from private label products. Schiff’s recent quarterly results bear the fruit of this strategy, as the company’s results showed improved growth and exceeded the market’s expectations. Net sales for the quarter ending August 31, 2012 were $85.1 million and net income was $6.0 million, increases of 46.2% and 28.2%, respectively. Operating margins also improved during the quarter, as the recent acquisitions have led to improved product lines and greater efficiencies in sales and marketing activities.
The merger with Bayer follows previous deals in the sector, as drug companies try to diversify into alternative areas outside of the traditional pharmaceutical business. According to industry estimates, 2010 sales of nutritional supplements were approximately $29 billion, as consumers sought to promote health and extend their active lifestyles. The nutritional supplement industry enjoys relatively light oversight, due to a 1994 law passed by Congress that regulates the products as a food product, rather than as a drug. As a result, FDA approval is generally not needed prior to sale, although manufacturers must determine product safety prior to marketing activities. More recent laws have added good manufacturing practices and reporting requirements for adverse events, as the FDA seeks to protect consumers from unsafe products. While the requirements have added costs, smart companies have been able to differentiate themselves through quality manufacturing processes and strong customer service.
Now that Schiff has decided to sell to a larger competitor, where will an investor find the next promising investment in the sector? Since the industry is highly fragmented and most of the companies are privately owned, a direct investment is unlikely. Instead, investors should be looking down the distribution chain. While the majority of the industry’s sales are to the mass merchandisers, Costco Wholesale and Wal-Mart in Schiff’s case, investors should be looking at the specialty retailers with knowledgeable sales staffs and a diversified geographic presence. These retailers, including GNC ) and Vitamin Shoppe ), have been earning a larger share of consumers' wallets and have continued to report strong results. In the third quarter of 2012, GNC reported revenues and net income of $621.6 million and $62.6 million, increases of 15.5% and 28.5%, respectively. The company grew its net store count and customer base during the quarter, with same store sales rising 9.8%. Meanwhile, Vitamin Shoppe reported a similarly strong business environment during the third quarter of 2012, with revenues and net income of $239.0 million and $16.3 million, increases of 14.4% and 36.8%, respectively. The company kept pace with its larger competitor by also growing its store count and customer base, reporting a same store sales increase of 9.6% during the quarter. Looking ahead to 2013, both companies expect further increases to their base of stores and their ability to generate increasing sales in existing stores.
The nutrition business is healthy, as the manufacturers and distributors of the industry's products can attest to through their financial results. Investors have recognized the industry's growth trajectory, with share prices for GNC and Vitamin Shoppe having increased approximately 25% and 51%, respectively, in 2012. Given the companies' recent share price appreciation and above average P/E multiples, investors should watch and wait for an opportunity to invest on any pullback in share prices.
rghanley owns shares of Schiff Nutrition International and GNC Holdings. 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.If you have questions about this post or the Fool’s blog network, click here for information.