1 Undervalued Consumer Stock, 2 Overvalued Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As the economy regains strength, investors should consider backing consumer good stocks that are likely to rise from greater spending during a full recovery. In some instances, stocks have been overly beaten down from criticism over a fundamentally weak consumer base. Some stocks have been overly hyped due to prospects of a turnaround. In my view, investors should take advantage of companies that have had a low bar set for them, and definitely steer away from companies that are currently struggling but priced as though they will recover soon.
Herbalife (NYSE: HLF): Not A Ponzi Scheme
Apparently, these days if you are in the business of multi-level marketing, you are running Ponzi scheme. Or at least, that's what the bears covering Herbalife would have you believe. At a respective 13.7x and 11.3x past and forward earnings, the stock is at a bargain as it continues to grow in the double digits. During the 5-year period surrounding the recession, EPS grew 28% annually! Analysts "only" forecast 15.5% annual EPS growth over the next 5 years.
Assuming Herbalife merely meets analyst forecasts, 2016 EPS will come out to $6.96. At a multiple of 16x, this translates to a future stock value of $111.36. Discounting backwards by 10% yields a present value of around $70, which is roughly where the stock was before Einhorn implicitly argued that there was a lack of sales coming directly from consumers. However, the company continues to be a strong producer of earnings.
And it is because of strong investments in training program, like the 5K supervisor qualification, that Herbalife can continue to deliver excellent results. In 2011, 20% of global supervisors came in through the 5K method; but in Russia, where the method was first implemented, the rate is 45%. Meanwhile, Herbalife24 is branding the company as hip and cool, which can attract younger consumers for longer streams of free cash flow. I recommend buying shares of Herbalife to profit from both growing volumes and multiples.
After years of letting the company underperform, Avon's Executive Chairman Andrea Jung has finally decided to step down from the board early. While growth has been strong in Brazil, management has failed to expand and instead relied on a series of cost cutting measures that have failed to offset the impact of lower-than-expected demand. To be sure, there is still more room to improve working capital, but the future lies in penetrating emerging markets. It also doesn't help that Deutsche Bank is forecasting to company to see nearly a 1,000 bps decline in ROE.
Unfortunately, Avon has lost the appeal it once had, and thus cannot rely on leveraging its brand to instantly produce results. It is therefore surprising that the company would trade at above 29x past earnings, which is at a substantial premium to the multiple on the S&P 500. Estee Lauder is similarly expensive; but at least it has produced a much better track record in recent years. In fact, despite macro uncertainty, it is impressive that Estee Lauder has been able to stay afloat as well as it has.
While Estee Lauder has the capital to expend on promotions should consumer confidence go south, according to Morningstar operating margins would need to rise by 300 bps to 16% in 2014 to justify the current market cap. Morningstar has been bearish on the stock, and while I agree with most of its analysis, I believe that "product innovation" is not the solution to greater purchasing discrimination from consumers.
Consumers tend to be very unpredictable, but they can be swayed by greater recognition that comes through marketing. That's why I think Estee Lauder should take advantage of its premium identity compared to Avon and start solidifying that image into a full recovery. Even if the company does this, however, there won't be too much upside given the need for margins expansions. Accordingly, I recommend holding out.
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