Nu Skin: False Allegations, True Fundamentals
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Share prices of Nu Skin (NYSE: NUS) have seen a 12% downfall in the last 20 days after short-seller Citron Research published a report alleging that the personal-care products maker was operating an illegal multi-level marketing scheme in China. However, the company’s business model in China is different from its global model and is in compliance with local regulations.
In all of Nu Skin’s markets except for China, distributors who reach a certain sales level qualify to become executive distributors, allowing them to make a commission off of the sales of their recruits. This is prohibited in China; as a result, the company offers full or part-time employment as sales representatives to their higher-level distributors, who are paid a salary plus bonus based on their sales. Thus, we believe this is a sound business model that complies with Chinese regulations.
Last month, the company reported excellent Q2 results. The company’s strong convention sales and executive distributor growth continue to drive sales upside and leverage down the P&L. Moreover, the company is in the midst of a powerful product cycle, coupled with a concerted effort to improve margins that should drive EPS upside. With few signs of slowing momentum despite a tough macro other than tough comparisons, we believe there is a room for EPS upside as well as multiple expansions as the dust around multi-level direct sellers settles.
Strong Product Pipeline
As the company highlighted at its analyst day last November, there are planned new product launches through 2017, likely supported by significant distributor activity including regional and global conventions. In the nearer-term, the company is staging the rollout of its ageLOC R2 supplements and Body Galvanic Spa products over the next several quarters. The company is also set expand its portfolio with weight management products.
- Higher margin ageLOC products
Over the past couple of years the company has launched several different ageLOC products that have higher incremental margins with respect to the company average. As ageLOC becomes a larger piece of the business, we expect the higher incremental margins from these products to flow through to the bottom line. The company has historically been conservative with their guidance, beating the high end of their guidance range for fourteen straight quarters now (1Q09-2Q12). We continue to believe that the company will deliver better than anticipated results through the remainder of 2012 and into 2013 as the company continues to benefit from the roll-out of their latest line of ageLOC products.
- Growth opportunity with Weight Management
The global weight management market is growing rapidly (at 6% over the last 5 years) and now stands at $13 billion. Nu Skin’s entry into this market offers a huge growth opportunity. For instance, Nutrilite range of health supplements is the Amway’s largest selling brand and Amway’s ~$4 billion Chinese business is over 60% weight management.
With a soft global macro environment, there are concerns over the growth prospects of company’s largely premium-priced portfolio will perform. However, the company has been able to maintain its organic growth even in weaker macro environments, as evident from the 4% organic growth during the recession 4Q07-2Q09.
Recent macro slowdown in key markets like South Korea (16% of sales) and China (9% of sales and key to future growth) remain a concern, but the merits of the company’s subscription model (~ 56% of sales are recurring via customer subscription) and strong Q2 results suggest that the business will be far more resilient in the face of macro headwinds and largely immune from austerity-driven consumption declines and currency hit from Europe that many are facing. Moreover, as company laps the tsunami in Japan, trends there are beginning to improve.
While Nu Skin has produced double-digit growth since 2005, Avon and Blyth have experienced earnings contractions. Avon appears to be well past its glory days and as a result of a series of poor acquisitions, the company is also weak on its working capital position. However, Nu Skin is expected to continue its impressive run with further white space expansion opportunities and signs of stabilization off a much lower base in Japan. We are confident the company will get its weight management product right, which should provide another leg of growth as the company laps the strong results from its current R2 and Body Galvanic Spa launches. Thus, we recommend it a buy.
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