Nu Skin Showing its Age?
Board: Value Hounds
All - I have been looking at Nu Skin who have been trading substantially lower than their price in January 2014. Would appreciate any feedback regarding my write up and conclusions outlined below.
A direct selling company operating in 53 markets. Develop and distribute anti aging products and nutritional supplements under the NuSkin and Pharmanex brands. Utilizing person to person marketing . Customers can purchase product directly through sales people or directlly from the company.
The Nu Skin brand markets and sells skin care products focused on anti aging. Their main product is ageLOC which accounted for 22% of total sales in 2013 and 42% of Nu Skin sales. The Parmanex brand markets and sells supplements and focused on their ageLOC TR90 supplement. This product represents Nu Skins offering for diet and lifestyle planning. TR90 accounted for 18% of all sales and 37% of Pharmanex sales.
Focus around direct selling utilizing person-to-person marketing and selling to consumers. Distribution is made of two groups; consumers who buy the product and the sales network who buy, use and resell product and recruit, train and develop new Sales Leads.
Revenue is created by selling product through direct sales or a sales person. In 2013 Mainland China accounted for 32% of total revenues with 92% of revenue sourced outside the US. In .2013 ~52% of revenues came Nu Skin
INCOME STATEMENT HIGHLIGHTS
One could easily pull the below from the income statement and balance statements. I have estimated the 2014 numbers based on Q1 and Q2 results and my read of the earnings transcripts, a bit subjective.
[See Post for Tables]
In early 2014 a news report was issued stating that Nu Skin was operating a suspected pyramid scheme in China, which was issued by a government run publication which prompted an investigation by the Chinese government. This prompted a substantial sell off of the stock in mid Jan. Recently the company was fined a small amount based an investigation provided by the regulatory agency. It seems the accusations in the article were not completely true, but I have read that China may be looking to change the regulations that affect multi-level-marketing companies. Not sure where this will go, but it seems there could be some challenges associated with the regulations. I assume management would anticipate this and work with the government to create regulations that work for both parties and that Nu Skin would changes its business model to mitigate impacts to revenues and earnings. I see this as the biggest hurdle currently. There have also been outspoken individuals about the legality of how this company operates its multi-level marking business.
As can be seen below, inventory has been increasing on a regular basis since 2010, which could be read as a sign of poor inventory management, slowing growth, etc. I was thinking that it could also be a sign of the company preparing for the next selling year and since between 2010 and 2013 the company was growing at a significant rate the inventory would grow as well. The part that does concern me is the number of weeks in inventory. It seems that if they were selling through the inventory that the turn-over would be a smaller number and not growing as it has. 2013 was a big inventory year and believe to prepare for what Nu Skin expected to be a stellar year with the selling of a new product. The regulatory thing occurred in China and the company could not sell its inventory, so the inventory numbers have not improved. In Q314, NuSkin wrote off $50M of inventory which hit the margins for Q114 and Q214 and will probably reduce them for the fiscal year. In my 2014 estimate I have assumed that inventory will continue to reduce with some inventory being written off.
All the ratios above appear to be healthy ratios you would want to see in a company. 2013 Current ratio was a bit low and I checked the financial statements and noticed that they had a significant increase in accrued sales commissions, which increased the current liabilities. I think this may have been done with the expectation that 2014 would be a big year for revenues and these commissions would be needed for 2014.
RETURN ON CAPITAL
Historic return on capital has been healthy and well above my estimated cost of capital for Nu Skin. 2014 I expect will see a significant reduction in ROC due to poor revenue. I estimate that 2015 will be similar to 2014. With these reductions in ROC I estimate negative short-term growth this year and next year with a move to positive growth in 2016, assuming they continue with similar capital investment.
To estimate where I think the stock will be I have made the following assumptions.
1. Cost of Capital = 11.66%.
2. Compound Annual Growth in EBIT = 8% over the next 5 years reducing to 2% forever.
3. Terminal Growth Rate = 2%
4. Terminal ROC = 11%, slightly lower than my cost of capital
5. Tax Rate = 35%
With these assumptions I estimate a stock price of $73/share. Keeping the above assumptions the same and reducing growth to 0% for the first 5 years, I estimate a stock price of $55/share.CONCLUSION
I have done my best to make what I feel are reasonable assumptions about growth, taxes, margins, cost of capital and ROC to determine a stock price. I have also looked at a scenerio where the company doesn't grow earnings in the next five years. I find the inventory trends a bit troubling, but feel the company was preparing for larger sales and was taken off guard by the regulatory investigation which put a big dent in revenues. I find it difficult to determine if this is a sign of larger problems related to supply and demand and whether their market is saturated or not. I do also think that revenue could be impacted by further regulation, but I doubt to the extent that the business will not increase revenues at all.
Finally, I do wonder about the long term prospects for this company. How many years can you sell face cream. Maybe they have acknowledge this limitation which is why they are tryinig to break into a lifestyle market. Another consideration is looking at AMWAY and AVON, who have been in business for a long time.
Appreciate the feedback.