The FTC inquiry
The thing that matters for Herbalife stock (for both bulls and bears) is not "earnings": it is the state of the Federal Trade Commission inquiry into the company.
There is no assurance that the results of an FTC inquiry will come with earnings however the chance of an FTC result in the medium term is high. [The company has indicated settlement is near and they recently settled a very similar class action case.]
The FTC inquiry has a range of outcomes from ordering the company to close, to a fine plus imposed changes in business practice to doing nothing.
Given market expectations a a fine and compliance changes consistent with the changes that the company has put in place (and agreed to as part of the class action settlement) would be a substantial victory for Herbalife bulls.
Contra: a fine greater than $100 million and highly restrictive business conditions would be a very big loss for the company and shutting down the US operations of the company would be catastrophic.
If the company were to be closed asking about earnings would be silly. "Apart from that Mrs Lincoln how did you enjoy the play?"
Herbalife is an event-driven stock.
The rest of this post is based on the assumption that Herbalife eventually clears the FTC inquiry with minimal damage. It only makes sense to talk about earnings on that basis. The shorts I talk to are convinced the FTC will close Herbalife.
Shorts think there is no point in this post. There ain't no point talking about the company's earnings power when the bullet has already passed through the brain.
Volume growth by region
Herbalife has grown VOLUMES in almost every region in almost every quarter for a very long time. This volume growth slowed in the last quarter. The slowing volume growth was a big disappointment to some longs (including me).
Most longs are far more interested in volume growth than in actual profits. It is the old saw: profit growth is good volume growth is better. If volume is growing the considerable noise in this quarter (Venezuela, legal costs associated with defending the class action, settlement provisions) will go away. And the profit will grow in the future. If volume growth is higher than the discount rate (say higher than 8 percent) it is almost impossible to model what Herbalife is actually worth in a DCF model. With high volume growth you can plausibly make the case that Herbalife is worth a very large price to earnings multiple. You have to value it as a growth stock.
By contrast if volume is shrinking then it will deserve a low price-to-earnings multiple regardless of current earnings.
Fortunately for Herbalife volume growth has been good for many years (roughly coinciding with the arrival of Michael Johnson as CEO). The growth was still good last quarter albeit markedly slower and if the slow-down continues it isn't good for longs.
This is easily seen by looking at the data on VOLUME POINTS by quarter. A volume point is a measure of how much Herbalife product is sold. The volume points determine remuneration of the sales force and their definition has not changed. Volume points are thus a very good measure of volume.
Below I am going to cut and paste volume points from the results for the last twelve quarters. This will show the nature of the slowdown in the last quarter.
2011Q3
Here is the table from the report
Third Quarter 2011 Regional Key Metrics 2,3,4
| Volume Points (Mil) | Average Active Sales Leaders | |||||||||
| Region | 3Q'11 | Yr/Yr % Chg | 3Q'11 | Yr/Yr % Chg | ||||||
| 252.9 | 12.2 | % | 58,897 | 15.3 | % | |||||
| 261.2 | 36.2 | % | 51,644 | 38.5 | % | |||||
| EMEA | 132.4 | 15.8 | % | 39,227 | 16.7 | % | ||||
| 180.6 | 23.5 | % | 49,772 | 25.9 | % | |||||
| South & | 149.7 | 39.5 | % | 35,993 | 21.8 | % | ||||
| 40.3 | 2.3 | % | 9,533 | 26.3 | % | |||||
| Worldwide Total | 1017.1 | 23.4 | % | 236,191 | 23.6 | % | ||||
| Volume Points (Mil) | Average Active Sales Leaders | |||||||||
| 3Q'11 | Yr/Yr % Chg | 3Q'11 | Yr/Yr % Chg | |||||||
| Emerging Markets | 544.5 | 26.9 | % | 134,467 | 26.4 | % | ||||
| Established Markets | 472.6 | 19.5 | % | 109,339 | 19.3 | % | ||||
| Worldwide Total | 1017.1 | 23.4 | % | 236,191 | 23.6 | % | ||||
These rates are absurdly good. Volume growth is high in every region except China (where the base was tiny). The growth rate in mature regions (North America, Mexico) grew at 12.2 and 23.5 percent respectively. Growth was faster in emerging markets.
2011Q4
The company gave year on year and quarter on quarter volume growth statistics in the press release. Here is the quarter on quarter:
| Volume Points (Mil) | Average Active Sales Leaders | |||||||||
| Yr/Yr % | ||||||||||
| Region | 4Q'11 | Chg | 4Q'11 | Yr/Yr % Chg | ||||||
| 232.1 | 16 | % | 59,599 | 16 | % | |||||
| 257.9 | 37 | % | 55,124 | 39 | % | |||||
| EMEA | 137.7 | 10 | % | 41,618 | 17 | % | ||||
| 185.4 | 20 | % | 52,172 | 26 | % | |||||
| South & | 166.0 | 35 | % | 39,724 | 27 | % | ||||
| 43.1 | 13 | % | 10,077 | 28 | % | |||||
| Worldwide Total | 1,022.2 | 23 | % | 249,779 | 24 | % | ||||
| Volume Points (Mil) | Average Active Sales Leaders | |||||||||
| Yr/Yr % | ||||||||||
| 4Q'11 | Chg | 4Q'11 | Yr/Yr % Chg | |||||||
| Emerging Markets | 574.0 | 26 | % | 143,997 | 29 | % | ||||
| Established Markets | 448.2 | 20 | % | 112,792 | 20 | % | ||||
| Worldwide Total | 1,022.2 | 23 | % | 249,779 | 24 | % | ||||
2012Q1
Here are the quarterly numbers from the first quarter of 2012:
| Volume Points (Mil) | Average Active Sales Leaders | ||||||||
| Region | 1Q'12 | Yr/Yr % Chg | 1Q'12 | Yr/Yr % Chg | |||||
| 298.4 | 23 | % | 62,532 | 19 | % | ||||
| 273.8 | 38 | % | 55,706 | 38 | % | ||||
| EMEA | 145.9 | 6 | % | 41,332 | 15 | % | |||
| 191.4 | 16 | % | 52,674 | 24 | % | ||||
| South & | 164.7 | 32 | % | 40,614 | 31 | % | |||
| 40.9 | 25 | % | 9,531 | 31 | % | ||||
| Worldwide Total | 1,115.1 | 24 | % | 252,321 | 23 | % | |||
By this stage you should realize that growth rates in individual regions is volatile. Also the growth rate (24 percent) defies conventional discounted cash flow analysis.
2012Q2
Here is 2012Q2 -
Second Quarter Regional Key Metrics1,2
| Volume Points (Mil) | Average Active Sales Leaders | ||||||||||||||||||||||
| Region | 2Q'12 | Yr/Yr % Chg | 2Q'12 | Yr/Yr % Chg | |||||||||||||||||||
| 305.0 | 18 | % | 65,828 | 18 | % | ||||||||||||||||||
| 313.8 | 29 | % | 61,329 | 35 | % | ||||||||||||||||||
| EMEA | 154.5 | 13 | % | 42,972 | 14 | % | |||||||||||||||||
| 203.9 | 17 | % | 55,969 | 21 | % | ||||||||||||||||||
| South & | 167.2 | 30 | % | 41,966 | 27 | % | |||||||||||||||||
| 57.7 | 54 | % | 11,949 | 43 | % | ||||||||||||||||||
| Worldwide Total | 1,202.1 | 23 | % | 269,974 | 24 | % | |||||||||||||||||
2012Q3
The third quarter of 2012 has the first meaningful slowdown in growth.
Third Quarter Regional Key Metrics1,2
| Volume Points (Mil) | Average Active Sales Leaders | ||||||
| Region | 3Q'12 |
Yr/Yr % Chg
| 3Q'12 |
Yr/Yr % Chg
| |||
| 287.4 | 14 | % | 67,826 | 15 | % | ||
| 305.6 | 17 | % | 66,433 | 29 | % | ||
| EMEA | 145.5 | 10 | % | 44,861 | 14 | % | |
| 211.2 | 17 | % | 60,123 | 21 | % | ||
| South & | 186.0 | 24 | % | 46,466 | 29 | % | |
| 57.1 | 42 | % | 12,692 | 33 | % | ||
| Worldwide Total | 1,192.8 | 17 | % | 288,397 | 22 | % | |
Volume growth is only 17 percent. North America is back at 14 percent having been as high as 23 percent.
2012Q4
The Bill Ackman attack on Herbalife was just before Christmas in the dying days of this quarter. If Ackman was going to affect sales it was not likely to be meaningful this quarter.
| Volume Points (Mil) | Average Active Sales Leaders | ||||||
| Region | 4Q'12 | Yr/Yr % Chg | 4Q'12 | Yr/Yr % Chg | |||
| 267.0 | 15% | 68,029 | 14% | ||||
| 304.6 | 18% | 69,553 | 26% | ||||
| EMEA | 156.6 | 14% | 47,226 | 14% | |||
| 208.9 | 13% | 61,836 | 19% | ||||
| South & | 222.5 | 34% | 50,874 | 28% | |||
| 50.5 | 17% | 12,560 | 25% | ||||
| Worldwide Total | 1,210.1 | 18% | 300,521 | 20% | |||
The growth rate globally pipped up from 17 percent to 18 percent. Growth in China dropped from 42 percent to 17 percent. South and Central America went ballistic growing at 34 percent.
2013Q1
This was the first full quarter after Bill Ackman's attack. If there was going to be a slowdown you would see it here. Moreover you would probably see it in North America because Bill Ackman is far higher profile there than elsewhere. I doubt many Herbalife consumers in Brazil have heard of him.
First Quarter 2013 Key Metrics2,3
| Volume Points (Mil) | Average Active Sales Leaders | |||||||||||||
| Region | 1Q'13 | Yr/Yr % Chg | 1Q'13 | Yr/Yr % Chg | ||||||||||
| 309.0 | 4 | % | 68,352 | 9 | % | |||||||||
| 320.0 | 17 | % | 68,690 | 23 | % | |||||||||
| EMEA | 161.3 | 11 | % | 46,094 | 12 | % | ||||||||
| 206.3 | 8 | % | 60,216 | 14 | % | |||||||||
| South & | 219.8 | 33 | % | 52,049 | 28 | % | ||||||||
| 47.6 | 16 | % | 11,864 | 24 | % | |||||||||
| Worldwide Total | 1,264.0 | 13 | % | 296,916 | 18 | % | ||||||||
And yes - you can see it a little. The North American growth rate had slowed to 3 percent and (at 13 percent) this was actually the slowest growth globally recorded in this sequence.
Mexico - which is the best market of all for Herbalife - has slowed to a mere 8 percent volume growth.
2013Q2
At the end of the first quarter Herbalife implemented several important changes in part in response to Bill Ackman. The most important of these is that they banned lead selling and kicked the lead sellers out of the organization. The Herbalife distributor who was the source of Bill Ackman's nastiest examples (Shawn Dahl) moved to another distributor of diet shakes.
The company suggested that this would have a low single-digit negative effect on sales. Essentially they argued Bill Ackman's examples came from a small minority tagged onto a gigantic and effective selling machine.
Here are the results:
Second Quarter 2013 Key Metrics2,3
| Volume Points (Mil) | Average Active Sales Leaders | |||||||||
| Region | 2Q'13 | Yr/Yr % Chg | 2Q'13 | Yr/Yr % Chg | ||||||
| 339.9 | 11 | % | 72,282 | 10 | % | |||||
| 316.9 | 1 | % | 70,802 | 15 | % | |||||
| EMEA | 179.3 | 16 | % | 48,008 | 12 | % | ||||
| 219.9 | 8 | % | 62,940 | 13 | % | |||||
| South & | 222.6 | 33 | % | 54,614 | 30 | % | ||||
| 85.9 | 49 | % | 14,070 | 18 | % | |||||
| Worldwide Total | 1,364.5 | 14 | % | 311,503 | 15 | % | ||||
2013Q3
This quarter was interesting - but again the problem was not North America.
| Volume Points (Mil) | Average Active Sales Leaders | ||||||||||
| Region | 3Q'13 | Yr/Yr % Chg | 3Q'13 | Yr/Yr % Chg | |||||||
| 314.0 | 9 | % | 74,085 | 9 | % | ||||||
| 296.2 | -3 | % | 72,886 | 10 | % | ||||||
| EMEA | 173.5 | 19 | % | 50,720 | 13 | % | |||||
| 219.4 | 4 | % | 64,633 | 8 | % | ||||||
| South & | 245.2 | 32 | % | 60,007 | 29 | % | |||||
| 97.4 | 71 | % | 15,882 | 25 | % | ||||||
| Worldwide Total | 1,345.7 | 13 | % | 326,797 | 13 | % | |||||
An Ackman effect is not obviously present. The US growth rate is a very nice 9 percent - slightly slower than the second quarter.
China took off producing a rip-snorting 71 percent growth.
The Asia Pacific region printed a minus 3 percent number. This is the first negative number reported - and it took me some time to work out what went wrong. The main reason appeared to be the country head in Malaysia leaving for a competitor and stealing the client list as he went out the door.
Still the growth rate for the company was still at 13 percent - a rate most companies would envy - but clearly a slower growth rate than in 2011-12.
2013Q4
The fourth quarter of 2014 was a continuation of the third quarter but on steroids:
| Volume Points (Mil) | Average Active Sales Leaders | |||||||
| Region | 4Q'13 | Yr/Yr % Chg | 4Q'13 | Yr/Yr % Chg | ||||
| 287.0 | 7% | 73,511 | 8% | |||||
| 292.4 | -4% | 73,792 | 6% | |||||
| EMEA | 183.9 | 17% | 53,776 | 14% | ||||
| 218.7 | 5% | 66,535 | 8% | |||||
| South & | 278.6 | 25% | 65,690 | 29% | ||||
| 102.7 | 103% | 17,416 | 39% | |||||
| Worldwide Total | 1,363.3 | 13% | 339,744 | 13% | ||||
Global growth remained at 13 percent - but Asia Pacific was now minus 4 percent, North America slowed a little and China was a rip-snorting 103 percent.
2014Q1
The first quarter of 2014 showed the slowest growth ever - but still within guidance. Here are the numbers:
| Volume Points (Mil) | Average Active Sales Leaders | ||||||||||
| Region | 1Q'14 | Yr/Yr % Chg | 1Q'14 | Yr/Yr % Chg | |||||||
| 336.5 | 9 | % | 74,241 | 9 | % | ||||||
| 302.1 | (6 | %) | 71,627 | 4 | % | ||||||
| EMEA | 202.2 | 25 | % | 54,113 | 17 | % | |||||
| 220.2 | 7 | % | 63,568 | 6 | % | ||||||
| South & | 227.7 | 4 | % | 61,862 | 19 | % | |||||
| 91.1 | 91 | % | 16,648 | 40 | % | ||||||
| Worldwide Total | 1,379.8 | 9 | % | 329,902 | 11 | % | |||||
But the global growth rate at 9 percent represents a slowing. It didn't thrill the longs.
Herbalife as a growth stock of the highest quality
Growth here is lumpy but almost no companies short of Facebook, Twitter etc grow like this. This is a growth rate associated with the highest value silicon value companies.
The disconnect between longs and shorts in Herbalife was extreme. As a bull I regarded Herbalife as one of the highest quality growth stocks I had ever seen - deserving of a premium multiple.
Shorts see a criminal conspiracy.
For dozens of quarters in a row Herbalife beat its earnings guidance and raised guidance again. They tended to low-ball guidance but with growth like this it was possible to raise guidance sharply almost every quarter.
Stocks with this sort of record trade at 40 plus times earnings not under 10 times earnings. The upside was enormous...
And then came the second quarter. Herbalife beat earnings (no surprise there) BUT THEY DID NOT RAISE EARNINGS GUIDANCE.
As a long I was disappointed.
Here are the volume point numbers for the second quarter of 2014.
| Volume Points (Mil) | Average Active Sales Leaders | |||||||
| Region | 2Q'14 | Yr/Yr % Chg | 2Q'14 | Yr/Yr % Chg | ||||
| 335.8 | (1%) | 75,772 | 5% | |||||
| 320.2 | 1% | 74,916 | 6% | |||||
| EMEA | 218.8 | 22% | 56,692 | 18% | ||||
| 231.3 | 5% | 64,656 | 3% | |||||
| South & | 206.3 | (7%) | 62,172 | 14% | ||||
| 118.5 | 38% | 18,703 | 33% | |||||
| Worldwide Total | 1,430.9 | 5% | 340,644 | 9% | ||||
Worse - really good markets like South America had seemingly fallen off a cliff. The minus 7 percent in South America was ugly - by far the worst looking result recorded since the (seeming) miracle worker Michael Johnson became CEO.
North America also shrunk suggesting that the Ackman attack was biting. And growth in China was merely rapid rather than blisteringly fast.
The stock has been weak ever since.
It is this slowdown (or a possible reversal of it) which - outside a result from the FTC - is what longs will most be looking for.
And bluntly - if the growth rate were to accelerate again (say to 8-9 percent) and the FTC were to clear the company - the company should be valued as a super-premium growth stock. [$6.70 earnings per share times 30 = $200 per share does not seem unreasonable.]
However if the growth rate continues to decelerate (say to 3 percent per share) then a 14 times earnings - say $6.30 times 14 = $88.20 - seems reasonable.
The range of "fair values"
The range of "fair values" for this stock is enormous.
If the FTC closes them the fair value is something close to zero.
If the FTC clears them and the growth rate decelerates then the fair value is say $80 per share. This would be a nice upswing on the stock - but it would only take us back to the 52 week high - and that was after Ackman was shown to be wrong.
If the FTC clears them and the growth accelerates then fair value is plausibly somewhere about $200 per share. Longs like me would be cheering. Shorts would be brutalized. Pershing Square would survive - but Bill Ackman would not look great.
To say this is an interesting earnings announcement is understating it.
---
Good growth and bad growth - Venezuela
Amid all this growth the short-sellers have made a huge deal about the sales in a single country: Venezuela.
The problem is simple. If you send product to Venezuela you can't get paid. Its worse than that even - if you send product to Venezuela you may have to pay a non-Venezuelan upline US dollars against Bolivar that you can't convert to US dollars and can't repatriate.
Sending product to Venezuela is bad news.
Now it is bad news that is grotesquely overstated. Herbalife has been growing like a weed in many countries where it can repatriate money. However it is bad news nonetheless.
There are a few underlying issues:
(a). Venezuela - absent currency controls - would be an absolutely natural market company for a company selling weight loss solutions. Venezuelans are beauty obsessed. It is a darn pity for the company that one of their best markets has imploded through no fault of their own. Because Herbalife is naturally strong in Venezuela many of the top-level distributors throughout South America are of Venezuelan origin. I have met a few.
(b). It is very hard for a multi-level-marketing company to stop supplying people. There are tens of thousand of people who have built businesses around Herbalife in Venezuela. If Herbalife were to stop supplying them their businesses would collapse. Herbalife has long viewed maintaining a good relationship with their suppliers as an ethical priority. This is a partnership. They believe that it is deeply unethical to destroy people's business and close off supply if something like currency control is temporary. [Incidentally I agree with the company here. Time and again I have found this company to be highly ethical in direct contradiction to the short thesis and in contradiction to my original belief.]
(c). Against this as Venezuela's currency controls made it profitable to buy Herbalife in Bolivar, collect the upline payments in US dollars and truck the product to another South American country to sell.
Until very recently Herbalife shipped a lot of product to Venezuela and bore the losses. Herbalife sales - according to the conference call - fell 40 percent in Venezuela last quarter. This was the bulk of but not the entire reason for the 7 percent negative print in Central and South American volumes last quarter.
I hope that Herbalife publishes Central and South America including and not including Venezuela so we can see the real quality sales growth separated from the Venezuelan disaster.
The other issue in South America is that Brazil is (I think) the biggest South American market. Trying to sell diet products during the World Cup looks rather tricky. That effect should reverse this quarter. Net of Venezuela I expect good South American growth this quarter.
Venezuela will also cause considerable noise in the earnings because Herbalife has considerable currency stuck there - unable to be repatriated - and the Bolivar is collapsing. They will probably have to take a charge.
If Venezuelan sales continue to fall as per above this is not a major recurring issue.
--
Revenue
Volume growth is the really important issue. Volume growth will translate to revenue over time - however this quarter it will not be as good as usual. The US dollar has been strong - and prices adjust with a trail.
As a result I think that revenue growth will be slightly weaker than volume growth. Dispassionately I think you should look through this. Volume (and the FTC) is what will determine value in the end.
Still over the years the volume growth has resulted in massive revenue growth. Here - so you can appreciate it in its glorious detail - is the quarterly revenue growth since 2003. There are VERY few companies this good.
March 2003
|
280
|
June 2003
|
288.9
|
September 2003
|
290.4
|
December 2003
|
300.1
|
March 2004
|
324.1
|
June 2004
|
324.2
|
September 2004
|
319.8
|
December 2004
|
341.6
|
March 2005
|
372.1
|
June 2005
|
384.7
|
September 2005
|
401
|
December 2005
|
409
|
March 2006
|
455.8
|
June 2006
|
466
|
September 2006
|
476.4
|
December 2006
|
487.4
|
March 2007
|
508.1
|
June 2007
|
530.1
|
September 2007
|
529.5
|
December 2007
|
578.1
|
March 2008
|
604.4
|
June 2008
|
639.7
|
September 2008
|
602.2
|
December 2008
|
512.9
|
March 2009
|
521.7
|
June 2009
|
571.8
|
September 2009
|
600.2
|
December 2009
|
630.9
|
March 2010
|
618.6
|
June 2010
|
688.8
|
September 2010
|
688.4
|
December 2010
|
738.4
|
March 2011
|
795.1
|
June 2011
|
879.7
|
September 2011
|
895.2
|
December 2011
|
884.6
|
March 2012
|
964.2
|
June 2012
|
1,031.90
|
September 2012
|
1,016.90
|
December 2012
|
1,059.30
|
March 2013
|
1,123.60
|
June 2013
|
1,219.20
|
September 2013
|
1,213.50
|
December 2013
|
1,268.90
|
March 2014
|
1,262.60
|
June 2014
|
1,306.20
|
I expect yet another record quarter. Herbalife is a growth stock of the highest quality and after the FTC matters settle should be repriced as such.
----
Other one-off charges
Herbalife's results are going to be full of one-off charges. The lawyer bills for (and maybe the settlement of) the class action will be expensed in this quarter.
Considerable legal bills associated with the FTC inquiry will also be there - and those will also go away.
Venezuela might be a moderately big number - but as long as sales there are sharply declining I suspect you should ignore that too.
Herbalife will post "adjusted" earnings adding back these charges. As these issues are temporary this is one company where I think the non-GAAP number is the one you should keep your eye on. [You can choose how to caveat the Venezuela numbers...]
Share count
Herbalife is - on the accounts - a fantastic company - it has a WAY higher than market growth rate, and buys back stock extremely aggressively. It has done so before Bill Ackman came along and it accelerated the buy back after Bill Ackman.
Given the huge growth rate and how cheap the stock is if (when) the FTC issue goes away every onf these buy-backs is massively value-adding. The share count has since Mr Ackman turned up dropped from about 106 million to the mid 80s. The share count is something bulls will be watching sharply.
Summary
The range of outcomes are as large for this company as any I have ever seen. A bad outcome at the FTC would render the stock near worthless.
A re-acceleration of growth and FTC clearance would render fair value greater than $200.
I have spent a lot of time looking in detail at this company and contrary to my prior expectations I have found the company to be consistently ethical - even to the detriment of short-term profits. I hope after examining the evidence that the FTC comes to the same conclusion and fines for (real) past indiscretions are minor. Venezuela - which shorts have turned into some monstrosity central to their thesis - is a good example. It is (a) minor and (b) a place where the company has been losing money by behaving ethically.
The $200 a share fair value after a good FTC outcome and re-acceleration of growth is before any short-squeeze. Short squeezes usually take stocks to values way higher than intrinsic value. I have placed my bets - many have placed their bets the opposite way.
It will be fun to watch.
John
