Is Nutrisystem Healthy?

October 15, 2007 by Joe Ponzio

Is the Nutrisystem drop old news? In the stock market, you’d have to say yes because things happen so quickly. Still, we can learn lessons from virtually every event in the market. Once we get through the noise and look at the business, things begin to make a lot of sense.

Let’s look at Nutrisystem from a business perspective:

Two weeks ago, Nutrisystem saw 25% of its market cap (and share price) wiped out in a New York second. Price follows value-and sometimes it can happen just that fast.

The Value of Nutrisystem

The science of investing tells us that the value of Nutrisystem is equal to the cash that can be taken out of the business during its remaining life, discounted by an appropriate rate. In this case, let’s use 9% because we are going to apply the F Wall Street and John Burr Williams/Mohnish Pabrai methods and need to compare apples to apples.

Modest Growth

Let’s assume that Nutrisystem (NTRI) will experience modest growth for the next ten years-say, 13% for three years, then 11% for three, and then 10% for the next four-ultimately slowing to 5% for years 11-20. Let’s further assume that Nutrisystem can be sold for 10 times cash flow in ten years (required for the Pabrai/Williams model).

Why did I choose these rates as opposed to the super-extreme growth rates Nutrisystem has been experiencing? No matter what happens in the past, a business will only grow at roughly its rate of CROIC going forward. That is, for every dollar invested, if the company can generate $0.15, it can be expected to grow at roughly 15%. (More on that tomorrow.)

For the past five years, NTRI has had a median CROIC of just under 17%. If we err on the side of caution, we can value the business using roughly 75% of that.

Note: Don’t think I’m changing assumptions here. Do the same thing with JNJ, AEO, or other companies we’ve analyzed here and you’ll find that the valuation comes out about the same for those.

The Results

The Pabrai/Williams and F Wall Street methods both come up with the same valuation-roughly $38.40 a share. Two weeks ago, the company went from nearly $50 to nearly $30 in a day-from overpriced to slightly underpriced. Price follows value-and here’s another chart to prove it:

Will It Become A Buy Under $19.50?

If we demand on a 50% margin of safety, NTRI would theoretically be a buy under $19.50 a share. Still, practice is different than theory which is why we have to look beyond the raw data.

Try and apply a fundamental (Pabrai-ish) rule to investing and you’ll likely stay away from NTRI-stick with simple, slow-changing industries.

The Nutrisystem Moat

What is it going to take for a competitor to swim across Nutrisystem’s fragile (if existent) moat and break down the walls? People are finicky, compulsive dieters (at least in the US), and are always looking for a quick fix to weight loss. A new book or diet will chip away at their market share-at least a little bit. But the real danger comes from outside Nutrisystem’s industry-big pharma.

Nutrisystem must contend with its direct competitors, and must ward off big pharmaceutical companies developing cheap weight loss drugs. NTRI has to fight for every penny, and has a finite future. After all, who is going to pay a few hundred bucks a month for their food when you can pay a few hundred bucks a month for a pill-and eat McDonald’s every day!

The Nutrisystem Result

Can money be made in Nutrisystem? Probably. Still, its inconsistent past, its finite future, and its fair price to value are less than mouthwatering. And its price drop? No surprise there. A company can be overpriced for days, months, or years. Still, if value doesn’t catch up to the price, price is certainly more than happy to drop to meet value.

A Note From Joe Ponzio

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