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NUS | NEW BEST IDEA SHORT | THE ROAD TO RUIN GOES THRU MALAWI

We are adding Nu Skin (NUS) to the Hedgeye Consumer Staples Best Ideas list as a SHORT.

 

Nu Skin Enterprises (NUS) is one of the largest multi-level marketing firms in the world. The company sells three core products, skin care & nutritional supplements as well as a food supplement that fights worldwide hunger.  Like many companies in the direct selling industry, Nu Skin has come under significant scrutiny for many elements of their business practices. 

 

Following the 3Q15 earnings call, there appears to be a new controversy brewing that could have significant implications for the company.  The new controversy centers around its business and sales practices surrounding the company’s food supplement charity, meant to fight worldwide hunger, VitaMeal.  To be clear, this call has nothing to do with the plight of starving children around the world, it’s about the process, ethics and execution of getting the needy children the food.     

 

Working against shareholders in the current environment is the company’s precarious financial position.  NUS ended 3Q15 with the balance sheet and cash flow statement showing significant signs of stress.  Excessive growth, scandals and a challenging business model, have the balance sheet showing significant inventory issues, and the company does not generate meaningful free cash flow.  It’s clear; another scandal/investigation could pose a very serious threat to the financial stability of the company.

 

We will be hosting a call on Wednesday, November 11, 2015 at 11:00am ET to discuss our thesis on the company.

 

Our call will cover the following topics:

  1. What is VitaMeal?
  2. How material is VitaMeal to the company?
  3. How NUS and its global charity partners work together. 
  4. Can VitaMeal and the selling process bring about increased regulatory risks?
  5. Is VitaMeal actually a tax deductible charitable contribution?  
  6. The NUS financial problems.
  7. What a new scandal means for future profitability. 

 

Details for the call will be provided next week.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

   


Cartoon of the Day: Rate Shock Ahead?

Cartoon of the Day: Rate Shock Ahead? - rate hike cartoon 11.05.2015

 

In today's Early Look, Hedgeye CEO Keith McCullough writes:

 

"Now, going on 78 months into a rate-of-change-slowing US economic expansion, Janet Yellen has the “live possibility” of making an even bigger mistake than not hiking into an acceleration – she could tighten into a slowdown!"


BDBD | ADDING IT TO THE LONG BENCH

We are adding Boulder Brands (BDBD) to our Hedgeye Consumer Staples LONG bench.

 

HEDGEYE OPINION

BDBD is a company we have been following on the sidelines for the past six months. One quarter does not make a trend, but with this most recent earnings call and the upside from a potential acquisition we feel confident in dipping our toes into this one.

 

3Q15 RESULTS

Business trends were mixed in the quarter, but it appears they have bottomed out and stabilized. Management has embraced SKU rationalization, and the efficiencies gained from that will play out over the next 12-18 months. Reported net sales decreased 0.7% in 3Q15 to $132.9mm, although topping consensus estimates of $130.2mm.

 

Gross margin declined 4.8% in 3Q15 to $48mm, or 36.1% of net sales versus 37.7% in 3Q14, additionally, actuals fell short of consensus estimates of 36.72%. This poor performance was driven by a mix shift to the lower margin Natural segment (Udi’s, Glutino, Davies and EVOL) from the higher margin Balance segment (Smart Balance, Earth Balance and Level Life).

 

BDBD reported non-GAAP diluted EPS of $0.08, beating consensus estimates of $0.06 by $0.02.

 

Management reiterated 2015 guidance of $0.20 to $0.25.

 

NOTABLE COMMENTARY FROM THE CALL

  • Identified SKUs to be rationalized and will begin the process in 2016
  • Will discontinue Level Life
  • Launched EVOL cups in Q3 in Target stores under three platforms, veggie, fajita and breakfast scrambles
  • Management is working diligently on improving the operations of the company by outsourcing certain manufacturing to co-packers and increasing efficiencies in their four North American plants
  • Seeing marked sequential improvement in core categories Udi’s breads and spreads
  • Although net sales declined 0.7% in the quarter, consumption was actually up 0.5%
  • Udi’s net sales increased 7.7%, consumption increased 8.5%
  • EVOL net sales increased 24.8%, consumption increased 30.3%
  • Earth Balance net sales increased 3.6%, consumption increased 3.7%
  • Company experienced declines in Smart Balance and Glutino (down -5.7%)
  • The company is experiencing higher yield loss in bread after implementing processes to reduce consumer complaints about air pockets and holes in the bread
  • Smart Balance is seeing velocity improvements, but offset by distribution losses
  • BDBD gluten free products were up 6% in the quarter, being outpaced by the segment, management determined to get back the share lost
  • Gluten free category growth has moderated but still growing much faster than the broader food segment
  • Foodservice category doing very well and accretive to margins, one current big partner is Pizza Hut

 

STRATEGIC OPTIONS PROCESS

On August 6, 2015, BDBD announced that its Board “has authorized a process to explore a range of strategic and financial alternatives to enhance shareholder value.” At that time the company engaged William Blair as its financial advisor to assist with the process. They have been mum about the project to date, but given the time that has elapsed they must be nearing a conclusion sometime in the next quarter. There are a range of possibilities that can come with this, but we believe all scenarios include a sale of all or a portion of the company.

 

As we have gone back and forth, we came up with a total breakup (or sale) of the company as a most likely scenario. In which a strategic buyer (CAG, GIS, PF) would purchase the entire company outright or if there is a sale of the parts, purchase just the highly valued assets, EVOL and Udi’s. Leaving Earth Balance, Glutino and Smart Balance to financial buyers. We have our bets on a total outright sale of the business.

 

Interim CEO James Leighton has done a good job of stripping out costs, and streamlining the operations, all while improving the trajectory of the business. Can they succeed on their own? Maybe.

 

VALUATION POTENTIAL

It’s not hard to see the upside in this company, relative to its peers it is undervalued, currently trading at just 11.1x EV / NTM EBITDA.

BDBD | ADDING IT TO THE LONG BENCH - CHART 1 replace

 

It has been a volatile year for BDBD shares. Currently trading 26% below their 52 week high of $11.68 on 2/24/15, and 34% above from their 52 week low of $6.42 on 7/8/15.

BDBD | ADDING IT TO THE LONG BENCH - CHART 2 Replace

 

WALL STREET CONSENSUS

Confidence in this company’s ability to succeed has continued to wane over the last year. In September of 2014, 83% of analyst rated it as a Buy, now just 33% rate it as a Buy. Where is the love? We firmly believe in this company’s ability to create shareholder value organically, as well as through their strategic review process.

BDBD | ADDING IT TO THE LONG BENCH - CHART 3

 

BDBD | ADDING IT TO THE LONG BENCH - CHART 4

 

We will update our thinking on the name over the coming weeks and bring forth additional insights we have.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


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This One Picture Captures Everything Wrong With Wall Street | $VRX

Click image to enlarge.

This One Picture Captures Everything Wrong With Wall Street | $VRX - VRX consensus

Source: Bloomberg

 

Valeant Pharmaceuticals (VRX) is trading around $80, down almost 70% from its August high. Here's the current breakdown of the 25 Wall Street analysts covering the stock:

  • 65% currently rate VRX a Buy
  • The average analyst price target is $199
  • That implies approximately 150% upside

No words.

 

Reality check. Our Healthcare analysts just released a research note to institutional subscribers outlining why we think shares are worth $20. To be clear, we’ve long been skeptical.

 

CLICK HERE to read their original Short thesis on VRX from 7/22/14.


The #Valeant Implosion Continues (We Warned You) | $VRX

Takeaway: We were early on this one but feel vindicated.

The #Valeant Implosion Continues (We Warned You) | $VRX - Ackman cartoon 10.26.2015

 

Hedgeye has long been skeptical about Valeant Pharmaceuticals (VRX). Last summer, before the barrage of bad news broke for the company, we issued a comprehensive Black Book laying out the short case. In it, our Healthcare analyst Tom Tobin highlighted Valeant's unsustainable business model.

 

Incidentally, Tobin's team sent subscribers an update just now explaining why they believe the stock may fall another 75% from here.

 

CLICK HERE to access their original institutional research report.

 

Fast forward to today... In the most recent deluge of bad news for Valeant and hedge fund manager/shareholder Bill Ackman, Congress is now getting involved. Not a good sign. Apparently, a bipartisan special committee has been put together to “better understand [Valeant’s] drug pricing” (sic “price gouging”). In addition, it was disclosed earlier today that Bill Ackman sent a letter to Valeant CEO warning that his reputation is at "grave risk" and Valeant is at risk of becoming "toxic."

 

Talk about being a day late and a dollar short. Shares of VRX are down 14.6% today on the news.

 

But that's not the worst of it for Ackman. Since March, when his hedge fund Pershing Square Capital first disclosed it's 5.7% stake in Valeant, the stock has fallen 54%.

 

The #Valeant Implosion Continues (We Warned You) | $VRX - 11 5 2015 valeant chart

 

Our Healthcare team warned subscribers of the many “underappreciated risks” we saw in the stock. From the report:

 

“Valeant is operating what we believe is an unsustainable business model of serial acquisitions and underinvestment, fueled by debt, that will continue to lead to deterioration in the ongoing business.”

 

The #Valeant Implosion Continues (We Warned You) | $VRX - vrx tobin 1

 

In October, the stock got hammered after Citron Research released its research note comparing the drug maker to Enron. Here's what Hedgeye Healthcare analyst Andrew Freedman had to say shortly afterwards:

 

“It was only a matter of time before Valeant’s debt-fueled acquisition binge would come to an end.  If you look at what the underlying assets are worth and subtract the debt, you get an equity value that is closer to $20.

 

 

We spent the better part of six months researching Valeant, and there were no shortage of red flags. To name a few: Alternative pharmacy channels, inventory accounting on the Aesthetics assets, FDA investigations, price increases and questionable organic growth rates…

 

Trying to reconstruct the financials of Valeant’s business was near impossible given the acquisitions/divestitures and number of reclassifications… a huge part of the long thesis was a “Trust Me” story with management and that didn’t cut it with us.”

 

The #Valeant Implosion Continues (We Warned You) | $VRX - vrx tobin 2

 

And then... Ackman came to the rescue! On that fateful October day, with VRX shares down as much as 20%, he rushed onto CNBC proclaiming to the world that he bought another 2 million shares. The stock bounced 10% the following hour.

 

But the story obviously doesn't end there.

 

Much of the recent VRX criticism has been focused on the drug maker's questionable relationship with the specialty pharmacy Philidor, which Valeant may have used to artificially inflate prices. Valeant has denied these allegations, but announced last week that it would sever its ties with Philidor, noting that Philidor accounted for only about 7% of its revenues.

 

Huh?

 

Here's Hedgeye CEO Keith McCullough today on the VRX “shenanigans.”

 

“There was a day when a $2.5B Hedge fund [position] blowing up was news. Ackman had a $2.5B position crash - and CNBC doesn't report it. This Ackman crash is going to ripple through the hedge fund community. They did everything, literally, to try to prop up $VRX - sucked little guys into buying it ... and Kaboom!”

 

The #Valeant Implosion Continues (We Warned You) | $VRX - vrx mccullough 1


VRX | BEAR CASE $20 | REDEMPTION CYCLE

REDEMPTION CYCLE

Institutional Consultants are the capital "gatekeepers" of the asset management industry, and are in the process of evaluating their client's exposure to Valeant (VRX).  As of 2Q15, 24 funds held a position in VRX that was > 4% of the portfolio, representing 26% shares outstanding. At this stage, VRX is not investable, with any long exposure bringing into question the research process and risk controls of the manager.  Consultants will likely be forced to recommend clients to redeem completely from those funds where VRX resulted in a significant capital impairment. Start to finish, this process can take 3-5 months depending on lock-up periods, finding a replacement manager and getting board approval.  We do not believe the precipitous decline in Valeant's stock reflects forced selling due to redemption requests that will likely come in full force later in 4Q15 and into 1Q16. 

 

bear case $20 

We don't think Valeant is worth anything more than the value of the assets management paid for them, less the accumulated debt during the 5-year, acquisition spree.  Due to the lack of organic growth and internal investment, the assets on Valeant's balance sheet reflect a reasonable fair value based on market prices paid.  Of course, value is in the eye of the beholder, and it can be argued that Valeant overpaid for certain assets as their now defunct model allowed them to extract "value" that others couldn't.  It has always seemed unreasonable to us how Valeant could purchase an asset for x and the market immediately value the equity in that asset at 3-5x or more.

 

The simple question we ask is if Valeant were to liquidate today, what would be left after meeting all liabilities?

 

The simple math is that Valeant has $48.5 bill in assets ($40 bill intangible) and total liabilities of $41.9 bill ($31 bill in debt), leaving $6.6 bill in equity.  Even if you assume the assets are worth 50% more today from when they were acquired, you get to a stock price of only $90.  At the stock's peak of $265/share investors were paying 14x the equity value of the company, which we find unreasonable in the most optimistic of scenarios given the risks inherent in the business model and debt load.    

 

Please call or e-mail with any questions.

 

Thomas Tobin
Managing Director 

@HedgeyeHC   

 

Andrew Freedman

Analyst

@HedgeyeHIT  


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