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Company: NutriSystem (NTRI)
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  Stock price lower than estimates

Small Cap Watch List (Track at Marketocracy) member NutriSystem, Inc. (NTRI) announced results for the second quarter ended June 30, 2007:

  • An increase in revenue of 61% to $213,556,000 in the second quarter of 2007 compared to $132,631,000 in revenue in the second quarter of 2006;
  • Growth in operating income to $52,729,000 (24.7% of revenues) in the second quarter of 2007 compared to $31,030,000 (23.4% of revenues) in the second quarter of 2006; and
  • An increase in diluted earnings per share of 81% to $0.96 in the second quarter of 2007 compared to $0.53 per diluted share in the second quarter of 2006.

The consensus among Wall Street’s finest was that the company would earn $0.85 on $194 million in sales, so at first blush it is hard to see why the stock plummeted in after hours trading. Scrolling a little further down the press release we see the likely explanation:

For the third quarter of 2007, the Company estimates that revenue will be between $200 and $208 million, and expects diluted earnings per share to be between $0.77 and $0.82.

The consensus for next quarter was $0.89 on $209 million in sales. So basically the company is saying it will give back $0.07 - $0.12 of the $0.14 upside they had in the second quarter.

The Company is raising its full year 2007 guidance and now expects revenue to be between $810 million and $820 million and 2007 diluted earnings per share to be between $3.46 and $3.52 per share.

The previous estimates were $3.43 on $800 million. So the $20 million upside to Q2 revenue is offset by approximately $5 million in downside to the rest of the year, while $0.05 - $0.11 of the $0.14 earnings per share upside is expected to be given back during the remainder of the year. Hardly justification for a 20% drop in value in two days.

  • The company has been in operation for the past 35 years with a strong brand presence. I foresee this company continuing operations for the next 10 years and beyond. Cash flow available to the firm was estimated for each of these 10 years going forward, starting in 2007.
  • Based on the 3rd quarter conference call, the company estimates 4th quarter 2007 revenues to come in flat with the same period a year ago. This estimates to about $701million in revenues for 2007. Although this amounts to 107% continuous annual growth rate (CAGR) since 2004 when the company jump started its business, the following growth rates were used for the upcoming years:

1. 2007 to 2011 at 20% CAGR 2. 2012 to 2016 at 5% CAGR (due to new entrants and existing competition) 3. 2017 and beyond at 5% CAGR

  • The company has done an excellent job at reducing their cost of good sold (COGS) as well as their selling, general, and administrative expenses (SG&A) over the past 5 years. I believe the company will be able to hold these costs relative to their revenues constant.
  • The company has no debt, and has been using their operating cash flow to reinvest back into the business. I have estimated the cost of equity to be at 16.29% (what the shareholders required rate of return is for investing in their business). This rate is used to determine the present value of all the cash generated in the future.

If you ask me, the investors in Nutri System are like binge dieters, and the weight of the stock (in their portfolios) goes up and down like a yo-yo. I look at the chart and see this isn’t the first big and sudden drop. I look at the fundamentals and think it could probably be as temporary as the others. [1]

The estimated value of the business today is $1.16 billion when you discount all future cash flows back to today. This roughly equates to $32.40 a share and represents my best case scenario.

Let us consider the worst case scenario if new entrants enter the market and the current subprime mess results in a full scale recession. Those $300/month meal plans maybe the first things to go for the every day NutriSystem customer. Let’s assume the company’s revenues shrink 5% for 2008 and 2009, but then turns back to a moderate 5% growth rate year over year from 2010 going forward. This equates to roughly $19.79 a share. At the time of this writing the market has almost priced in this worst case scenario at $23.45/share. Given the company’s focus and investment on building a social support business for weight loss and wellness, I think they are poised for good growth going forward.

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