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November 01, 2011

Canaccord Summary

December 2011 – Are Europe and Currencies the Next Headwinds?

by Scott Van Winkle

Canaccord GenuitySeptember was just another version of August for direct selling stocks ... more volatility. The accompanying chart of stock performance doesn’t really tell the whole story. The average direct selling stock fell just 2.4% during September, which appears far better than the 6.4% decline for the Dow Jones Industrial Average or the 7.7% decline in the S&P 500.

However, when we consider that the best performing stocks were generally the smallest of the market capitalizations and the largest capitalization companies underperformed, the reality is that September was much worse than a simple average tells us. The direct selling group lost over $2 billion of market capitalization during September. The common thread among the negative performance for the larger direct sellers, beyond the challenging equity markets of course, was that global businesses encounter global currency challenges when the U.S. dollar is rising. Many investors believe that the U.S. dollar will continue to rise given the financial challenges in Europe and concerns around the euro. For example, the euro is down about 10%, as is the Mexican peso, and many Asian currencies are off several percent (except the remarkably strong Japanese yen).

A strong U.S. dollar dilutes the contribution of most foreign markets and thus investors anticipate that there could be a measurable earnings challenge for the large multi-national direct sellers based in the U.S. This of course is the opposite for Oriflame, but its heavy exposure to Europe is equally perceived as a challenge, not due to currency but austerity measures and consumer spending concerns. While foreign currencies have begun to strengthen at the time of this writing in mid-October, currency will undoubtedly be a hot topic for investors until the global financial markets settle.

News flow, at least market-moving events, in the direct selling sector was limited during September and focus will now turn to third quarter earnings reports. There doesn’t appear to be any cause for concern that trends measurably weakened across the channel during Q3. However, the currency issue will be a topic discussed and will again have an impact on investor expectations for future earnings. It is likely that negative currency swings could temper the expectations of the companies themselves and most investors expect to hear of more cautionary earnings outlooks as a result.

While today’s major currency swings are modest in comparison to the late 2008 U.S. dollar surge, the challenging period of October 2008 to April 2009 remains top of mind for investors. Our take is that the late 2008 currency swings prepared executives for the impacts of currency volatility and we suspect that most companies are better positioned this time around with appropriate hedging activities. The good news for the stocks is that almost any news could be good news at this point given how robust investor fears are around recession across Europe, slipping into a double-dip recession in the U.S., and the impact of a strong U.S. dollar. Expectations are therefore low, thus providing ample opportunity for a positive turn to sentiment.

While September was no better than the challenging August we last discussed, the good news is that the direct selling group as a whole is still holding its own among the market turmoil. If not for the currency concerns, we suspect that the direct selling sector would be significantly outperforming the broader market at this point. What is now needed is a string of good third quarter reports for direct sellers, successful efforts to mitigate currency risk and positive outlooks being broadcasted. Or, a solution to the financial challenges in Europe could easily do the trick.

Scott Van Winkle

Scott Van Winkle is a Managing Director of Equity Research at Canaccord Genuity, the global capital markets division of Canaccord Financial. Canaccord Genuity offers institutional and corporate clients idea-driven investment banking, research, sales and trading services from 16 offices worldwide. Van Winkle, based in Boston, has followed the direct selling channel since 1997.

Disclaimer: Canaccord Genuity has published research recommendations on Herbalife, Medifast, Nu Skin Enterprises and USANA Health Sciences and makes a market in shares of Herbalife, Medifast, Nu Skin Enterprises and USANA Health Sciences. Canaccord Genuity has provided non-investment banking securities-related services to Herbalife, Nu Skin Enterprises and Relìv International in the last 12 months. Past performance is not indicative of future results and these comments are not a recommendation to buy or sell the specific securities discussed.