December 01, 2009
Direct Selling: A Model for the Times Industry Overview
by Douglas M. Lane
Direct selling companies have been gaining momentum this year driven by their ability to recruit in times of rising unemployment, coupled with their broad global diversity, providing access to the consumer-growth markets of the world. Underlying momentum should continue to build, with reported results poised to benefit from recent currency headwinds becoming tailwinds beginning in the fourth quarter. We have seen steady and marked acceleration in results for our direct sellers (Tupperware Brands Corporation (TUP—NYSE), Herbalife Ltd (HLF—NYSE), USANA Health Sciences Inc. (USNA—NASDAQ), Nu Skin Enterprises Inc. (NUS—NYSE) and Avon Products Inc. (AVP—NYSE) that are on calendar quarters vis-à-vis expectations over the past couple of quarters after what we believe was the fundamental bottom in the fourth quarter of 2008.
Direct sellers, on average, beat consensus EPS by more than 21.5 percent on an equal-weighted basis in the second quarter of 2009, up from more than 8.9 percent in the first quarter, after missing by nearly 1 percent in the fourth quarter of 2008. Consequently, consensus estimates for the group were increased in the upper single digits following second-quarter results, a sequential improvement from being largely maintained in the first quarter and being reduced by approximately -10 percent following the fourth-quarter 2008 earnings cycle. We expect this momentum to be largely carried through into third-quarter earnings.
On top of our direct sellers beating expectations, reported results are due to benefit from a sharp reversal in the impact of foreign currencies. The third quarter should be the last of the quarters with onerous currency headwinds, turning sharply to quite substantial tailwinds beginning in the fourth quarter.
Particular beneficiaries are those companies with exposure to Brazil (AVP, HLF, TUP) and Australia (USNA, TUP), with those exposed to the euro (TUP, HLF, AVP, NUS), pound (AVP), Canadian dollar (USNA) and zloty (AVP) also benefiting, although companies with exposure to Mexico (TUP, HLF, AVP) will have less of a currency benefit. The yen, which primarily benefits NUS, continues its pattern of appreciating against the dollar.
Additionally, the biggest gainers vs. the dollar have been Australia, Brazil, Japan, Russia, South Africa and Korea, which should particularly benefit NUS, HLF, AVP and TUP versus previous expectations, partially offset by dollar appreciation vs. the pound (AVP), with little movement vs. the peso (TUP, HLF and AVP).
Lastly, we note that despite the recent move up for our direct sellers as a group, they are simply approaching the five-year average prospective P/E ratios during the pre-global recession period of 2003–2007. As Exhibit 1 illustrates, current prospective P/E ratios on 2010E remain below pre-recession averages for each of our names, with the prospective 2010E P/E ratios at our price targets still below five-year, pre-recession averages except for TUP, which we believe has fundamentally improved following its beauty acquisitions in late 2005.
We are raising our 2009E from $1.72 to $1.75 with the third quarter going from 39 to 42 cents. We are also raising our 2010E from $2.10 to $2.20, with a further upside possible. We note that management does not provide an EPS outlook. Consensus is $1.67 and $2.13 for 2009E and 2010E, respectively.
AVP remains our top pick among the direct sellers. All three metrics we track—active reps, organic sales and unit volume—have accelerated for the past two quarters, and all are firmly in positive territory year over year. We believe, most important, active reps were up double digits in the second quarter. This salesforce strength, coupled with most foreign currencies becoming a tailwind in 2010E after being a substantial headwind throughout most of 2009E, gives us confidence in our +10 percent forecast for 2010E revenues for AVP, and in fact bodes well for potential upside to that number.
Further, as currencies gravitate toward pre-meltdown levels, the substantial margin pressures felt recently should also reverse. This, coupled with the company now being in a mode of dropping the cost savings to the bottom line versus previously reinvesting it in its brand and sales reps gives us confidence that 2010E operating margins can match the 13.1 percent rate of 2008, if in fact not do better.
HLF is best value pick and has the highest cash return to shareholders, with yield based on the 2.3 percent yield and the large $300 million stock buyback. We have updated our models to account for our increased conviction that fundamentals will improve for HLF heading into 2010E, and for more favorable currency benefits. We are raising 2009E from $3.00 to $3.05, above management’s $2.97 to $3.03 range, with our 2009 4QE going from 82 to 87 cents; no change to our consensus number of 71 cents for the third quarter. Our 2010E is going from $3.35 to $3.50, which still only assumes low- to midsingle digit local currency sales growth and operating margins still 100bps below 2008 levels. Consensus is $3.02 and $3.39 for 2009E and 2010E, respectively.
With easier comparisons in Mexico and given momentum building in China behind the daily consumption model, we believe HLF’s underlying fundamentals, which had been among the weakest of our global direct sellers, will sustain the sequential improvement exhibited in the second quarter. Although we remain cautious in our outlook for Mexico and Western Europe, we believe strong momentum elsewhere in Latin America, the Latino market in the United States and the Asia-Pacific region, particularly China, will drive the acceleration in underlying trends. We note that while we still have Europe and Mexico flat to down next year, we believe the declines will mitigate from 2009E levels, allowing the strong growth elsewhere to drive accelerating top line growth. HLF is also poised to benefit from the currency tailwinds expected for our global names next year.
Nu Skin Enterprises
We believe the 25th anniversary global convention held in Los Angeles in October could prove to be a meaningful spark that energizes the salesforce, leading to acceleration in growth rates heading into 2010E. We are raising 2009E from $1.28 to $1.30, above management’s range of $1.23 to $1.28, and 2010E from $1.45 to $1.50. Consensus is $1.28 and $1.43 for 2009E and 2010E, respectively.
With stringent cost-cutting measures coupled with its largest market being yen-based, which has been strong versus the dollar, NUS has quietly put together a string of reported EPS growth spanning 10 of the past 11 quarters, despite having 85 percent of its business outside the United States during the recent global crisis. In fact, the company has posted midsingle local currency sales growth in each of the last five quarters.
The three things that had held us back previously from recommending the stock were a) double-digit organic sales declines in Japan, its largest market accounting for about a third of its total sales, b) lack of growth in China and c) flattish average executive distributor trends. We believe all three are poised to head in the right direction. Record revenue for the third quarter was pre-announced earlier this week. September specifically was the biggest revenue month in the company’s history.
NUS’ 25th-anniversary global convention was well attended, with the company selling out the Nokia Center in Los Angeles, as well as two nearby facilities to accommodate the strong distributor demand. Enthusiasm was strong, especially as it pertained to the highly anticipated launch of a new daily regimen of ageLOC-enabled skincare products.
Usually at its global conventions the company would generate about $5 million in product sales, split between new and existing products. However, at this convention, the company put the entire focus on the new ageLOC line and was not selling any of the other skincare or nutritional products in its portfolio. The company underestimated the demand for on-site purchases, nearly selling out of the products within just a few hours, and had to get additional products for the remainder of the convention. We believe product sales at the convention could approach double a normal convention, seemingly a clear affirmation of distributor enthusiasm for the new products.
We are raising our 2009E estimate for TUP from $2.70 to $2.80, above management’s range of $2.59 to $2.64, which was raised from a previous $2.16 to $2.26. Our third-quarter estimate is going from 41 to 44 cents, and the fourth-quarter estimate is going from 98 cents to $1.05. For 2010E, we are going from $3.15 to $3.30 to reflect better underlying momentum as well as the expected currency tailwind. Consensus is $2.69 and $3.07 for 2009E and 2010E, respectively.
We believe the underlying businesses remain largely on track, with the flagship Tupperware durables business, which accounts for approximately three-quarters of total profits, showing excellent momentum, as evidenced by the strong, high single-digit growth in its average active salesforce metric. We remain somewhat cautious on the beauty businesses, with BeautiControl in the United States and Fuller in Mexico continuing to struggle, although if they are able to improve, that could be additional upside to our estimates.
With local currency sales growth expected to be +5.5 to +7.5 percent in the 2009 4QE, we believe TUP has every shot of hitting its longer-term +6 to +8 percent targets in 2010E. Therefore, coupled with the expected currency tailwind, our new 2010E sales forecast is for +9 percent, above our previous expectation for +6 percent growth. In addition, with pretax margins looking to be north of 10 percent this year, we also believe management has every shot of exceeding its longer term 9.5 to 10.5 percent pretax margin targets next year.
We believe TUP has become a substantially better performer following its late 2005 acquisition of Sara Lee’s (SLE; $10.97; NC) global direct selling beauty businesses, and that the multiple ought to be sustainable in the mid- to upper teens, closer to where its direct selling peers have historically traded.
USANA Health Sciences
We expect acceleration in sales and EPS growth as the company’s recent changes to its compensation plan begin to gain traction and as foreign currencies go from being a headwind to a tailwind. We are maintaining our consensus $2.15 estimate for 2009E, which is also above management’s range of $1.95–$2.00, and are raising our 2010E from $2.45 to $2.50 to reflect increased confidence that the recent acceleration in active associates is sustainable and will translate into an acceleration of revenues next year. Consensus is $2.03 and $2.28 for 2009E and 2010E, respectively.
For EPS, after having reported EPS decline for the past six quarters, we look for growth of +9 percent in the 2009 2H and +16 percent in 2010FYE. We look for sales growth to break out beginning this quarter with 4 percent growth, the 4Q with 6 to 7 percent growth and our new 2010E sales forecast in the upper single digits, still lagging the recent double-digit increases in average active associates, so we believe that estimate could have room to move up depending on new associate productivity.
Douglas M. Lane, CFA, is Managing Director, Equity Research at Jefferies & Company, Inc. This article was excerpted with permission from a report published by Jeffries & Company on Oct. 9, 2009. For more information, visit www.jeffries.com.