NTRI: Resolving to Make Money on NutriSystem
The following is a reprint of my January 2, 2008 RealMoney column.
After Nutri-System (NTRI) missed its third-quarter earnings estimate in early October, I said it didn’t qualify as a sound investment opportunity, despite an apparently cheap valuation. However, I also said “after we gorge ourselves this holiday season, we are likely to make the same New Year’s resolutions we have often made in the past. And in each of the last three years, NutriSystem has enjoyed a strong rally from January through April.”
To decide whether there really may be a resolution rally, and to figure out how to play it if there is one, I decided to update my inputs. In the three months since that article was published, a few things happened:
- Analysts trimmed their 2007 earnings estimates from $3.49 to $2.98, and their 2008 estimates from $4.21 to 3.14.
- The Chief Financial Officer was replaced.
- The stock continued to decline, losing 14.6% compared to a 4.6% loss in the S&P 500.
- The company expanded its share buyback program and attracted some value investors.
- The company also announced a new meal plan that promotes a healthy heart in addition to weight loss.
The lowered estimates still show some modest earnings growth for the coming year, the momentum has fallen sharply. Its current Zacks rating of 4, for example, indicates that NutriSystem’s earnings revisions are among the worst 20% of all the companies tracked.
On the other hand, the Zacks rank was 5 (the worst) last week. So perhaps the loss of earnings momentum is bottoming out. The valuation also looks enticing, with a P/E ratio of just 8.5x. With trailing 12 month free cash flow of $95 million against an $845 million enterprise value, the 11.2% free cash flow yield offers a juicy return even if there is not growth.
In fact, given the current 5-year Treasury bond is yielding less than 3.5%, investors should be able to earn a 100% risk premium even if NutriSystem’s cash flow declines by 4% per year.
Cockroach Theory
Seldom is the first earnings miss also the last. It is also uncomfortable having a new CFO around. So before jumping in, I want to get a feel for the earnings quality and whether there have been any major changes. To do this, I calculated the accruals ratio, which measures how much of the earnings are due to accounting methods rather than cash flow. The closer to zero, the better the ratio.
Source: Zacks Research Wizard, compiled by William A. Trent
NutriSystem is in a trend toward higher earnings quality. The spike up in the latest quarter is somewhat concerning and bears watching, but is not particularly surprising given that there was an earnings miss.
How I Would Play A Resolution Rally
NutriSystem preannounced the last quarter’s earnings miss on October 3, which suggests that any preannouncement for the current quarter is could come in the next week. If we get to, say, Monday the 14th without an announcement I’d consider that an all clear signal for the trade.
The actual earnings report will probably come out in early February, along with the guidance for the first quarter that will be so important for the resolution trade. Given the uncertainty around this name, the resolution rally trader probably won’t want to hold for more than a few days past the February announcement unless there is some really good news – and even then it might be wise to clear out before the first quarter is reported in April.
Alternatively, I’d consider writing put options. As of the close on December 31, the February 16 puts were selling at about $2.00. With the stock at roughly $27, that gives a breakeven price of $23 if things go wrong, and an 8% gain in 6 weeks if things don’t go wrong.
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