Shareholders of the Vitamin Shoppe Inc (NYSE:VSI) are no doubt scratching there heads after the company’s terrible performance so far this year. Shares are down almost 25%, while broader markets have returned double digits on the back of economic strength and loose monetary policies. I stumbled upon this small-cap company while actually purchasing pre-workout from one of the local locations on the recommendation from a friend. Previously, I had never visited any locations nor researched the company whatsoever. I was perplexed by its terrible performance and I wanted to get to the bottom of this stock. In this article, I will share my findings and offer my take on the struggles which lay ahead.
The supplement industry is expected to grow a whopping 35% in the United States to a $15.5 billion dollar industry by 2017. The supplement industry is pretty broad, as it includes everything from multi-vitamins, weight control products, weight loss products, protein powders, fish oils, pre-workouts, mass gainers, energy bars, etc. I also took a look at competitor GNC Holdings Inc (NYSE:GNC), which is up a bulky 35% this year alone. What could be causing the huge difference in returns?
Lets first take a look at Vitamin Shoppe Inc (NYSE:VSI)
Last month, the company reported its first quarter results wherein the company announced comparable store sales grew 4.5%, while E-commerce revenues increased 16.1%. The company enjoyed its 7th consecutive quarter of double-digit growth, completed the acquisition of Super Supplements, earned $0.72 per share excluding transaction and integration costs from the Super Supplements acquisition, and opened 13 new stores in the U.S, alongside a South American expansion. There are obviously many positives on the surface, but when you dig deeper you see fears of a slowdown and threats of competitors on the horizon.
With the acquisition of Super Supplements, the company added 31 new locations to drive revenue growth. Unfortunately, these Super Supplement locations operate at lower margins than the company brand. When you have a perfectly competitive product in a monopolistically competitive market, economies of scale are everything. Over time, I expect Super Supplement margins to increase with the leverage of Vitamin Shoppe as its distribution channels improve. I would recommend the company completely scrap the Super Supplement identity and convert these locations into Vitamin Shoppe Inc (NYSE:VSI) stores to improve brand recognition and to drive traffic to its E-Commerce website.
When one analyst asked about unexpected weakness during the quarter, the company responded by attributing this weakness to broad economic weakness. This is a classic case of management spitting nonsense. Consumer confidence and consumer spending have been driving an economic recovery this year, as seen in the earnings of many consumer staples. This weakness needs to be attributed to weakening market share and a growing number of direct competitors. Vitamin Shoppe Inc (NYSE:VSI)’s e-commerce division has been growing strong, but this growth will not last forever. Online you can get almost every one of their products via hundreds of supplement websites. This problem is caused by the lack of differentiation between supplements. The supplements are so similar that manufacturers can not afford to limit the merchants of their products without risking losing market share of their own. As a result of this competition, margins will continue to weaken and market share will dwindle.
Now lets take a look at the company’s huge competitor GNC Holdings Inc (NYSE:GNC), which operates with a very similar business model.
GNC Holdings Inc (NYSE:GNC) is positioned far better for domestic and international expansions, as the company has greater economies of scale than Vitamin Shoppe. GNC Holdings Inc (NYSE:GNC)’s market share has allowed the company to build a better distribution channel and reap the rewards of much higher operating margins(seen above). GNC Holdings Inc (NYSE:GNC) has greatly improved both its wholesale and E-Commerce businesses to meet the demand for supplements. The company is growing its E-Commerce segment at rates above 20%, which far outpaces Vitamin Shoppe Inc (NYSE:VSI). Its very simple in my opinion–the greater the market share, the greater odds of maintaining growth in the years ahead.
Wrap-Up
With a small market share, Vitamin Shoppe Inc (NYSE:VSI) is struggling to maintain its current position and compete with online rivals. As a result, I believe Vitamin Shoppe needs to leverage its balance sheet for further acquisitions and mergers in the future. A merger between Vitamin Shoppe and GNC Holdings Inc (NYSE:GNC) would be interesting for both companies. Similar to the airline industry, companies in the supplement market would benefit greatly from greater economies of scale.
The article Supplement Struggles originally appeared on Fool.com and is written by Nathaniel Matherson.
Nathaniel Matherson has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Nathaniel is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
