Weight Watchers International, Inc. (NYSE:WTW) is among the many stocks that have experienced sharp price increases over the last six months. However, the stock recently pulled back from its yearly high and now trades at a level that may be attractive for long-term investors.
Market leader
Weight Watchers International, Inc. (NYSE:WTW) is the unquestionable leader in the weight-loss industry. The company’s strong member network and regular group meetings has proved to be the key to successfully losing weight.
It is important to stress that it is the member meetings, not the nutrition plan, that makes Weight Watchers International, Inc. (NYSE:WTW)’ program effective. Other companies, like NutriSystem Inc. (NASDAQ:NTRI) and Life Time Fitness, Inc. (NYSE:LTM) compete based on a specific diet or exercise regimen. In fact, Nutrisystem attempts to control every meal consumed by its members to ensure that clients are eating in a manner that allows them to lose weight.
However, while NutriSystem Inc. (NASDAQ:NTRI)’s meal plan creates a captive customer during a member’s time on the diet, it does not benefit from the key support group aspect that might otherwise motivate its members to stay on the diet. Having captive customers is an advantage only as long as the customers stay motivated to keep buying in the market. But without that motivation, many members drop out before achieving their weight loss goal. As a result, NutriSystem is unable to achieve anything close to the customer retention that Weight Watchers International, Inc. (NYSE:WTW) enjoys.
While NutriSystem Inc. (NASDAQ:NTRI) pushes a strict diet, Life Time Fitness, Inc. (NYSE:LTM) attempts to keep members on a healthy exercise regimen. The company has one of the largest fitness club networks in the United States, which affords it economies of scale. Many members think that if they exercise regularly, they do not have to adhere to a strict diet in order to lose weight. This convenient lie is often an impetus to sign up for gym membership, but the lack of a strong support group to provide motivation for the long-haul leads to high customer churn.
Motivation is the most important part
There are countless diet and exercise plans that can help people lose weight — if only people would follow them. The Weight Watchers International, Inc. (NYSE:WTW) diet adds the least value to the program; the real value is in the support groups that motivate members to stick with the diet — and keep paying dues — much longer than any other major program.
Over the decades, the amazing results achieved by Weight Watchers International, Inc. (NYSE:WTW) members has earned the company a stellar reputation. But more importantly, the size and scope of its member network makes its success difficult to replicate. Its strong brand and the lack of direct substitutes enables the company to earn high margins and predictable earnings.
Weight Watchers International, Inc. (NYSE:WTW) earns a consistently higher pre-tax margin than its peers. Not only is Weight Watchers’ margin higher than NutriSystem Inc. (NASDAQ:NTRI) — its primary diet competitor — but it is also more stable. This stability is financial evidence of the Weight Watchers brand, which attracts a steady flow of customers throughout the economic cycle.
Although Life Time Fitness, Inc. (NYSE:LTM) also has a stable pre-tax margin due to its ability to attract a consistent flow of customers each year, its return on assets is substantially lower than Weight Watchers’. The discrepancy is due to the nature of each company’s assets; while Life Time Fitness has to purchase large floorspace and expensive equipment, Weight Watchers operates with hardly any tangible assets. As a result, Weight Watchers International, Inc. (NYSE:WTW) can return more capital to shareholders than Life Time Fitness, which must invest a substantial portion of cash flow in order to expand.
Cheap stock
Weight Watchers trades at just 10 times trailing earnings and free cash flow. However, the company has about $2.3 billion in net debt — more than four times operating income. Weight Watchers International, Inc. (NYSE:WTW) history of stable earnings allows it to carry a heavier debt burden than most other companies would consider safe, but the company will need to pay down about one year’s operating income worth of debt in order to reach a more sustainable level. As a result, shareholders lose out on about one year’s worth of earnings.
A simple way to think about the opportunity is this: investors can buy a perpetual bond with a 10% coupon at par, but must forgo the first year’s worth of interest payments. In a market driven upward by quantitative easing, this is a pretty good deal.
Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Recent Dip Provides Buying Opportunity for This Stock originally appeared on Fool.com.
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